A Seemingly Good Idea with Bad Outcomes

As of January 1, 2012, the minimum wage in the City of San Francisco will increase to $10.24 per hour―about $3.00 above the Federal minimum wage. To be sure, this is a well-intended move. San Francisco is a very expensive place to live. According to Kiplinger’s it ranks third in the list of most expensive places to live in the US, behind only the New York Metropolitan area and Honolulu, Hawaii. Giving those at the bottom end of the income scale a bit of a boost seems only fair―it seems like the right thing to do. Unfortunately, when government bureaucrats rather than the free market determine wages, there are very negative, if unintended, consequences.

First Order Effects – Jobs will leave the city and unemployment will rise. Think about it. You’re a widget manufacturer in San Francisco. You need lots of low skilled labor to build your widgets. In most of the US, you could hire this labor for $7.25 per hour. In San Francisco, the law forces you, to pay a 41 percent premium over what your competitors, who manufacture widgets elsewhere, pay. You won’t be able to compete. You’re left with two choices: move your production facilities outside of San Francisco, or shut your doors.

Small businesses, which fuel the economy, will be hurt disproportionately. Larger companies can more easily shift jobs to other geographies where they already have operation. Small businesses are more likely to remain local, become uncompetitive due to higher labor costs and ultimately close their doors. Either way, San Francisco loses the jobs. Workers who might have held these jobs will be unemployed. The cost of government entitlements will increase (e.g., welfare, food stamps, unemployment compensation, and Medicaid). Ultimately, these higher costs will be borne by taxpayers.

Second Order Effects – Fewer new jobs will come to the city―even those that would pay well above $10.24 per hour. Here’s why. As explained above, jobs at the lower end of the wage scale that are mobile will leave the city. However, many jobs are not mobile. Fast food restaurant workers, those who clean hotel rooms, and retail store clerks are examples of employees at the lower end of the wage scale whose jobs aren’t mobile. These people will see an increase in their take home pay. Good for them―that was the intent of the law. Some workers currently making more than the new minimum wage will also see increases in their compensation. When employees at the bottom end of the wage scale are bumped up, some of those above them in the economic pecking order will also be paid more so that their relative position will be maintained.

Unfortunately, the story doesn’t end there. Shareholders (like those with 401(k) plans), who legitimately want to see a return on their investment, will not allow employers to accept lower profits. Therefore, the cost increases will be passed on to consumers. The cost of living and working in San Francisco will be pushed even higher. Companies thinking about relocating their executive offices to the city will reconsider because the city will be so expensive. Associations deciding where to hold their national meetings will conclude that the cost in San Francisco is prohibitive. Developers will put plans for building new hotels and office buildings on hold―engineers, architects and contractors will suffer. We could go on and on, but you get the picture. Second order effects will mean fewer jobs in San Francisco at every point on the income scale.

Third Order Effects – In the long run, even those who seemingly benefit from the new higher minimum wage won’t see the improved lifestyle that might be expected. As described above, increasing the minimum wage will drive up the cost of living and working in San Francisco. The purchasing power of low wageworkers will be reduced―$10.24 per hour won’t buy what it used to. Eventually, people at the low end of the wage scale (now defined as $10.24 per hour) will have no more purchasing power than they did to start with. Cries will again go out to increase the minimum wage for those at the bottom end of the scale and the job destroying cycle will begin anew. While the government may be able to legislate a higher minimum wage, it can’t legislate a better lifestyle.

For those who still think that a government mandated minimum wage is a good idea, we have a question. If $10.24 per hour is good, wouldn’t $15, $20 or even $30 per hour be even better? Of course, it wouldn’t! All of the things outlined above would happen―just at an accelerated rate. This would make the inherent flaws in a government-mandated minimum patently wage obvious.

There is an alternative. Let the free market set wages. Employers will pay what they need to pay to fill their jobs with people who have the skills they need. For years, the Federal minimum wage was $5.15 per hour. However, by 2000 even McDonalds paid significantly more than this for entry-level jobs, not because they wanted to, but because they had to in order to fill their positions. A government-mandated minimum wage may seem like a good idea and it may be politically expedient, unfortunately, the economic reality is that it does more harm than good.