How Special-Interest Groups Benefit from Minimum Wage Laws

Guest post by Gary Galles

Those campaigning for a “living wage,” or a substantial jump in the minimum wage, all assert that the purpose is to help working families. Unfortunately, careful students of the evidence come to a different conclusion. As Mark Wilson summarises it, “evidence from a large number of academic studies suggests that minimum wage increases don’t reduce poverty levels.”

Some workers lose jobs (high minimum-wage places have among the highest unemployment rates); others have hours cut. The least-skilled get competed out of the jobs that remain (e.g., the minimum wage hits teenage employment hardest). It crowds out on-the-job training, impeding workers’ ability to learn their way out of poverty. And those effects are worse in a recession.

It also raises costs and prices that workers pay as consumers.

How can we explain support for a policy that harms people supporters say they wish to help? We explain it by focusing not on low-income workers, but their substitutes.

Consider an analogy. If the price of ice cream was pushed up, earnings of ice cream producers might go up or down, depending on how much less was bought as a result. But producers of frozen yogurt, a substitute for ice cream, will definitely benefit, because a higher price of ice cream will increase demand for frozen yogurt, clearly benefiting its producers.

Similarly, increasing the minimum wage will raise the cost of hiring low-wage workers. And while it might actually hurt low-wage workers, it will help each substitute for low-wage labour by increasing its demand. Thus, what may best explain support for higher minimum wages is not compassion for the working poor, but the narrow self-interest of those offering substitutes for low-skill labour.

Unions top that list. [Which is why union blogs The Standard and The Daily Blog support them.]

A higher minimum wage increases the demand for union workers by reducing competition from lower-skilled workers. For instance, if the minimum wage was $15 and the union wage was $30, employers give up 2 hours of low-skilled work for every union worker-hour utilized. But increasing the minimum to $20 means employers give up 1.5 hours of low-skilled work for every union worker hour.

Union employers benefit as well, because the higher costs imposed on non-union competitors raise the prices they must charge, increasing demand for union employers’ output.

This can also explain why other “altruists” support higher minimum wages.

Other beneficiaries are non-union workers and employers in high cost-of-living areas, where virtually everyone earns above the federal minimum wage, – they benefit by raising the cost of production imposed on rivals where wages are lower (which is why many in high-wage areas in the U.S. favour higher federal minimum wages, while those in low-wage states — the alleged beneficiaries — often oppose them). Workers and producers where state minimum wages exceed the federal minimum also gain because it raises the cost of production where the federal minimum is binding, relative to where they are located.

Because all these substitutes for minimum-wage workers will see increased incomes, businesses and politicians in those locations will also benefit, and so join the bandwagon pushing for “doing good” in a way that directly benefits them.

Even Wal-Mart benefits from this effect. Because Wal-Mart already pays more than the federal minimum, in low-wage areas a federal minimum-wage increase raises competitors’ costs, but not theirs. In high-wage areas, supporting a higher federal minimum wage is a costless way for Wal-Mart to demonstrate compassion for workers.

Virtually everyone who supports higher minimum wages asserts their intent to help working families. But it may frequently be a false compassion whose common denominator is advancing one’s own self-interest while harming working families. That would also explain why so many are unwilling to seriously consider whether such compassion actually works, rather than just sounding good.

The same mechanism is at work in the depression-era Davis-Bacon Act, which is still in force. It required the payment of “prevailing wages” on any project that received federal money. But its genesis was the explicitly racist intent to exclude lower-cost southern firms employing black workers from underbidding local white workers for construction projects, by forcing them to pay their workers more.

A similar illustration came from South Africa, under apartheid. White labour unions backed “equal pay” laws for blacks and whites in the guise of helping black workers. But what it really did was raise the price of hiring blacks, who had less education and fewer skills on average, as well as being discriminated against, relative to the price of hiring whites. Whites gained, but black unemployment jumped as a result of that “compassion” on their behalf.

Another illustration from outside the labour market is the support of corn farmers, corn syrup processors, and those in their communities for restrictions on sugar imports from other countries. By substantially raising the price of sugar in the U.S., the policy has driven many candy makers and the jobs they create outside the U.S., harming those workers and their communities. But it has raised the price of a substitute for corn syrup, increasing demand for corn syrup and the inputs that go into making it, benefiting those in corn-producing states.

Most people don’t seem to recognize this clearly self-interested mechanism behind support for supposedly compassionate or altruistic policies to benefit others, which is why it typically stays under the political radar. But once a person thinks through it, the connection becomes obvious.

Further, it suggests the appropriate test that should be applied in such cases: Whenever someone claims an altruistic reason to support a policy, but it clearly advances their narrow self-interest, the latter effect can explain such support regardless of whether it actually helps the supposed beneficiaries. Therefore, a great deal of cynicism is justified. And when their “story” for how supposed beneficiaries are helped cannot stand the slightest real scrutiny, as with the current minimum-wage campaign, there can be no doubt that such cynicism is justified.

Gary M. Galles is a professor of economics at Pepperdine University, and the author of The Apostle of Peace: The Radical Mind of Leonard Read.
This post first appeared at the Mises Daily.