Yes, the Minimum Wage Harms the Economy
The 2021 Nobel Prize in Economic Sciences was awarded to David Card, Joshua Angrist, and Guido Imbens. David Card received the award for his paper (coauthored with Alan Krueger) “Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania.” This was used by some as scientific proof that the minimum wage does not create unemployment and should be raised. However, this is untrue, and even Card and Krueger do not draw this conclusion.
Why the Minimum Wage Creates Unemployment
According to Austrian economic thinking, the scientific method (isolating variables and changing others to verify the possible relationships between them) is not applicable to economics, which is not a natural science.
Instead, Austrian economics relies upon praxeology, the study of human action, which is complex and not very predictable since one cannot use control variables in this context. It is only possible to carry out “pattern predictions” as F.A. Hayek explains and Jesús Huerta de Soto mentions in this book:
These predictions are of an exclusively qualitative and theoretical nature and refer to the prediction of mismatches and effects of lack of social coordination caused by institutional coercion (socialism and interventionism) that is exerted on the market.
Here are some examples:
- The increase in the money supply tends to cause prices to increase, but it is not possible to know exactly what the level of price inflation will be. The government releases several price inflation indices, but for many reasons, they do not represent the actual price.
- Taxes harm the economy because the government wastes resources in unnecessary and unsustainable ventures since the government does not operate under the profit/loss mechanism.
- Artificially low interest rates create malinvestments that lead to business cycles. This prevents efficient resource allocation since interest rates do not represent real time preferences.
The minimum wage is a barrier to entry for people with little or no work experience or skills. If the minimum wage is above the value that a person creates, there will be no incentive for the company to hire.
Thus, like other government interference in voluntary transactions between an employee and an employer, the minimum wage harms the weakest party of the transaction. The employee gets a lower salary (since the company must bear these costs) and consumers ultimately pay higher prices. The cost of any imposed law or of a voluntary transaction is always paid by the weakest party in the transaction.
The freer the market, the greater the degree of competition or potential competition. Companies must invest in productivity to lower their prices. The freer the market, the better the working conditions that companies must provide. After all, if there is a high degree of competition or potential competition, it is easy for another company to attract professionals by providing working conditions that are at least a little better.
All labor costs and regulations make hiring more expensive. Thus, the higher the salary (generally in jobs that require specific training), the higher the cost of the employee, and the lower the chance less experienced people will start a career. To offset the cost, companies will only hire the most experienced and skilled people.
It can be argued that the minimum wage in Germany is €10.50 per hour, and Germany has a lower unemployment rate than Portugal, which has a minimum wage of €4.75 per hour. However, the minimum wage is not the only government intervention in voluntary transactions. According to the Heritage Foundation, Portugal is less economically free than Germany. Portugal also has a higher public debt to gross domestic product ratio.
Germany is not much more economically free than Portugal, but Germany is free enough for the Germans to be more productive than the Portuguese. Thus, a minimum wage of €10.50 per hour in Germany does not do more damage than a minimum wage of €4.75 per hour in Portugal, which has a weaker economy.
Card and Krueger’s Case Study
Card and Krueger’s paper analyzes the effect of the minimum wage on the fast-food industry in Philadelphia (a city split between Pennsylvania and New Jersey). In April 1992, the minimum wage in New Jersey was raised from $4.25 per hour to $5.05 per hour. Pennsylvania’s minimum wage did not change at the time.
Therefore, Card and Krueger chose a “natural experiment” (mentioned in Joshua Angrist’s and Guido Imbens’s studies), a situation that occurs spontaneously but allows for an experiment. Two examples of natural experiments include the Cold War separation of East and West Germany and the separation of North and South Korea. Note that natural experiments, unlike experiments in the natural sciences, cannot be controlled. They are also neither spontaneous nor natural as they did not occur by individuals’ choices. But it is possible to observe some differences between each variable (the sides of each territory).
Card and Krueger’s study examined the side of Philadelphia with a minimum wage increase (New Jersey) and the side with an unchanged minimum wage (Pennsylvania). Normally, there should be an increase in unemployment on the New Jersey side, correct? The paper shows that, in fact, there was a small increase in employment. Why?
In the conclusion, Card and Krueger state that none of the existing models explain what happened: “Taken as a whole, these findings are difficult to explain with the standard competitive model or with models in which employers face supply constraints (e.g., monopsony or equilibrium search models).”
Card and Krueger also note that fast-food prices “increased in New Jersey relative to Pennsylvania, suggesting that much of the burden of the minimum-wage rise was passed on to consumers.” They mentions later that no evidence was found to prove that “the rise in New Jersey’s minimum wage reduced employment at fast-food restaurants in the state.”
The paper also shows that wages have increased to a median value within New Jersey’s wage range. Therefore, some businesses were already paying more than the new minimum wage, and the increase did not make much difference. But this happened specifically in the fast-food industry. There is no evidence that it did not cause unemployment in other sectors or long-term unemployment (including the fast-food industry since the study was limited to a single city using data from two years after the minimum wage increase).
The Consequences of the Minimum Wage Increase in New Jersey
In economics, consideration is given to that which is seen, and that which is not seen. Imagine that the government decides to build a bridge and it raises taxes to do so. We can see people who are employed in the construction and people using the bridge after it is finished. However, we do not see the people who became unemployed, did not get (or got smaller) raises, or the people that were unemployed and could not get jobs because of the tax increase (which forcibly diverted resources that would have been used voluntarily in other ventures).
In the case of the minimum wage increase in New Jersey, we see that there was no increase in unemployment in the fast-food industry, but there are two things we do not see:
- The consumption that individuals had to cut due to the increase in fast food prices
- The reduced revenues in other industries (since consumers had to pay more for fast food), which invested less in increasing productivity (i.e., because they had a harder time maintaining or lowering their prices) and hired fewer or even fired some people
Of course, these are extreme extrapolations. But given that consumers had lower disposable income, these consequences occurred at least to some degree.
The minimum wage creates unemployment and a lack of opportunity for people with little or no work experience or skills. Only if the minimum wage was set below the productivity of all individuals, would it not cause unemployment. This is unlikely since the minimum wage would have to be low enough that it would become irrelevant as a government voting tool.