What should minimum wage be in a capitalist economy?

In last nights State of the Union address President Obama made a case for raising the minimum wage from $7.25 per hour to $9 per hour.  The wailing and gnashing of teeth on the internet this morning was pathetic.  “It’s an invisible tax”, “We’ll have to lay people off or go out of business!”, “It will make inflation skyrocket!”, “If those people want to be paid more they should get an education!”.  I am here to say an unapologetic BULLSHIT to all of these, but more importantly to address the issue of what wages should be in a capitalist economy and how they should be set.  But first I want to address each of these claims individually.

IT’S AN INVISIBLE TAX – Actually it’s employers who fail to pay their employees a living wage that are imposing tax burdens on the rest of us.  If an employer (I’m looking at you Wal-Mart) fails to pay a living wage, they are in effect forcing their employees to take government assistance, and guess who pays for that?  You and I do whether we shop at Wal-Mart or not.  Wal-Mart costs us millions every year in government subsidies.  Raising the minimum wage means less need for government assistance and lower taxes for all of us. Paying less than a living wage is a form of corporate welfare and makes you a taker rather than a maker.

WE’LL HAVE TO LAY PEOPLE OFF OR GO OUT OF BUSINESS — Too bad.  If you cannot pay people a living wage then your business is a burden on America and not a benefit and you have failed.  You should go out of business or figure out a way to become more profitable.  That is capitalism.  Suck it up cupcake.  Honestly it is disturbing how many people seem to believe they have a right to be in business.  You do not.  If you can’t cut it then too bad.  If there is a need for the services you provide somebody will meet them, if not then you are not really providing anything useful at all.  Join the labor force  and see how you feel about receiving a living wage when you are on the other side.

IT WILL MAKE INFLATION SKYROCKET – Not necessarily but if it does, too bad.  This is actually a good thing.  As it stands now paying less than a living wage is an externality because it imposes some of the costs on persons not involved in the transaction.  I choose not to shop at Wal-Mart but I still have to pay the costs of them paying so little.  This results in inefficiency in a capitalist economy.  If increasing the minimum wage causes prices to increase a bit that’s OK because it means that the parties involved in the transaction are the ones paying the costs rather than imposing them on me and my tax burden will be decreased.  That’s a good thing.  But there are many reasons that increasing wages might not result in higher prices, ar at least reduce the amount of inflation that you might expect.

Increasing the minimum wages will result in an influx of a minimum of 13 billion dollars into the US economy to those on the lowest rung of the economic ladder. As a result we can expect that every penny of it will be spent and the multiplier effect in that scenario is huge. More money being put into the economy means that producers make more money in the end because they will sell more goods.  Increased sales volume also means you can make a little less per item and still be profitable

Paying people a living wage means that your employees will not always be looking for a better deal, out of necessity. They may choose to stay and work for you and they will work harder for you in order to keep their jobs. They will not be as bitter and be less inclined to sabotage or steal from your business, all of these things will result in lower total costs for your business.  For instance, CostCo pays its employees double what Wal-Mart does but makes more money per employee and has lower labor costs per employee because of it.  More importantly they achieve this without imposing costs on you and I through externalities.  The following chart must be taken with a grain of salt because Wal-Mart and CostCo clearly have different business models.  It would be good to see a direct comparison with Sam’s Club only but nevertheless, it is clear that paying higher wages does not necessarily mean higher cost of labor.

wal_martFinally, the percent of the cost of goods and services that is attributed to wages is often a small part of the price we pay.  Consider a typical manufacturing company, it has to pay for raw materials, factories, energy, transportation of goods, plus manufacturers, wholesalers, and retailers all take a bit of profit as well.  Assume that the cost of labor was 20% of the total price you pay (it might be more, it might be far less) and everybody in the US decided to double everybody’s wages all at once.  Even if all of the increase in wages were passed on to the consumer it would only increase the price we pay by 20%.  Would you pay 20% more for goods if it meant your salary were doubled?  You better believe I would take that deal in a heartbeat!!!!   Of course for the reasons stated above doubling wages might not increase labor costs at all, but the effect on the economy and the number of jobs created would be staggering.

IF THOSE PEOPLE WANT TO BE PAID MORE THEY SHOULD GET AN EDUCATION – This is great advice on an individual level.  If I knew somebody personally who was unhappy with the wages they were being paid I would encourage them to make an investment in education and better their position in life.  This is not always possible for some people who find themselves with families to support and the inability to just stop earning money for a few years (or even months) while they return to school, but this issue could be addressed.  More important is that this idea is fundamentally flawed when applied to the entire population.  We live in a service oriented economy more and more every day.  As manufacturing jobs get shipped overseas, what remains that cannot be shipped overseas are relatively low-paying service jobs.  One of the results of increased efficiency from computerization and automation is that some people need increasing amounts of education to be engineers, scientists, and programmers, while simultaneously others require less education because their jobs become increasingly easier.  And as the scientists, engineers, and management earn more money they are able to travel more, go out to eat more, pay others to do their labor for them, and spend more money on recreation and entertainment, but jobs in those industries pay less and require little education.  The result is that we have an increasing need for people to clean motel rooms, cook food, watch our children, and provide recreational opportunities for us.  This becomes a large and structural part of our economy and should be honored rather than looked down upon.  We cannot tell such an increasingly large part of our economy to just go get a real job.  There are not available high-paying jobs for everybody, some people need to provide services. They may not require advanced education but the work that they do is necessary, it is difficult, and it is generally unpleasant.  They deserve to earn a wage that they can live on and even support a family.  To do less means that we all end up subsidizing the costs in the end.  Wouldn’t it be better to pay them up front in a transaction that only involves the producer and consumer as would be required by a capitalist economy rather than subsidizing them through our tax dollars?  Those types of externalities result in economic inefficiency that will always cost us more in the end.

I argue that increasing wages is the single easiest way that we can stimulate our economy.  Capitalism is inherently a bottom-up system.  The idea that you can stimulate the economy by moving wealth from the bottom to the top in the hope that some crumbs will trickle down is misguided.  That is a top-down solution (i.e. socialist) to a bottom-up problem.  Nobody will create a job to provide goods or services if there are no consumers able to afford them.  Henry Ford knew that if he were to sell cars he had to pay his factory workers enough that they were able to afford to buy one.  Sadly this concept has been lost in recent years.  Wages have not kept up with inflation over the past 40 years and as a result our economy has not grown nearly as fast as it did when wages were rising during the previous several decades, even though more and more wealth has been concentrated at the top and an increasing tax burden is imposed on the bottom.  Trickle down is a failure.  Wealth might eventually trickle down but it absolutely gushes up, creating more wealth along the way.

IF HIGH WAGES BENEFIT EVERYONE THEN WHY ARE WAGES SO LOW? – If we accept my premise that paying higher wages is beneficial to everyone then it is reasonable to ask the question of why wages have stagnated over the past 4 decades.  Classic economic theory would predict that employers would act in their long-term best interest and pay the highest wages they possibly could, yet the opposite has occurred.  This is due to some fundamental elements of human psychology that prevent us from acting in our best interest.  First of all we tend to prioritize short-term gains over long-term security.  As a result an employer might be tempted to realize short-term increases in profit by lowering wages.  Doing so gives them a competitive edge and forces competitors to respond by also lowering wages. This perverse incentive results in a race to the bottom for wages and a net loss of wealth to the economy as a whole.  Second, in order for the best possible economic outcome to occur, individual employers must trust that if they increase wages then other employers will also increase wages.  They must resist the temptation to cheat temporarily to give themselves a competitive edge.

This is the classic prisoners dilemma from game theory.  In this scenario two criminals are brought in for questioning about a crime.  The police have suspicions but no real evidence to convict them.  We know how this works, we’ve all seen it on television cop shows over and over again.  The best possible outcome (from the criminals perspective) is for both criminals to keep their mouths shut and both will be able to walk.  They are separated, however, and unable to communicate, they are led to believe that the police have more evidence than they actually do and that the first one to rat on the other will get a greatly reduced sentence.  Since criminals are generally not known for their faith in their fellow human beings, inevitably one or both admit to the crime and both end up in jail.  This is the worst possible outcome (from the criminals perspective).  In the same way,  the ability for individuals to cheat in capitalism is its weakness.  Each employer seeking a way way to provide short-term benefits for themselves and not being able trust other employers to play by the rules results in an inevitable race to the bottom for wages.

SO HOW CAN WE FIND A CAPITALIST SOLUTION TO INCREASE WAGES? – The only way to prevent this decreasing wage creep is to remove the perverse incentive for individual employers to reduce wages.  The only way to remove that incentive is through some type of structured minimum wage scale.  In the past labor unions provided the basis for collective bargaining agreements that prevented individual companies from being able to cut wages.  As a result wages increased with increasing union involvement and our economy grew rapidly.  Unfortunately there is a significant problem with unions.  Unions represent only the interest of employees, and as a result many of them went too far, emphasizing job security and seniority over productivity and resulting in an extremely inefficient work force.  Employers revolted and were able to reduce the power of unions until Ronald Reagan dealt them a death blow when he fired the striking air traffic controllers en masse  in 1981.  Today union’s still exist but are greatly reduced in power.  I’ll be the first to agree that union’s overstepped their bounds and worked to reduce incentives for productivity that damaged the efficiency of the American work force (see my personal story below).  Nevertheless, I also believe that the resulting lack of any available structure for collective bargaining is damaging our economy.

If we accept my premise that the role of government in a capitalist economy is to ensure that the conditions exist that allow capitalism to achieve its peak efficiency then clearly there is a role for government to provide regulations to prevent these perverse incentives and reduced efficiency.  This does NOT mean government run unions, rather it means a plan to provide collective bargaining that provides benefits to both labor and employers.  For instance employers can negotiate a salary package with a base rate plus performance incentives to ensure productivity.  The mediators might be either part of a government agency or contracted to the private sector as long as it can be ensured that basic guidelines are followed and true competition is in place.

MY PERSONAL EXPERIENCE – I spent my last three years of high school in a boarding school and when I graduated I never moved back home.  For reasons unimportant to this discussion I was unable to attend college right away and so I had to get an apartment and support myself with only a high-school diploma right after graduating.  One of the options available to me was construction and I saw that as having the highest income potential.  I got a job as a carpenter but it only paid $4 per hour.  This was not really enough to live on and all I could really afford to do was share a tiny one-bedroom apartment with a friend, eat spaghetti every night, watch television, and I couldn’t even turn the heat on it winter.  I survived but just barely and if I would have had a health issue or car problems I would have been in dire straights, unable to work but needing more money.  A downward spiral.  After three months or so I recognized that I was just as productive as my co-workers who were getting paid significantly more than I was and I asked for a raise and was turned down.  My morale decreased and I felt taken advantage of but I continued working hard in the hopes that a raise would eventually be granted.  After another six months without a raise I was in dire financial straights.  Another friend offered to train me to hang-drywall and promised I could make at least $100 a day, about triple what I was currently making.

Drywall at that time was paid piece rate.  That meant I got paid a set amount for each sheet of drywall I hung and the harder I worked the more money I made.  I also had the opportunity to work long hours if I needed to make money fast.  I was thrilled at the opportunity to earn what I was unambiguously worth  and jumped at the chance.  My previous employer felt I was disloyal because he had “trained” me in construction but he refused to pay me more than a wage I could survive on so I had no choice.  I was highly motivated and a fast learner so I rose quickly in the company and made a lot of money.  I was able to afford a truck, because I was earning so much it was easier and more efficient to eat out than it was to go grocery shopping and cook for myself.  I put money in the bank, I was able to afford vacations, health insurance, go skiing, buy camera’s, and gun’s etc.  I took a summer off and volunteered as a camp counselor.  I trained people to work for me and provided opportunities for others.  In short I wasn’t just surviving I was able to be a viable contributing member of society.  That is the multiplier effect of paying higher wages.   When my company moved into metal stud framing I was able to switch jobs because I had previous framing experience. In a few years a was supervising multi-million dollar commercial construction projects and when I quit to return to school I was making more money then I have ever made since.

The company I was working for was expanding fast because it paid its workers based on performance and thus had highly motivated work force and also a more stable business model.  Its hard to lose money on a contract when you are paying piece rate and thus know exactly what your expenses will be.  Many of the jobs we got were taken over from union crews who were thrown off jobs because of their inefficiency.  Their pay and advancement was based on seniority rather than production and thus they had no incentive to work hard and they didn’t.  I would have had no opportunity to join a union crew because I had no seniority but working on a non-union piece rate crew where I was paid according to my ability and motivation, I advanced quickly and my company expanded rapidly because it had a reputation for fast, high-quality work.  It was a win-win situation.

So in a nutshell, when I was paid less than a living wage I was bitter and unmotivated and looking for new opportunities and my original boss had to find somebody else willing to do construction in the winter for $4 an hour and he lost the investment he had made in me.  When I was paid a living wage and rewarded for my effort I worked hard and was a loyal employee and reached my full potential very quickly and was proud of the work I did.  I also contributed significantly to the local economy doing my small part to provide a multiplier effect that ultimately made even more money for my employer.  Union crews on the other hand were losing jobs to us on a regular basis because, although they paid well there were no performance incentives and they took little pride in their work.

Sadly in America today there are few opportunities for good-paying jobs for those without college education.  Labor is looked down upon by those who consider themselves to be entrepreneurs and job-creators.  Most of them have the attitude of my first boss.  Why should they be worried about paying a living wage?  Especially now when people have very limited opportunity to move to a better job as I did.   Too many people in America feel trapped and unable to live up to their potential.  Too many people are living hand-to-mouth.  Too many people are just barely surviving, only able to afford to go to work and come home and watch television rather than thriving and contributing to society.  Too many people are one health issue or car breakdown from financial disaster, homelessness, and/or going on government assistance.  They are doing jobs that need to be done, often times miserable jobs, and their work should be respected, honored, and paid enough to live on rather than looked down upon.  We need to fundamentally change the way we approach work and wages in this country.

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