Every so often--usually for political reasons--we see talk about raising the minimum wage. It is a touchy political subject, not so different from social security. Both are a bad idea and destined to failure but no-one wants to be seen as the "bad guy" that goes against either one.

There are both philosophical as well as logical and economic problems with the concept of a minimum wage and I will discuss these here.

Philosophical Problem with Minimum Wage

The free market economy is based on the free exchange of goods and services. One side offers a particular product at a given price and the other decides whether or not to accept that price; if the price isn't accepted, a negotiation may ensue to reach a mutually agreeable price to consummate the transaction. The labor market is no different than the market for any other goods. Someone has an asking price and the other side either accepts it or attempts to negotiate. The best interests of both sides will generally lead to what neither side considers to be a perfect deal, but which is reasonably acceptable to both sides.

Philosophically, many people believe (and objective study of economy seems to support) that the free market should remain free. The market is most efficient when it is allowed to work freely. Government regulation of the free market should exist primarily to ensure that the free market remains free and that no participant is allowed to wield an unfair level of power that basically would inhibit fair bargaining in the market. The government's participation in the free market, then, is only to protect the market from egregious abuses.

For example, society--and therefore the government--has a compelling interest to highly regulate monopolies because such markets do not conform to the normal free market "rules." A monopoly can theoretically charge any price it wants because there is no real competition. For this reason, the government closely monitors monopolies to try to prevent these market abuses.

A minimum wage is essentially the government meddling in the labor market with arbitrary price controls. As will be explained below, price controls are generally a bad idea in any market--and the labor market is not particularly different. The only difference is that the labor market is essentially the market of human effort and time. In a worst-case extreme scenario, employees with no bargaining power and an employer with overwhelming bargaining power could essentially make its employees slaves. This is exactly what happens in U.S. sweatshops were the employees are made of illegal immigrants that are desperate to remain in the U.S. Due to the employees' illegal status, they have no bargaining power so the employer can dictate the terms and conditions. This leads to an unacceptable situation akin to slavery.

The minimum wage, if we agree we are to have one, should exist solely to protect employees from outright exploitation. As I'll explain below, we cannot legislate prosperity. As such, philosophically, we may accept that we have a minimum wage, but it should not be a "livable" wage--it should be the absolute minimum level of pay that, below which, we as a society believe it is unconscionable to expect a human being to work.

Economic Problems with Minimum Wage

There are a number of objective, factual, and logical reasons why a minimum wage--other than to prevent outright exploitation--is bad idea. With some Democrats talking about a minimum wage of $9.50 an hour by 2011 , it's critical that we, as a society, start informing ourselves about the economic truth regarding minimum wage. It's easy to support a minimum wage with the good intentions of supposedly helping the poorest in our society, but it turns out that minimum wage increase tend to hurt those people, and the economy, and only really help the politicians that attempt to score political points with the voting public that isn't informed about the realities of minimum wage hikes.

Minimum Wage is a Price Control

Minimum wage is a price control, pure and simple. It's an artificial and arbitrary minimum price that the government states must be paid for a specific commodity--specifically, a person's time.

Economists are generally opposed to price controls, except briefly during emergencies, because when the government fixes prices in the free market, bad things usually happen . When you arbitrarily adjust the price of a product based on anything but supply and demand, a situation is created where demand is too high and supply is too low. This is what creates long lines and scarcity of product. Consumers would be willing to pay more which would motivate producers to produce more to increase profit, but an arbitrary government mandate limits the price. So even though consumers would be willing to pay more and producers would be willing to produce more, supply is artificially limited which results in some consumers getting a real good price, but the rest are left without any product at any price. During the 1970's, the federal price caps on gasoline is what lead to the long gas lines--not a lack of gas.

Of course, if a price cap mandated by the government is below the cost of producing that product, producers will simply stop producing and selling their product. The alternative is to lose money with every sale. That is exactly what has been happening in Zimbabwe where its president, Mugabe, has instituted arbitrary price caps to try to control run-away inflation. The result has been that store shelves have been left bear of their products and there are acute gas shortages due to Mugabe mandating the sale of gas at half the price it costs to import. The result is an unsustainable situation that will eventually lead to the collapse of the economy in Zimbabwe and/or Mugabe being removed from power by his people .

Price controls are dangerous and almost always counterproductive. The same is true when it comes to minimum wage.

The government cannot determine the value of a service offered by an employee. Only an employer and an employee can arrive at that determination. By establishing a minimum wage, the government is effectively dictating a minimum value for someone's service that very well may not reflect the value of that service to the employee or society. That is, the value of the employee hasn't increase simply because the government has mandated it as such. The employer, then, will have to pick one of three options: 1) It may compensate by laying off some of the employees that have suddenly become more expensive. This will cause hardship to those that are laid off and will cause those that remain employed to have to work harder. 2) The employer may compensate by increasing the prices of its product or services to its customers. This will increase the cost of living for all its customers which in turn increase their prices to their customers. The inflationary effect ripples through the economy. 3) The final alternative is for the employer to pay the additional labor costs out of its own profit. There is little or no incentive to do this, however, and it's likely that it seldom happens. In those few cases that it does happen, the higher operating costs will still be factored into the next price increase the company institutes. So, ultimately, even if a minimum wage hike initially comes out of company profits, it will eventually be passed on to the customers.

Minimum Wage Hikes are Inflationary

Despite what some minimum wage proponents will say, minimum wage hikes are inflationary. When you increase costs on a business, the prices they charge their customers definitely don't go down. In some cases, businesses can't increase their prices immediately due to competition; but in other cases a business can and will increase their prices to compensate for their increased operating expenses. And even if a business can't immediately increase its prices due to competition, the minimum wage increase will also lead to increases in the costs for the competitors. Over time, the increased costs in the industry will lead to industry-wide price increases.

If prices go up, that is by definition "inflation." Increases in labor costs inevitably lead the company to increase its prices which is inflationary. This cause-effect relationship is crystal clear world-wide .

Minimum Wage Hikes Cost Jobs

While the inflationary effect of minimum wage hikes is hard to quantify, there can be no doubt that increasing minimum wage costs jobs.

If a business has $9,500 a month available to spend on labor, that's enough to fund 10 full-time employees at minimum wage. If the minimum wag is increased to $7.25, the employer only has enough money to hire 8 full-time employees. The employer doesn't automatically have more money available just because the minimum wage has increased. Unless the employer is able to increase employee productivity, he will either have to let two of the employees go or ask all of them to start working less than full-time.

As such, there can be no doubt that increasing the minimum wage results in more unemployment among those that are earning the minimum wage. Minimum wage hikes hurt the very people they are supposedly implemented to help!

The Minimum Wage Paradox

Those that support minimum wage hikes will often claim that such hikes do not cost jobs and are not inflationary. This is patently absurd and defies all logic. If that were true, we could just make an arbitrary decision to make the minimum wage $100/hour and we'd all be rich. Obviously that's not possible. It wouldn't work. It would lead to the collapse of most companies and/or extreme inflation. If it were possible to legislate prosperity, we'd certainly do it and be instantly rich. The fact that we don't do it and the fact that even supporters of minimum wage hikes recognize this would be a silly proposition is evidence that they know there isn't a free lunch and that minimum wage hikes are inflationary and contribute to unemployment. If it weren't, why wouldn't they just propose a $100/hour minimum wage?

The reason, plain and simple, is that there is a cost to pay. We pay for increases in the minimum wage with higher consumer prices (inflation) and with higher unemployment. Every increase in the minimum wage raises prices and costs jobs. It's not like we can raise the minimum wage to $15/hour with no negative impact but when we raise it to $15.01 there is suddenly job loss. The more we increase it, the more inflation and the more unemployment.

Increasing the minimum wage from $5.85 to $7.25 will cause less inflation and cost fewer jobs than raising it to, say, $10.00/hour, but even raising it to $7.25 will increase inflation and will cost jobs. There's no two ways about it. Anyone that says otherwise has a political agenda.

The Concept of a "Livable Wage"

Something that has been talked about more and more lately is the concept of minimum wage providing what people consider to be a "livable wage." They believe it is the job of the minimum wage to make sure people can actually "live" somewhat comfortably on that. I submit that that is not the purpose of the minimum wage--and shouldn't be.

The minimum wage should be a wage to prevent absolute unconscionable abuse. Minimum wage should be for people that are just entering the job market and are still getting education. No-one should be trying to live off minimum wage, much less raise a family on that wage. And very few do.

America is based on people working hard and striving to do better. That requires effort and constant betterment of individuals and society. If people are earning minimum wage and want to do better economically, they should not be waiting for the government to give them a raise. They should be spending time educating themselves and learning new skills so that they can find a better job and earn a better wage on their own merits. Instituting any kind of a "livable wage" will only reduce the motivation of people to truly better themselves.

The Honest Truth About Minimum Wage

When you cut to the chase, the real truth about minimum wage is that it costs jobs of those people it purports to help, and causes inflation in the general economy. Both of these are negative to the economy.

As such, minimum wage should simply exist to prevent blatant abuse of employees. The purpose of minimum wage is not to guarantee a comfortable standard of living to every American, nor is it even to guarantee they will not be poor. It is simply to guarantee that Americans will not be unconscientiously abused as if they were working in third-world sweatshops. Success, betterment, and climbing the ladder of success out of poverty is something we must leave to individual effort. It can only be achieved through individual perseverance and hard work--not by government-mandated pay raises in the form of minimum wage increases.