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The Wages of Sinful Economic Arguments / Artikel mises.org

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<h3>http://www.mises.org/fullstory.aspx?control=1577</h3>
<h3>The Wages of Sinful Economic Arguments</h3>

<h4 class="MsoNormal">by Tom Lehman</h4>
[Posted August 5, 2004]

<img alt src="http://www.mises.org/images3/blacksmith.jpg" align="right" border="0" width="234" height="168">A
recent article in the Wall Street Journal is a perfect example of how bad
economic arguments in support of good ends can be easily twisted and used to
confuse the general public (Gwendolyn Bounds,"Argument
for minimum-wage boost," 7/27/04, p. B3). 
When we engage in poor reasoning and faulty economic logic in support of a noble
cause, we can end up doing much more harm than good in the pursuit of liberty
and economic freedom.

Examples of this dilemma abound, and
conservatives are especially prone to this type of error in reasoning.  For
instance, we frequently hear arguments in favor of free trade because free trade
"boosts exports," ignoring the real benefits in the form of cheaper
imports and a better use of scarce resources.  Arguments against socialism
are often made on the basis that the system creates poor incentives rather than
the bigger problem identified by Ludwig von Mises: socialism’s inability to
permit rational economic calculation.  Some conservatives now argue against
the recent invasion of <ST1:COUNTRY-REGION>
<ST1:PLACE>
Iraq</ST1:PLACE>
</ST1:COUNTRY-REGION>
merely because weapons of mass destruction have not yet been found, as if
unearthing WMDs would justify military invasion of another nation.  In this
political season, we hear daily arguments in favor of tax cuts as a means to
"stimulate" the economy, rather than on the basis of efficiency in
resource use and private property rights.  And, especially relevant to the
topic at hand, arguments are often made against raising the minimum wage on the
basis that an increasing minimum wage will elevate prices or harm small
businesses.

The news article in question was
written as a response to just such an argument.  This argument goes as
follows: An increase in the minimum wage cannot be justified because it will
unfairly and disproportionately harm small businesses that, unlike large firms,
cannot absorb the additional costs imposed by mandated higher minimum wages. 
Dynamic small businesses are responsible for a relatively large part of
employment.  If they cannot afford these higher labor costs, they will fail
and go out of business, and workers will lose jobs.  Ergo, a hike in the
minimum wage cannot be justified.

As with most arguments, this one
contains a kernel of truth.  Indeed, the scenario it portrays is certainly
possible and may result for some small business owners.  However, using
this argument against minimum wage laws puts one on very shaky economic ground,
because it skirts the chief problem of minimum wages and diverts attention
instead to that hallowed and sacred institution known as"small
business."  This may seem like an easy sell to the American public,
but it is a lazy argument that fails on its economic merits, as the news article
makes patently clear.

In response, the author of the
article points to a recent study released by the Small Business
Administration’s Office of Advocacy which finds that, surprise, small business
firms in America are not in fact the low-wage sector of the economy that many
people believe them to be.  On the contrary, the report finds that, on
average, small businesses tend to pay above the minimum wage in order to compete
in the labor market and attract workers.  In reality, according to the SBA
study, it seems that larger wholesale and retail discounting firms employ a
proportionately higher number of minimum wage workers, in part enabling them to
keep their prices low.   Small businesses, on the other hand, must pay
wages well above the minimum in order to attract and retain reliable and
productive employees.   The theory is that by paying higher"efficiency
wages," small businesses may be able to reduce worker absenteeism and
turnover, and also cut down on labor search and retraining costs associated with
employee churn.

The author of the article does not
reveal the details of the SBA study or suggest why it would be necessary for
smaller firms to pay higher wages than larger firms to attract and retain
workers with similar levels of skill and education.  However, it is
plausible that some form of"compensating differential" is at work in
larger firms that is not available to employees in smaller firms.   Hence,
the higher wages paid by smaller firms are necessary to offset the non-wage
benefits of working for a large firm.  For example, it could be that larger
firms pay lower wages but offer better health care or sick-leave benefits as
non-wage compensation.  Or, it might be that larger firms have the capital
resources to invest in a safer, cleaner, and more inviting workplace, offsetting
lower wages.  The prestige associated with working for a larger and more
well-known enterprise might also play a role.  Either way, some form of
amenity in larger firms (or its absence in smaller firms) must explain the wage
premium paid by smaller firms, or it would not persist.

However, the conclusions of the
Small Business Administration study, as reported in the newspaper article, are
very revealing, and clearly indicate the extent to which even small business
owners are infatuated with turning the power of government to their own private
advantage.  Contrary to the arguments made by so many well-meaning but
misguided opponents of the minimum wage, small business owners actually favor
an increase in the minimum wage.   The reasoning is that it would force
their larger rivals to pay higher wages, thus making it more difficult for large
firms to offer discount prices on wholesale and retail products.  In other
words, according to this news article, many small business owners desire an
increase in the minimum wage as a way to hamstring larger firms that offer
lower-priced goods and services and out-compete them in the marketplace. 
Small business owners who push for an increase in the minimum wage see it as a
tool to prevent their larger rivals from realizing efficiencies in labor costs,
partially insulating themselves from the intense competition created by
large-firm economies of scale.

Of course, this tactic should be
seen for exactly what it is: typical rent-seeking behavior by less efficient
firms who, rather than finding creative ways to cut costs and lower prices,
reach for the lever of government coercion to hamper their more efficient rivals. 
This has been the history of government regulation for at least the last 100
years.  Business firms support government intervention on some ostensibly
noble grounds, such as reducing poverty or raising wages or enhancing consumer
safety.  In reality, their intent is usually much less dignified,
supporting intervention only to create barriers that insulate them from
competition.

Beyond this issue, however, the
reasoning of the pro-minimum-wage argument made by some small business owners is
itself dubious because, again, it ignores the primary problem associated with
minimum wage laws to begin with.  Minimum wage laws create unemployment
among the lowest skilled and least educated workers.  As any freshman
economics student knows, wages mandated above the market-clearing equilibrium
wage will create a binding price floor that causes the quantity of labor
supplied to exceed the quantity of labor demanded, resulting in a surplus of
labor.  And, a surplus of labor leads to unemployment for those whose
productive skill value is below the legal wage floor.  The larger the
increase in the minimum wage, therefore, the greater the labor surplus and the
more detrimental the policy becomes. 

For example, ask yourself if, all
else equal, you would hire me for $7 per hour if I can only generate an average
of $5.15 per hour of revenue for your firm.  Clearly you would not. 
As a result, many unskilled workers who seek employment cannot find a job
precisely because the government tells them that they must be paid more than
they are worth to a potential employer.  Teenagers, and especially minority
teenagers, are the most likely to fall into this low-skilled category.   It
should thus come as no surprise that teenage and minority teenage unemployment
rates are among the highest of any demographic group, topping out, respectively,
at 16.8 percent and 32.6 percent in June 2004, according to the Bureau of Labor
Statistics.  This compares poorly to a national unemployment rate of just
5.6 percent in the same month.

Thus, forcing larger rival firms to
pay higher minimum wages will not necessarily lead them to raise prices for
their goods and services, as some small business owners apparently believe. 
If the demand in the market for these products is price elastic (which is highly
likely), these firms will not be able to raise prices and pass on higher labor
costs to consumers.  After all, this explains why small business owners
despise paying"efficiency wages" in the first place: the inability to
raise prices.  Instead, it is probable that large firms faced with
artificially higher labor costs will find it more advantageous to invest in
additional technology and capital equipment that would replace the lowest
skilled employees who earn the minimum wage.  In the end, the singular most
likely outcome is that a hike in the minimum wage will harm low-skilled
employees who currently have a job working for a large firm by throwing them out
of that job.

This recent news article and the
story it tells is highly instructive for those who care about promoting free
markets and economic liberty. Making bad economic arguments for noble
economic ends puts us on shaky footing and opens the door for those arguments to
be used against us.  Arguing against minimum wage laws because they harm
small businesses or lead to rising prices opens us up to just the kind of
counterargument so vividly pointed out in this story.  If minimum wage
laws are not found to harm small businesses or lead to rising prices, then they
must be ok. Of course, this is wrong.  We must learn to always make
the strongest and most consistent arguments against the enemies of free markets,
or we will lose the battle.  As Mises himself always reminded us, that
requires constant study and a steadfast pursuit of the truth.

_________________________

Tom Lehman [mail] is
Associate Professor of Economics at Indiana Wesleyan University. Comment on the blog.