The Minimum Wage Farce A Case Study

Election time in America these days is definitely not a time when one should be searching the various pearls of ‘wisdom’ dumped on the airwaves, billboards, and newsprint for the truth. Such is especially the case when it comes to economics. So twisted is the entire notion that the stock market is equated to ‘economics’ as if it is some ersatz term that is used whenever someone wants to pull the wool over our eyes. That is just but one example. This election cycle is no different. There have been fabrications so colorful I’ve often felt compelled to yank out a pad and pen and write them down. However, there is one that sticks in my mind as being the ultimate in misunderstanding. It is a shame that someone could so boldly assert themselves to be right and their opponent so wrong (of course) and then go on to butcher a topic in such totality that it nearly made my head explode.

This article dovetails almost perfectly with a ‘Two Cents’ from earlier this year and rather than link it, I’m going to include it in its entirety at the conclusion of today’s commentary. The March column contains just some of the science behind the minimum wage; today’s installment is a good example of the type of fraudulent reasoning that is so prevalent in the specter of economics today.

The forum was an interview of a candidate for office here in Pennsylvania. I won’t say which office or who the candidate was, because it really doesn’t matter. This sort of ‘flat-earth’ type thinking is virtually ubiquitous in the arena of those who wish to lead.

The topic was the minimum wage. As soon as I heard the question, it piqued my interest for several reasons, mainly because the concept is grossly misunderstood and secondly, because it is often used as a weapon in class warfare. Sadly, I was not to be disappointed.

The segment starts with the interviewer introducing the minimum wage as a point of contention in the 2014 elections. The candidate agrees it is a compelling issue and goes on to present the following actual exchange she had with a small business owner in her district. The following is not verbatim, but you’ll quickly get the idea. I will admit up front to making some assumptions in creating the extensions of the example laid out by our candidate. However, based on my knowledge of a variety of business operations, the assumptions are likely conservative in nature.

The candidate asks the small business owner how a 25% increase in the minimum wage would affect him and his restaurant. He is quick to point out the obvious – that it would increase his costs. How much, she asks. Would it increase his costs by 25%? No, he says, just the labor portion of his costs. Make a note of that; we’ll get back to it later. It’s the first false assumption. Our heroic champion of government intervention then asks what percentage of his overall costs labor represents. He says about 35% for his particular business, which, again, happens to be a restaurant. She goes on to make an example of a $10 meal. $3.50 of that meal represents the business owner’s labor costs. If that goes up 25%, the $3.50 becomes $4.38, a difference of 88 cents. She then asks if he’d have to raise his prices. He says ‘yes’. She asks by how much – would he raise prices by just the 88 cents or by more. He responds that he’d probably raise them more since it would be an opportunity to raise prices with a ‘get out of jail free’ card. The price increase could be pinned on our heroes in government. Keep in mind that this is exactly the kind of answer that champions of government intervention love to hear because it then gives them an excuse to start talking about additional price controls. I say additional because the minimum wage itself is a price control; something you rarely hear in these types of discussions.

Of course the upshot of all this is that the guy is greedy and there would need to be even further government intervention to prevent him and other greedy entrepreneurs like him from gouging the public should the minimum wage be raised.

Obviously, there are some gaping holes so far. The owner was never asked if he’d have to consider cutting staff if the minimum wage were raised. After all, he’s running a business. His employees need to produce at least as much as his cost to retain them; otherwise he’d be better off without them. The higher wages go, the more the workers need to produce in order to justify their continued employment. Of course, the structure of costs and production is different for every type of business. Businesses that utilize highly skilled workers are unlikely to even think about the minimum wage because it really isn’t applicable to them. However, it will impact their employees – they’re going to be paying at least 8.8% more for the hypothetical entrée described in the example above. In all likelihood they’ll be paying an awful lot more than that and not because of entrepreneurial opportunism as we are usually led to believe, although let’s not be naïve here; there are probably lots of business owners who would use this as an excuse to widen their margins if they could get away with it.

Second, totally ignored in this example, is the cost of the restaurant’s inputs. The candidate is assuming that the restaurant operates in a bubble and fails to understand that there are multiple other businesses that have to operate to provide the restaurant with the materials it needs to produce the hypothetical entrée. Every one of those businesses has a cost structure and will end up raising their prices in accordance with that structure and how the minimum wage might affect their own operations. Let’s make an assumption that the cost of the restaurant’s inputs goes up by the 8.8% amount that represented the restaurant’s final cost increase. Since labor accounts for 35% of the restaurant’s costs, then other inputs represent 65% of the cost or $6.50. We increase that by 8.8% and arrive at $7.07; an increase of 57 cents. Totaling it all out, our entrée now costs $11.45 or an increase of 14.5%. Again, I readily admit this is an assumption on my part, but it is meant to be illustrative in nature: input costs are going to go up along with labor costs. Therefore the total price increase is not limited to just increases in labor costs.

Using a bit of simple logic, we can conclude from this that all the people who eat at that restaurant are going to be worse off for having done so. They’re paying 14.5% more for the same meal and we’re making some pretty generous assumptions here. It is quite likely that the actual cost increase will be much higher. Our champion of government intervention never bothered to analyze how increased wages hike the labor cost beyond the cost of the wage increase alone. Various insurance programs like unemployment and Social Security are all based on wages. Increase the wages and the employer’s contribution to these insurance programs goes up. In a nutshell, a hypothetical 25% increase in the minimum wage ends up costing the employer much more than that. He’ll pass on those costs if the demand curve for his product is elastic. If not, he goes into cost-cutting mode and will likely end up laying off employees.

Another mechanism and one almost every American has already seen for a different reason (masking inflation) is decreases in quality/quantity of end user products. In the case of our restaurant owner, he might decide to limit his cost increase to the amount necessary to maintain his margin, but he might cut the amount of food his customers get. Or he might switch to some lower quality inputs or even a combination of the two. Let’s use fast food joints as an example here. A few years ago, most of them came out with ‘Dollar Menus’. Everything was a buck. You didn’t get much, but it was a buck. Now most of them are called ‘Value Menus’, things are more than a buck and you don’t get nearly as much. You know this is really getting bad when you can almost see through your value menu burger.

As I pointed out before, the above mechanism has been used to help hide price inflation. It could also be further utilized to hide a minimum wage hike. The problem is the consumer is onto it for the most part.

We’ve seen one example of a minimum wage hike so far – in Seattle, Washington. It is a sanitized example though and an inaccurate one. Why? Because many of the inputs that go into products produced in Seattle come from outside the city and as such have not been affected by the hike in the minimum wage within the city. So the costs of inputs in Seattle are not going up by as much as they would be if the entire country were under a higher minimum wage. I might be a total pessimist here, but I’m guessing that, as usual, there’s a good reason for why this was done. While I admit I haven’t had a chance to study Seattle for quirks in price inflation trends, demographics, and other econometric trends, it is a good bet that the minimum wage increase won’t impact the folks in Seattle in a representative nature. The externally sourced inputs will dilute the impact even more. Then the so-called wizards of economics in Washington, New York, and elsewhere can say ‘See? It won’t be so bad – we NEED this minimum wage increase and if you oppose it then you’re against the poor’. Class warfare at its finest. All based on a farce that is perpetuated because of misinformation and the Proletariat’s stymied desire to understand why it feels like it is being squeezed out of existence.

The Science Behind the Minimum Wage – March 2014

It has been quite some time since we did a ‘Myth Busters’, even though there obviously remains quite a bit of mythology. So we’re going to chop away at it piece by piece and demonstrate once again that the media, government, and what I like to the call the ‘establishment’ (which is the concatenation of the aforementioned and the banksters) couldn’t give a rip about the truth. The establishment only cares about what is expedient and convenient for itself.

I am continually amazed, especially when I step outside the world of economics and finance, how LITTLE people really understand what is going on. It’s all about paradigms and where your comfort zone is.  At any rate, we’re here to smash paradigms and hopefully encourage some critical thought in the process. This week’s Myth Buster deals with the idea of a minimum wage. Recently there has been quite a bit of scuttlebutt as Congress and politicians in general try to cozy up to the public before another set of what will almost assuredly be ‘more of the same’ elections slated for this fall. The catering is on. Suddenly the local intelligencia is on the radar of the politicians and we’ll get to spend the next 8 months listening to them tell us how they hear us and feel our pain, etc. Hogwash.

One of these cheap show gimmicks is the idea of raising the minimum wage. It sounds really good because all those people who are working for $7+/hour up to maybe $9 or so are expecting a nice raise if this goes through. It has already gone through for certain government contractors. One might make a very good case for discrimination, but we’ll leave that for the slip and fall crowd to hash out. We’re going to throw some cold water on the euphoria – as usual – and tell you why this is yet another really BAD idea.

The Myth:

“A minimum wage is good for the economy because it ensures that everyone has an equal chance to earn a living wage.”

It is my opinion that this gimmick is particularly appealing because we live in an instant gratification world for the most part. People will have their wage go up by as much as, say 40% from one week to the next, and suddenly the economy will be absolutely splendid. And they will benefit in real terms. But this is the NFL – and in this case that means ‘not for long’. But since most can’t see past their noses financially, it’ll work – until the inevitable happens and they find themselves right back where they started – and probably in worse shape when all is said and done. Will the establishment then pump another increase? There are ramifications to that, but we’ll save that for the end.

The Anatomy of the ‘Minimum Wage’

Essentially, the minimum wage is nothing more than a price control. Think of a supply and demand chart. Price is on the y-axis (see below). Well, labor has a price as well, just like any other good or service. And the price of labor is generally referred to as the wage. So, in classical fashion, we can plot a simple supply and demand chart. For the purposes of this essay, we’ll use linear functions to depict supply (QS) and demand (QD), but acknowledge that these functions are almost never linear. In the case of a price floor, the price is set (by the government) at some point above the equilibrium price. We’re already in trouble, because now the system is not efficient. There is what we economists call a welfare loss. If we were to analyze this quantitatively, we could calculate the magnitude of the welfare loss. However, in this case, we’re only interested in demonstrating that such inefficiency exists. This is a point of very hot contention between the various schools of economic thought, but it’s actually a lot worse than the price control alone.

There is another concept one needs to consider and that is the cost of labor. This is the point of view the employer looks at. What does it cost the shop to hire another worker? Well, obviously there is the wages paid. Then there are various carrying costs associated with the new marginal (economic definition) employee. This is not to imply that the employee is of a low quality, but it is an employee who is hired at the margin, or edge. Think of a microeconomic situation where we look at marginal cost. That is the cost of adding one more unit of production. Well, the marginal employee is adding one more employee. What is the marginal cost (MC) of that employee? It is his/her wages, plus unemployment insurance costs, plus workmen’s compensation costs, plus social insecurity costs, training, and the list goes on. So it’s not just the minimum wage. The cost, depending on the industry, can be much, much higher.

At this point, the employer asks the question: “Does this employee’s marginal revenue (the value the marginal employee generates for the firm) at least equal the marginal cost of having the employee? If the answer is no, a smart employer won’t hire. If the answer is ‘yes’, the hire will happen, and there will likely be additional hires until MR=MC. In the case where MC > MR, there will be layoffs until that micro equilibrium is met. I realize there are factors and variables that play into these decisions that are simply too numerous to count. The point is to paint a general picture and bring some common sense to the subject.

Now let’s consider the situation where we have an individual who is working for $8/hour. Let’s say the carrying costs are another $2/hour, making the cost of that employee $10/hour. At this level, the business is fairly near equilibrium (MR~MC). The employee is paying for him or herself by working there. Then you have Congress, with its infinite desire to meddle in the business of others in its never-ending quest to be loved, stepping in. Given that Congress’ approval rating currently rests several orders of magnitude lower than the Titanic, it figures it needs to do something for the people before asking for votes. And all the advisors think this is a great idea because they were taught by a bunch of Marxist-Keynesians – like the ones who ‘educated’ Bernanke and Yellen.

So Congress steps in and jacks the minimum wage to $10/hour. Looking back on the aforementioned example, the carrying costs are still $2/hour – for now. Suddenly the MC for any new hires is greater than the MR and subsequent hires won’t be made – or the firm will raise prices. Perhaps a combination of the two will be used. In addition, it is also very likely that some firms will cut back on employees because their equilibrium is now upset. Many firms don’t have the pricing power to just pass it all on to the consumer. They have to eat it. Well, they don’t end up eating it – their employees do because they now have people on the payroll that can’t pay for themselves. It’s not any fault of the employee, but rather, is the fault of Congress for using an idiotic price control.

The Macro Perspective

Let’s look at things from a macro perspective. Most people are aware of the fact that the vast majority of the jobs that have been ‘created’ since the great recession allegedly ended have been lower-end service/retail and temporary positions. They’re exactly the types of positions that stand to be affected by a change in the minimum wage. Again, we’re assuming these jobs were even created at all. We know for a fact there haven’t been nearly as many as the government says, but that’s another essay. We’ve been down that road. So the net effect is that you’re going to have a bunch of people who are suddenly going to get the equivalent of a raise. What do you think they’re going to do with it? The responsible thing would be to attack the liabilities portion of their balance sheets, but a thinking person is going to look at past history and conclude that since we learn next to nothing from history, that this money, by and large, will be spent. More dollars chasing a fairly static supply of product? Shazam – price inflation. There is plenty of money in the system. There now needs to be a vehicle to get it into the hands of the spenders because the economy is flagging big time.

This is precisely the thinking of what I like to call ‘Flat-Earth Economists’. These are intellectual reprobates like Paul Krugman, Ken Rogoff, Mike Norman, and the majority of the policy steering arm of the Western banking syndicate. These are the sort of klutzes who think that the government should take your retirement accounts, force you to buy their debt, and bombard you with massive inflation – and yes, the minimum wage is a very good vehicle. We'll have more on that in the conclusion section.

It is very likely that I’m not the only one who is paying attention to the velocity of money metrics and staring aghast. The big shots in DC and NY watch those metrics too and they know full well what they mean. There is no recovery. M2 velocity of circulation is cratering with no bottom in sight. This means that money is moving more and more slowly through the economy. Not good. Things need a boost. People are strung out on credit and they must know the end is in sight. After all, there is a point certain when one simply cannot borrow anymore, at least from a practical perspective. The establishment needs to get some money in the hands of these people. It is not to increase their standard of living, however, it is merely another trick to buy some more time. A stunt to push the sun up just enough to get past another election.

Some Common Arguments for a Minimum Wage

The first argument that we hear against the free market is that there needs to be a minimum wage, otherwise the evil companies would run roughshod over their employees and pay them $2/hour or something ridiculous like that. First of all, it wouldn’t work because below a certain level it wouldn’t pay the employee to even show up for work and they’d quit. See how long any firm lasts with no employees. Companies aren’t mandated to provide benefits, but most do because they want the best people. They are competing with other firms. They know if they get the best people, they’ll have a competitive advantage. They’re not stupid – and neither are the folks driving these kinds of insane policies. The $64,000 question is would Wal-Mart pay below minimum wage if it could get away with it? Sadly, we’ll never find out, thanks to our government.

Another argument is that we need a minimum wage to guarantee that folks can earn a subsistence level wage. Too bad you can’t have employees making a subsistence level wage – even with the price control – in a fiat monetary system. Many businesses will end up raising their prices as a result of the policy shift. They’ll retain their employees, but pass the cost on to the consumer. The excess demand from the new higher wages drives up prices elsewhere. We’re looking to start a full-scale trade war with the Chinese. Does anyone think they’re going to ramp up the supply of imported goods just so the USGovt can play pretend economics? I don’t think so.

Eventually, everything resets at a higher price level. Nobody is economically better off in the long run. Think of that welfare loss from the supply/demand chart. Note that the supply of labor is now greater than the demand. It is like that any time a price floor is set above the equilibrium price. The flat earth econ crowd will say, however, that there is no demonstrable proof that wage price equilibrium is lower than the minimum wage and that the minimum wage, in fact, is holding people back. Really? Do you know anyone who is working for minimum wage? Because if you do, then that theory goes right out the window. If the equilibrium price were higher than the control, then nobody would make just the minimum wage; everyone would be making more.

Finally, let’s not forget the history behind the minimum wage. This isn’t the first time it has been discussed for sure, nor has this been the first time we’ve had a minimum wage or been ‘forced’ to raise it. What’s happened each time in the past? Prices reset higher and eventually the wage has to be increased again. Wash, rinse, and repeat. Let’s not forget history here. Nothing is different this time.

Having used common sense to dispense with that bit of lunacy, let’s get back to the welfare loss. It is not borne evenly, but it is a net loss. The truth is that the minimum wage laws end up hurting precisely the folks they’re purported to help. And the laws hurt those folks disproportionately to the rest. And yes, the policymakers know that. Maybe your local dunce of a representative doesn’t have the brains to figure it out, but you can bet their advisors know all about it.

Conclusions

Many fine analysts have been calling for hyperinflation, citing only the money supply as evidence. However, there is one triggering event that is necessary concomitant to a rapidly growing money supply, and that is a wage-price spiral. Think about it. To have hyperinflation, prices have to start at p, and then move to 2p, then 4p, 8p, and so forth. Prices double every so often. The interval required for doubling starts out pretty lengthy, then gets shorter and shorter.  People think of a rapidly growing money supply such as we have in the Western corridor and think that is enough. However, the limiting factor, so to speak, with prices is not just supply and demand. It is not just supply and demand plus the aggregate money in the system. It is the amount of this money that the average person can get his hands on. If wages are stagnant, prices can only rise so far. Credit abuse such as we have can create the ability to do quite a bit of excess purchasing, but even that only goes so far. And it is a diminishing returns situation anyway. If you want to trash a currency as the not-so-USFed does (just look at its track record), then there needs to be some type of wage-price spiral. Running up the minimum wage is a great way to kick things to the next level. Transfer payments from government to the populace are another and we’ve certainly seen plenty of that.

Hopefully this essay has been informative. If you know someone who is under the impression that an increase in the minimum wage is going to be to their eternal benefit, please share this essay with them. Remind them also, that the same people who are allegedly striving to look out for them are the same people who are plotting behind the scenes to destroy their currency, make them subject to bail-ins, and, among other things, reduce their standard of living. There’s an old adage to beware of Greeks bearing gifts. Evidently, that advice should not just be limited to those of Mediterranean ancestry.

Andrew W. Sutton, MBA

Chief Market Strategist

Sutton & Associates, LLC

http://www.sutton-associates.net

andy@suttonfinance.net

Sutton & Associates, LLC is a Registered Investment Adviser in the Commonwealth of Pennsylvania.  This message, and its contents is intended solely for the entity named herein. If you have received this message in error, please reply to the message's originator then delete the message from your system.

Interested in what is going on in the markets and the economy? Read Andy Sutton's weekly market and economic commentary 'My Two Cents' - go to www.my2centsonline.com