Election time in America these days is definitely not a
time when one should be searching the various pearls of Âwisdom 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 Âeconomics 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 IÂve 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 ÂTwo Cents from earlier this year and
rather than link it, IÂm going to include it in its
entirety at the conclusion of todayÂs commentary.
The March column contains just some of the science behind the minimum wage;
todayÂs 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 wonÂt say which office or who the
candidate was, because it really doesnÂt matter.
This sort of Âflat-earthÂ
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 youÂll 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; weÂll get back to it later. ItÂs 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
ownerÂs labor costs. If that goes up 25%, the $3.50 becomes $4.38, a
difference of 88 cents. She then asks if heÂd have to raise his prices. He
says ÂyesÂ. She asks by how much  would he raise prices by just the 88
cents or by more. He responds that heÂd probably raise them more since it
would be an opportunity to raise prices with a Âget 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 heÂd have to consider cutting staff if the minimum wage were
raised. After all, heÂs running a business. His employees need to
produce at least as much as his cost to retain them; otherwise heÂd 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 isnÂt applicable to them. However, it will
impact their employees  theyÂre going to be paying at least 8.8% more for
the hypothetical entrée described in the example above. In all likelihood
theyÂll be paying an awful lot more than that and not because of
entrepreneurial opportunism as we are usually led to believe, although letÂs
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 restaurantÂs
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. LetÂs
make an assumption that the cost of the restaurantÂs inputs goes up by the
8.8% amount that represented the restaurantÂs final cost increase. Since
labor accounts for 35% of the restaurantÂs 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.
TheyÂre paying 14.5% more for the same meal and weÂre 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 employerÂs
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. HeÂll 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. LetÂs use fast food
joints as an example here. A few years ago, most of them came out with ÂDollar
MenusÂ. Everything was a buck. You didnÂt get much, but it was a buck. Now
most of them are called ÂValue MenusÂ, things are more than a buck and you
donÂt 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.
WeÂve 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 IÂm guessing that, as
usual, thereÂs a good reason for why this was done. While I admit I havenÂt
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 wonÂt 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
ÂSee? It wonÂt be so bad  we NEED this minimum wage increase and if you
oppose it then youÂre against the poorÂ. Class warfare at its finest. All
based on a farce that is perpetuated because of misinformation and the
ProletariatÂs 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 ÂMyth BustersÂ, even though
there obviously remains quite a bit of mythology. So weÂre 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 Âestablishment (which is the
concatenation of the aforementioned and the banksters) couldnÂt 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.
ItÂs all about paradigms and where your comfort zone is. At any rate,
weÂre here to smash paradigms and hopefully encourage some critical thought
in the process. This weekÂs 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 Âmore of the same elections slated for this
fall. The catering is on. Suddenly the local intelligencia is on the radar of
the politicians and weÂll 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 weÂll leave that for the slip and
fall crowd to hash out. WeÂre going to throw some cold water on the euphoria
 as usual  and tell you why this is yet another really BAD idea.
The Myth:
ÂA minimum wage is good for the economy because it ensures that
everyone has an equal chance to earn a living wage.Â
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 Â and in this case that means Ânot for longÂ.
But since most canÂt see past their noses financially, itÂll 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 weÂll save that for the end.
The Anatomy of the ÂMinimum WageÂ
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, weÂll
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. WeÂre 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, weÂre only interested in demonstrating that such
inefficiency exists. This is a point of very hot contention between the
various schools of economic thought, but itÂs actually a lot worse than the
price control alone.
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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 workmenÂs
compensation costs, plus social insecurity costs, training, and the list goes
on. So itÂs not just the minimum wage. The cost, depending on the industry,
can be much, much higher.
At this point, the employer asks the question: ÂDoes this employeeÂs
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 wonÂt hire. If the answer is ÂyesÂ, 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.
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Now letÂs consider the situation where we have an individual who is
working for $8/hour. LetÂs 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 Âeducated 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
wonÂt 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 donÂt
have the pricing power to just pass it all on to the consumer. They have to
eat it. Well, they donÂt end up eating it  their employees do because they
now have people on the payroll that canÂt pay for themselves. ItÂs not any
fault of the employee, but rather, is the fault of Congress for using an
idiotic price control.
The Macro Perspective
LetÂs look at things from a macro perspective. Most people are aware of
the fact that the vast majority of the jobs that have been Âcreated since
the great recession allegedly ended have been lower-end service/retail and
temporary positions. TheyÂre exactly the types of positions that stand to be
affected by a change in the minimum wage. Again, weÂre assuming these jobs
were even created at all. We know for a fact there havenÂt been nearly as
many as the government says, but thatÂs another essay. WeÂve been down that
road. So the net effect is that youÂre going to have a bunch of people who
are suddenly going to get the equivalent of a raise. What do you think theyÂre
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 ÂFlat-Earth
EconomistsÂ. 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 IÂm 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.
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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 wouldnÂt work because below a certain level it wouldnÂt
pay the employee to even show up for work and theyÂd quit. See how long any
firm lasts with no employees. Companies arenÂt 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, theyÂll have a competitive
advantage. TheyÂre 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, weÂll 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 canÂt 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. TheyÂll retain their employees, but pass the cost on to the
consumer. The excess demand from the new higher wages drives up prices
elsewhere. WeÂre looking to start a full-scale trade war with the Chinese.
Does anyone think theyÂre going to ramp up the supply of imported goods just
so the USGovt can play pretend economics? I donÂt 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, letÂs not forget the history behind the minimum wage. This isnÂt
the first time it has been discussed for sure, nor has this been the first
time weÂve had a minimum wage or been Âforced to raise it. WhatÂs
happened each time in the past? Prices reset higher and eventually the wage
has to be increased again. Wash, rinse, and repeat. LetÂs not forget history
here. Nothing is different this time.
Having used common sense to dispense with that bit of lunacy, letÂs 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 theyÂre
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 doesnÂt 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 weÂve 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. ThereÂs 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.
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