Minimum Wage Laws Cause Unemployment

The traditional economic take on the minimum wage is that it causes unemployment. If the law says that an employer must either pay a man $7 an hour or nothing, and the man is only worth $5 an hour to the employer, then he will pay him nothing, and the man may go jobless. Many people are skeptical of this line of reasoning. After all, the U.S. recent raised the minimum wage from $5.25 an hour to $7.15 an hour, and it’s not like unemployment is terribly high right now.

Okay, bad example. The truth is that while the theoretical case against the minimum wage is sound, it can be hard to test the theory empirically by looking at the U.S. because minimum wages here tend to be low enough as to only apply to a small portion of the population (around 3%). Given that the minimum wage applies to so few workers – and the fact that market wage for even those workers is probably not far off the legal minimum – its not surprising that whatever effect minimum wage laws have on unemployment tends to get obscured by larger trends in the economy.

The picture is different if we take a worldwide perspective rather than confining ourselves to looking at the U.S.

In absolute terms the U.S. minimum wage is fairly high. According to economic theory, however, what matters is not the nominal level of the minimum wage, but how much and how often that wage diverges from market rates. A minimum wage of $1, for example, would not be expected to have any real impact on unemployment in the U.S., because even in the absence of such a law few if any workers would take a job for that amount. By contrast, there are many places in the world where a $1 an hour minimum wage would be extremely high, and we would expect a larger effect on unemployment in that case.

To test this, I compared Wikipedia’s list of countries by unemployment rate with the level of each country’s minimum wage as a percentage of GDP (which serves as a proxy for the relative value of the wage for that society). As the chart above shows, economic theory holds up pretty well.

We get the same result if we look at a country’s labor market freedom (as determined by the Index of Economic Freedom). This ranking is based on more than just the minimum wage – it also includes other labor market regulations such as restrictions on the ability of an employer to fire workers – but economic theory predicts that many of these other regulations will also tend to increase unemployment:

As John Adams famously said, a man is entitled to his own opinions, but not his own facts. And the facts seems to indicate that higher minimum wage laws are associated with higher levels of unemployment, exactly as classical economics would predict.

9 Responses to Minimum Wage Laws Cause Unemployment

  1. Mike Petrik says:

    In some quarters it is better to be unemployed at a “living” wage than employed at an inadequate one. It is a matter of moral principle that is supported by highly intelligent interpretations of CST.

  2. Zach says:

    This seems like a basic truth of market economies. The analysis is helpful, and it’s nice to see that the data supports the intuitive understanding of how businesses function.

    I wonder, though, in the face if this evidence how people still object to this claim. I think it’s easier to sleep at night, in a big house and with every comfort of modern life, if you believe that there’s some minimum guaranteed standard of must be easy to make yourself believe the minimum wage does something like this.

  3. Anthony says:

    At this point society and the economy is too wrapped up in troubles to consider doing away with the minimum. Inflation, defined as the increase in money supply, is not helping matters.

    What is frustrating to me is why some kind of compromise on the issue cannot be reached. Why not freeze the minimum wage for 10 years? Or, allow high school and college age kids to compete at a lower wage? Or allow that during summer months? Why not get rid of taxes on tips of all kinds?

    I keep hearing about this “living wage” claptrap, but the reality is that such laws PRICE OUT individuals who are willing to work at the bottom of the economic latter. To say nothing of the fact that you would allow citizens to compete against undocumented workers…

    It’s just insane…

  4. Art Deco says:

    Inflation, defined as the increase in money supply, is not helping matters.

    ‘Inflation’ is an increase in the general price level. The general price level is influenced by the increase in the size of the monetary base, but the increase in this value has be neutralized by countervailing elements.

  5. Alex V says:

    Lets be honest, son. You want to know what min. wage is in the united states? Its a bullet point for politics. As you had already said in the post it has very little effect in the U.S. as percentage of legal people. Internationally, I think you are right, but how productive are those societies in terms of overall economics? What kind of negative externalities does it pose to society overall? Think a person is willing to work, but when 90% of the population is willing to only work for enough to eat then I would think you could argue that would be slavery. Outside the people in the top tier of society who is benefiting ? If you want to know the ideas of true economics read The Theory of Moral Sentiments. Many people in this blog seem to recall Smiths book Wealth of Nations and the idea of the invisible hand that has been taught in grade school but does not teach what Smith really met by it. Economics is more than direct supply and demand and labor and capital. What I find funny most conservatives I speak to are very very liberal when it comes to economics. I find myself to be very odd ball since i am both conservative when it comes to social issues and economics… end rant

  6. […] Does the minimum wage increase unemployment? It would seem so. […]

  7. Anthony says:

    Sorry Art. I do not believe inflation to be an increase in prices. Rather, the increase in prices is the RESULT of an inflation of the money supply.

  8. Mike Petrik says:

    The definition of inflation is normally tied to price levels. The cause of inflation is normally tied to the money supply. All things equal an increase in money supply in excess of an increase in productivity yields inflation. But first, money supply is tricky to define and measure; and second, all things are not equal. The velocity of money is key and is not constant. Currently we are increasing the money supply at a very fast pace but velocity is so slow there is no increase in general price levels, and therefore no inflation. Velocity will increase eventually and inflation may well follow.

  9. American Knight says:

    Anthony has it right. Inflation is the increase in the money supply, as in to inflate the quantity of money. Properly understood, it is also deflation, as in the devaluation of the money unit. Prices are affected by inflation (deflation). That is the result that we see, the increase in money, we don’t see. It is easier to deal with the things we see, but it is more important to deal with the things we don’t see.

    To anyone who thinks that minimum wage laws don’t cause unemployment; have you ever had to make a payroll?

    It doesn’t matter what wage level the payroll is. If I am paying my staff $15/hr and min. wage is $5 then I am paying 200% more than min. If min is raised to $7, then my staff will expect $21/hr, or at least $17. If the revenue isn’t increased, then this constitutes an increase in the percent of costs allocated to payroll. Something else has to be cut and that may also reduce quality and effectiveness, which can reduce profits. That will usually lead to a reduction in employment.

    Additionally, if you’ve never had to make a payroll, you may not know that it often takes years for a company to make enough of a return and increase cash-flow so as to make the upcoming payroll and the next. Increases in payroll costs will usually lead to reduced profits, which render the endeavor pointless, at least fiscally speaking. Furthermore, it puts a strain on cash-flow and that will lead to either layoffs or a reduction in per employee compensation. This is usually coupled with increased workloads.

    If higher earning employees wages do not rise and those at the lower wages do, then the prices of goods in the market get bid up and the losers are those who were earning more because now the effective use of their earnings is reduced. How is that fair? How is putting so much pressure on a company to cover the extra cost fair? The owners of these companies often earn way less than minimum wage for a long, long time. Often they are in debt for even longer and yet they make the payroll for their employees and families. Does it really make sense to add pressure to the risk associated with providing the entrepreneurial spirit that creates jobs?

    Economic analysis has the luxury of operating in the abstract and in theory, yet the policies devised have a real effect in the real world. Look at it at the most local level, the smallest businesses in your market and tell me that those jobs are better served by increasing the burden on payroll.

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