Minimum wage laws: Why a government cannot legislate a nation into prosperity

Despite irrefutable evidence to the contrary, governments still remain tied to the idea that you can legislate a nation into prosperity. And the resurgence of political support for minimum wage restrictions highlights this misguided philosophy.

Six years after the crash, we are beginning to see a return to on-trend growth in major economies. The US in a cycle of tapering its quantitative easing asset purchases, citing an improving economic outlook. The UK has seen a consistently robust run of economic data through the second half of 2013 and continuing into this year, with the IMF forecast for economic growth placing the UK second only to the US.

The headline rate of unemployment stands at 6.70 percent according to US Bureau of Labour Statistics data released from January. The figure represents a drop from 7 percent November and is part of a longer-term declining trend in unemployment.

UK unemployment now stands at 7.1 percent, close to crossing the threshold set out by Bank of England Governor Mark Carney as the rate below he would consider the economy to have sufficiently dropped to consider hiking interest rates.

While headline Eurozone unemployment remains at 12 percent, there is some sign of improvement in the labour market, with the number of unemployed falling by 129k in December, the biggest drop since 2009.

But while headline unemployment rates are showing a broadly declining trend, under the surface things are not quite so positive. In the ultra-loose monetary environment pursued by central banks following the crash, monetary expansion has acted as a tax on savers while exerting downwards pressure on real wages as inflation outstrips wage growth. As a result, individuals (voters) may see rosy economic news on the six o’clock news. But they feel poorer than they did last year.

As a result of this, we have seen a resurgence in demand for implementation or hikes in minimum wage laws.

In last month’s State of the Union address, US president Barack Obama called for a “year of action”. As part of this, he proposed an increase in the Federal minimum wage from the current USD7.25/hour to USD10/hour, with the hike to be phased in over two years. He also set out plans to raise Federal contract worker wages by executive order. The announcement followed minimum wage hikes in 13 states introduced on 1 January 1014.

In the UK, where the decline in real wages has been particularly noticeable, Chancellor George Osborne has said he wants to see an above-inflation increase in the minimum wage. He claimed that the improving UK economic outlook meant that the “economy can now afford” to hike the minimum wage.

But the arguments in favour of raising the rate labour price controls are fundamentally flawed. The calls for minimum wage hikes also epitomise the flawed approach to the economy that has dragged on real economic growth throughout developing economies. Rather than meaningful supply-side liberalisation and through a downsizing of government, we have instead seen an increase of central planning and attempts by bureaucrats to legislate a nation into prosperity.

Instead of removing government obstructions to private enterprise, European policymakers have instead seen the contraction in business lending within the Eurozone as a demand-side problem that can be fixed with European Central Bank monetary policy. Rather than allowing businesses to operate under the conditions that attract lending, they have instead tried to free up conditions by ever-lower borrowing rates.

And the same is true of the labour market. Rather than cutting taxes, removing legislation and allowing economic activity to rise, pushing up wages, policy makers have instead approached the problem with centrally planned labour price controls.

But by instituting a minimum price below which a person’s labour cannot be employed, you are placing a floor on the labour market, pricing low skilled labour out of the market.

Some proponents of hiking the minimum wage cite the inelasticity of the demand for low-wage labour. However, the biggest response to that argument is increasingly found in supermarkets and McDonalds restaurants. As minimum wage laws price low-skilled service sector labour out of the market, they have instead been replaced by automated self-service machines. And as wage controls are increased, so will employers’ focus on finding substitutes for artificially mis-priced labour, shifting instead to more labour-saving methods of production.

The government control of the price at which a person can sell their labour violates their freedom as an individual. Even if the individual wishes to sell their labour to an employer at a price that both parties deem to be mutually beneficial, they are prohibited from doing so by state controls.

If a person is capable of providing USD9 an hour of economic benefit to a business, pushing up the price at which they can be employed does not increase their worth to the employer. In circumstances such as supermarket checkouts where there is a clear substitute for overpriced labour, the result is that fewer workers will be unemployed.

However, in industries where low skilled labour demand is more inelastic, the employer forced to employ a worker that provides USD9-an-hour of economic benefit at USD10-an-hour will instead have to make up that shortfall elsewhere.

As Frédéric Bastiat writes in his 1850 essay “That Which is Seen, and That Which is Not Seen” - “Between a good and a bad economist this constitutes the whole difference – the one takes account of the visible effect; the other takes account both of the effects which are seen and also those which it necessary to foresee.”

It is in Bastiat’s “not seen” that lies a further damaging effect of state restrictions on labour prices. A factory owner may have intended to make capital investment in machinery to increase productivity or quality of his output. But because of the higher price that he is now being forced to pay for labour that does not bring a corresponding economic benefit, he instead does not make that investment. The result of which is constrained productivity or quality and so a reduced competitiveness compared to those countries in which labour can be freely exchanged without government control. This will ultimately export jobs to those more free economies.

A government cannot legislate a person’s economic value to be greater. No country has ever taxed itself into prosperity. But despite this, the rhetoric surrounding minimum wages shows that governments have not let go of the idea that the central planner can better organise resources better than the market or that the individual should be able to form voluntary agreement with the employer to price his labour. And until there is a fundamental shift, private enterprise and individual freedom will continue to be held back by the meddling of the bureaucrat.