When President Obama advocates a higher minimum wage in his State of the Union Address, he will no doubt argue that by increasing the minimum to $10.10, workers will have fatter pay checks and spend more, thus stimulating the economy and creating more jobs. In fact, economic logic tells a different story.
The law of demand is more powerful than the minimum wage law: when the price of anything, including labor, goes up, the quantity demanded goes down, other things constant. No one has ever disproven this economic law—and neither the President nor Congress can overturn it.
The idea that raising the minimum wage will increase income confuses the price of labor (the wage rate) with labor income (wage rate x hours worked). If a worker loses her job or can’t find a job at the higher minimum wage, her income is zero.
Proponents of the minimum wage argue that those workers who do retain their jobs will consume more, which will increase aggregate demand and increase GDP. But that line of argument is a case of upside-down economics. Consumption is not a determinant of economic growth; it is the result of a prior increase in production. Workers cannot be paid what they haven’t first produced.
A higher minimum wage—without a corresponding increase in the demand for labor caused by an increase in labor productivity (due to more capital per worker, better technology, or more education)—will mean fewer jobs, slower job growth, and higher unemployment for lower-skilled workers. Higher-skilled workers and union workers will benefit, but only at the expense of lower-skilled workers, especially the young and minorities. There is no free lunch.
Small business owners will see their profits cut, which will either drive them out of business or slow their expansion. If prices are increased to offset the higher minimum wage—something that is difficult in globally competitive markets—consumers will have less money to spend on other things. Thus, there will be no net increase in employment. Moreover, an increase in the minimum wage cannot lead to an increase in aggregate demand unless the Federal Reserve accommodates the higher minimum by pumping up the money supply, which would lead to inflation and a loss of purchasing power.
Mr. President, there is no magical way to stimulate the economy by increasing the minimum wage. The only sure way to increase jobs and wages for lower-skilled workers, and thus to increase their standard of living, is to increase economic growth. The minimum wage is neither necessary nor sufficient for economic growth. Hong Kong grew rich without a minimum wage because it undertook the reforms that fuel growth: free trade, low tax rates, limited government, a stable rule of law that safeguards private property, sound money, and low costs of doing business. The United States should do likewise.
Increasing the minimum wage is the wrong medicine for an ailing economy. Further government intervention in free markets is the path toward socialism, not market liberalism. Letting free markets determine wage rates is consistent with a free society and also with economic logic. It is the surest path toward greater income mobility as younger, low-skilled workers get experience and move up the income ladder. Cutting that ladder off by mandating a higher minimum wage is a recipe for poverty not progress.