Why a Higher Minimum Wage Can Result in a Lower Unemployment Rate

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Those who argue in favor of raising the minimum wage often point to examples of when the unemployment rate fell after the government increased it. One reason why this can happen is the unemployment rate only includes people who are actively looking for work. As a result, the more people who give up looking for work, the lower the unemployment rate will be.

One of the most popular statistics reported by the government is the unemployment rate: “the percentage of the total labor force that is unemployed.”1 However, this statistic is not an accurate measure of unemployment. If a person has not searched for a job in the past four weeks, they are no longer counted as a member of the labor force.2 The U.S. government classifies them as a discouraged worker: someone “who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment.”3 If a higher minimum wage results in companies laying off employees or hiring fewer new ones, then more people will become discouraged workers. Although increasing the minimum wage is supposed to help reduce income inequality, it can have the unintended consequence of driving more people out of the labor force due to a lack of job opportunities. Ironically, this can cause the unemployment rate to go down.

To measure the true economic impact of a minimum wage increase, the labor force participation rate is a better statistic than the unemployment rate. The labor force participation rate is “the percentage of the population that is either … working or actively seeking work.”4 For example, in June 2015, the U.S. added 223,000 jobs, and the unemployment rate fell to 5.3% from 5.5% in May.5 However, the size of the labor force decreased by 432,000 as the labor force participation rate fell to 62.6% from 62.9%.6 The unemployment rate fell by .2%, but the labor force decreased by .3%. The unemployment rate went down because of the sharp increase in the number of discouraged workers.

While a higher minimum wage can sometimes result in a lower unemployment rate, forcing companies to pay a higher price for labor will not benefit all workers. According to the law of demand, “all other factors being equal … the higher the price, the lower the quantity demanded.”7 If all other factors remain the same, the higher the price of minimum wage labor, the less hourly units of labor a company will purchase from workers. Raising the minimum wage is an economic policy that is motivated by good intentions, but it will not produce good results for everyone who wants a job.

Notes

  1. Investopedia, s.v. “Unemployment Rate,” accessed May 10, 2016, http://www.investopedia.com/terms/u/unemploymentrate.asp
  2. “Labor Force Characteristics,” U.S. Bureau of Labor Statistics, accessed May 10, 2016, http://www.bls.gov/cps/lfcharacteristics.htm#discouraged
  3. Investopedia,v. “Discouraged Worker,” accessed May 10, 2016, http://www.investopedia.com/terms/d/discouraged_worker.asp
  4. “Labor Force Participation,” U.S. Bureau of Labor Statistics, accessed May 10, 2016, http://www.bls.gov/bls/cps_fact_sheets/lfp_mock.htm
  5. Claire Zillman, “U.S. economy adds 223K jobs in June as unemployment dips to 5.3%,” Fortune, July 2, 2015, http://fortune.com/2015/07/02/june-2015-jobs-report-unemployment/
  6. Ibid.
  7. Investopedia, s.v. “Law of Demand,” accessed May 11, 2016, http://www.investopedia.com/terms/l/lawofdemand.asp

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How a $15 Minimum Wage Creates Winners and Losers

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In the United States and Canada, many municipal, state, and provincial governments are raising the minimum wage to $15 in the hope of reducing poverty and income inequality. Unfortunately, good intentions do not always produce good results. Raising the minimum wage to $15 will create winners and losers in the job market because of a basic economic principle: the law of demand.

According to the law of demand, “all other factors being equal … the higher the price, the lower the quantity demanded.”1 For example, if the cost of an airplane flight to Hawaii increases by 25%, consumers will demand less plane tickets. Minimum wage labour is not immune from the law of demand because labour is a service purchased by companies. If all other factors remain equal, the higher the price of labour, the less hourly units of labour a company will purchase from workers.

The central problem with raising the minimum wage is the government can control the wage, but companies control the number of hours that they buy. The consequence of increasing the minimum wage to $15 is some workers will receive a wage increase with little or no reduction in hours, while other workers will have their hours reduced or be laid-off.

When the government increases the minimum wage, a company has numerous options to reduce labour costs. These include

  • Reducing its hours of operation.
  • Reducing the number of staff working per hour.
  • Hiring part-time employees instead of full-time and no longer paying benefits.
  • Relocating to another state, city, or country where wages are lower.
  • Investing in labour-saving technology.

Advocates of a $15 minimum wage believe that companies can simply pay for the increased labour costs out of their profits. While many large, successful corporations might be able to afford to pay some (or all) of their workers $15 per hour, this does not mean that all companies can do so and remain profitable, especially smaller businesses. More importantly, if a company cannot make a profit due to increased labour costs, it will go out of business, and workers will earn $0 per hour.

While advocates of a $15 minimum wage believe it is about achieving fairness for workers, forcing companies to pay more for labour has unintended consequences. The most experienced and productive workers might earn more, but inexperienced and less productive workers will earn less. At $15 an hour, there are many workers that companies will no longer employ (or hire) because they can’t make a profit from their labour. In the private sector, making a profit is more important than what is “fair” for workers. Profits are to a company what blood is to the human body. Without profits, a company cannot exist.

Notes

  1. Investopedia, s.v. “Law of Demand,” accessed April 10, 2016, http://www.investopedia.com/terms/l/lawofdemand.asp

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