Relation between minimum wage and unemployment

On January 21 2021, the US President Joe Biden, through an executive order announced an increase in workers minimum wage from $7.25 per hour to $15 per hour i.e. more than double.

Some economists are of the view that the increase in the minimum wage could cause an increase in unemployment. Other economists think that the increase is unlikely to harm the labour market. Hence, they are of the view that raising the minimum wage could lift the workers living standards.

For example, in a study conducted in the 1990’s, economists David Card and Alan Krueger examined a minimum-wage rise in New Jersey by comparing fast-food restaurants there and in an adjacent part of Pennsylvania.1 They found no impact on employment.

Based on this study, many mainstream economists have expressed sympathy to President Biden’s executive order to double the minimum wage, which they hold is going to raise workers living standards.

In recent study, the National Bureau of Economic Research (NBER) surveyed a body of economic research on minimum wage increases and rebutted the notion that empirical data show no impact of increases in minimum wage hikes. The authors find that of all the available research on the subject they reviewed, there is a “clear preponderance” of findings that show a job-killing impact.

The documentation of job losses is even more pronounced for teenagers, young adults, and the less educated. “The body of evidence and its conclusions point strongly toward negative effects of minimum wages on employment of less-skilled workers, especially for the types of studies that would be expected to reveal these negative employment effects most clearly,” economists David Neumark and Peter Shirley wrote.2 

Given the contradictory results is there an alternative approach to decide whether the increase in the minimum wage will result in an increase or reduction in employment?

Can historical data inform us how the economy works?

Note that the so-called data that analysts are looking at is a display of historical information.

According to Ludwig von Mises, in Human Action pp. 41-49

History cannot teach us any general rule, principle, or law. There is no means to abstract from a historical experience a posteriori any theories or theorems concerning human conduct and policies.

Also in the The Ultimate Foundation of Economic Science p. 74, Mises argued that,

What we can “observe” is always only complex phenomena. What economic history, observation, or experience can tell us is facts like these: Over a definite period of the past the miner John in the coal mines of the X company in the village of Y earned p dollars for a working day of n hours. There is no way that would lead from the assemblage of such and similar data to any theory concerning the factors determining the height of wage rates.

Furthermore,

The historian does not simply let the events speak for themselves. He arranges them from the aspect of the ideas underlying the formation of the general notions he uses in their presentation. He does not report facts as they happened, but only relevant facts.

Contrary to the natural sciences, facts in economics cannot be isolated and broken into their simple elements. The realities of economics are complex historical facts that have emerged on account of many causal factors.

In the natural sciences whilst a scientist can isolate various facts he does not, however, know the laws that govern these facts. All that he can do is hypothesize regarding the “true law” that governs the behaviour of the various particles identified. He can never be certain however, regarding the “true” laws of nature. On this Murray Rothbard wrote,

The laws may only be hypothecated. Their validity can only be determined by logically deducing consequents from them, which can be verified by appeal to the laboratory facts. Even if the laws explain the facts, however, and their inferences are consistent with them, the laws of physics can never be absolutely established. For some other law may prove more elegant or capable of explaining a wider range of facts. In physics, therefore, postulated explanations have to be hypothecated in such a way that they or their consequents can be empirically tested. Even then, the laws are only tentatively rather than absolutely valid.3

In economics however, we do not need to hypothesize for in economics we can ascertain the essence and the meaning of people’s conduct. For instance, one can observe that people are engaged in a variety of activities. They may be performing manual work, driving cars, walking on the street or dining in restaurants. The essence of these activities is that they are all purposeful.

Furthermore, we can establish the meaning of these activities. Thus, manual work may be a means for some people to earn money, which in turn enables them to achieve various goals like buying food or clothing.

Dining in a restaurant can be a means for establishing business relationships. Driving a car may be a means for reaching a particular destination.

People operate within a framework of means and ends; they use various means to secure ends. We can also, establish from the above that people’s actions are conscious and purposeful.

The knowledge that human action is conscious and purposeful is certain and not tentative. Anyone who tries to object to this in fact contradicts himself for he is engaged in a purposeful and conscious action to argue that human actions are not conscious and purposeful.

Various conclusions derived from this knowledge of conscious and purposeful action are valid as well. The theory, that human action is conscious and purposeful stands on its own regardless of what the so-called data is showing. Needless to say that the established theory does not require any statistical verification.

Contrary to natural sciences in economics we do not hypothesize, we know the essence of things i.e. that human action is conscious and purposeful. Hence, in economics we do not have to set a hypothesis and then test it.

For instance, we know that all other things being equal an increase in the demand for bread will result in the increase in its price. We do not require a statistical verification that this is so.

Minimum wage and unemployment

Given that each individual’s ultimate goal is their life maintenance and wellbeing, a businessperson is unlikely to pay a worker more than the value of the product that the worker generates. If a worker generates per hour a value of $10 towards the business, then the businessperson is not going to pay more than this amount.

If the minimum wage is set at $15 per hour whilst the worker can only generate a value of $10 per hour it will then be illegal for the business to pay the worker less than the minimum wage of $15 per hour.

Consequently, in such a scenario, the business would be forced retrenching the worker since employing the worker for $15 per hour is going to undermine the profitability of the business.

It is only through the increase in capital goods i.e. through the enhancement and the expansion of the infrastructure, that labour could become more productive and earn a higher hourly wage.

We conclude that a policy of raising the minimum wage could backfire and likely to result in more unemployed individuals.

Note that there is no need for statistical studies that are based on complex mathematics to ascertain that the increase in the minimum wage is going to result in the increase in unemployment. All that required is a logical discussion that most human beings could follow.

Conclusions

Contrary to the popular way of thinking, we do not assess a theory in respect to whether it corresponds to the data as such, but on the contrary, we assess the data by means of a theory.

We suggest that there is no need for a statistical verification to establish the effect of the increase in the minimum wage on the unemployment. A simple logical analysis shows that an increase in the minimum wage is going to increase unemployment.

1 David Card and Alan Krueger,1994, “Minimum wages and employment. American Economic Review, vol 84 pp 772-93.

2 David Neumark & Peter Shirley, Myth or measurement: What does the new minimum wage research say about minimum wages and job loss in the Unites States? NBER Working paper 28388 January 2021.

3 Murray N. Rothbard, “Towards aReconstruction of Utility and Welfare Economics”, On Freedom and Free Enterprise: The Economics of Free Enterprise, May Sennholz, ed. (Princeton, N.J.: D.Van Nostrand, 1956), p3.

1 Comment

  • “If a worker generates per hour a value of $10 towards the business, then the businessperson is not going to pay more than this amount.”

    There are certainly some circumstances under which this is not true.

    For example, a particular job which only generates only $10 per hour of value toward the business, but which 1) is absolutely necessary to the business functioning at all and 2) nobody is willing to do for less than some wage higher than $10.

    Or, for that matter, a particular job which is absolutely necessary, but which the effects of on the business are not easily calculated. For example, the janitor who keeps the floors clean so that other workers aren’t slipping and falling on them.

    Labor is like anything else. People don’t want to sell it for any less than they can get, and people don’t want to buy it for any more than they have to pay.

    The claim that wages correlate to the marginal value of labor is true (as a maximum) in the aggregate (that is, an employer can’t afford to pay his work force an aggregate wage that exceeds the value they add to the product) and an attempt to make reality conform to a model rather than the other way around when applied to an individual worker.

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