Tuesday, February 13, 2007

Minimum Wage and Inflation

We've heard from several sources that the increase in the minimum wage will "cause" inflation. Actually, an increase in the minimum wage doesn't cause inflation, although that is a common misconception. The real cause of inflation is a decline in the value of money. A general rise in prices (i.e. inflation, as we usually think of it) occurs because money has less value, not vice-versa.

Once you have recognized that subtle, but critical point, a lot of things become clear, including who is responsible for money losing its value: the federal government. Money (today) is entirely a government monopoly, and it is government actions and policies that determine whether the dollar (or any currency) has a stable or declining value. Politicians always try to blame labor (for increasing costs), businesses (for raising prices), and consumers (for "excessive demand"), but those are all effects of inflation, not causes. Those claims do help hide the culpability of the politicians, though.

This is not to say that the minimum wage is a good idea or that it has no harmful effects. Suppose we just raise the minimum wage to $50/hr so we can all get rich? How many of us would still have a job the day after that law went into effect? (Answer: approximately zero) Ultimately, setting a minimum wage doesn't guarantee anyone will have a job at that wage. It only guarantees that you won't have a job for less than that. Unless the value of anyone's work product is greater than the cost of employing him (including wages, taxes, and benefits) that job will not exist (or at least not for long).

So what does happen when the minimum wage is increased? Most people who were making less get a raise, and they feel great about the new law. Employers who now have to pay more for the same amount of work have higher costs, which means:
  1. Some will lay off employees to cut costs. (Labor is the biggest cost for most businesses.)
  2. Some will put off hiring new employees or give smaller raises to their other employees.
  3. Some will raise prices, if the market will allow it, to try to pass the cost on to customers. But price increases suppress demand, so customers may go elsewhere to spend their money.
  4. Some will put off expansion plans or purchases of durable equipment, reducing the demand for other people's products (businesses and workers).
  5. Some, those who were already weak, will go out of business.
Notice that the losers in this process are much less visible than the winners (with the possible exception of group 1 above). Politicians get to take credit for "doing good," for The Little Guy. while others bear all the costs and take all the blame for the plight of the losers. This is why even politicians who know it's bad policy have a hard time resisting a vote for increasing the minium wage. Buying votes with other people's money: that's what it's all about.

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