How Minimum Wage Laws Create Unemployment

The Emergence of a Market Wage

Wage is the price of a labor service. An entrepreneur exchanges money against a worker‘s labor, combining factors of production, and yielding consumer goods. The amount of money to be paid for the labor is negotiated between the entrepreneur and the worker. How much the worker accepts depends on the offers he receives from competing entrepreneurs, how much the entrepreneur is willing to pay depends on the wages that competing workers of similar skill set are asking.

The entrepreneur will only be able to pay a wage that still grants him a sufficient entrepreneurial profit, otherwise he will not embark upon the project in question.

When an entrepreneur looks for a worker to employ, he will, as a tendency, hire that worker who asks least, out of the available pool of skilled workers. The next entrepreneur who is looking for a similar worker, will have to hire one with the next highest asking price, and so on and so forth.

The workers who are already employed, but at lower wages, will ask for higher wages if they notice that other fellow workers are being hired at higher wages, or else they will leave and start working for those entrepreneurs who pay more. So long as the entrepreneur still earns a sufficient profit, he will be able to up his pay. Some entrepreneurs will have no problem at all to up their pay accordingly, others who are less profitable will have to follow along reluctantly.

At some point the wage reaches a level beyond which the least profitable entrepreneur, the marginal entrepreneur, would be unable to employ a worker. He would have to cease his operation and release the worker. The unemployed worker would now have to offer his labor at a lower wage again in order to find employment.

In addition, there is also a wage level below which some workers would be unwilling to sell their labor. They would withdraw themselves from the market for that particular labor and force entrepreneurs to now compete for workers from a smaller pool of people, by upping their offer.

Thus, a market wage emerges somewhere between those two narrow boundaries, which ensures that all workers who have a certain skill to offer can find labor with entrepreneurs who are looking for that skill. It also ensures that all entrepreneurs can find workers at a price level that they will be able to afford.

Minimum Wage Legislation

When a government imposes a minimum wage, is threatens employers with police force if they accept an offer from a worker below a certain wage level. A voluntary agreement between two individuals is outlawed by compulsory means.

If this minimum wage is below the market wage it has no effect at all. It is an empty decree with no purpose whatsoever. The scenario we have to examine more closely here is the one where the minimum wage is set at a level above the market wage.

If the government begins enforcing a wage that is above the market wage, the marginal entrepreneurs that I mentioned above will have to cease their operation. The people who are let go would have to offer a lower wage in order to find new employment. But if the minimum wage is persisted and enforced at the higher level, the worker will not be able to find employment because he won’t be able to work at the wage he is voluntarily offering to accept. Unemployment ensues in the sector where the minimum wage is being enforced. If it is enforced across all sectors, unemployment across all sectors will inevitably ensue.

Current Minimum Wage Situation

Recently the federal minimum wage was raised to $7.25 per hour:

The FLSA establishes minimum wage, overtime pay, recordkeeping, and youth employment standards affecting employees in the private sector and in Federal, State, and local governments. Covered nonexempt workers are entitled to a minimum wage of not less than $7.25 per hour effective July 24, 2009. Overtime pay at a rate not less than one and one-half times the regular rate of pay is required after 40 hours of work in a workweek.

It is true that for most occupations, this wage may currently be below the prevailing market wage. There are separate minimum wage laws in most states which fix it above the federal level.

But we are now in an environment of deflation, with market prices and wages declining left and right. The ability for prices to adjust during such a deflationary environment is the number one driver for employment. The failure to let prices adjust quickly was one of the main causes of mass unemployment during the Great Depression.

One friend of mine recently posted a simple job at the San Francisco minimum wage which is $9.79. He got flooded with tons resumes from college graduates and experienced people. This tells me that even well below that wage he would find willing and able workers for the position he posted.

The solution would be an unconditional abandonment of all minimum wage legislation across the country. Tantamount to this would be a drop or a maintenance of minimum wage levels well below market wages where they fulfill no purpose other than maybe make people feel good.

States and the federal government have to pay serious attention to this issue. If market wages across the country fall below the minimum wage, long-term mass unemployment will ensue and not go away anytime soon. Lots of people will of course seek refuge on the black market, get paid in cash, and pay no taxes. But to the extent that governments actually enforce those minimum wages that are fixed above market wages, I see nothing but trouble ahead on the employment market.

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2 thoughts on “How Minimum Wage Laws Create Unemployment”

  1. I was going to send you an email last week asking you to write about minimum wages and you just did it :-)

    You are the best blogger ever!!!

  2. Ya, I’ve been wanting to write about minimum wage for a while. Now that it was raised recently, I thought it would be good occasion.

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