Recently, Seattle has been the buzz of free market enthusiasts throughout social media and business websites. Soon, Seattle will attempt to implement a “living wage” of $15 per hour. The web has been awash in reports of restaurants and small businesses already closing their doors or , at least, preparing to downsize significantly in anticipation of the new minimum.
Understand, a living wage is nothing more than a glorified minimum wage. It’s a minimum wage with a new, more heart-tugging name. After all, shouldn’t all workers earn enough of a wage that would allow a comfortable lifestyle? Isn’t that some kind of human right? One is to presuppose that living at a certain predetermined level at any given time, is some sort of inherent God given right. Advocates have even gone so far as suggesting The Bill of Rights ought to be amended to include a living wage as a government protected basic right, not unlike the freedom of speech or the press.
I’ve written extensively on the negative effects of minimum wage laws. To be clear, a minimum wage law is nothing more than a mandatory unemployment law. The law clearly implies that unless a worker is able to provide labor services at the minimum level, it is illegal to hire them. In Seattle’s case, in order to secure employment, a worker must be able to provide $15 per hour worth of labor. If the worker only has the skill set to provide $14.50 per hour worth of labor, he or she will be unemployable.
Clearly, such legislation is extremely short-sighted, if not downright naive. Well, intentioned city technocrats are in for a rude awakening once their brainchild is fully implemented. The belief is that wages are just arbitrarily set by employers. They seem to think that an almost two-fold increase in wage minimums will be a net benefit for their residents. The hubris to simply legislate a middle-class wage level as the new bottom without there being a negative impact on prices or labor markets is quite, well, ignorant.
Once we understand how wages are arrived at, and that they aren’t simply pulled out of a hat, then we clearly see how this living wage law will only be a giant net negative for the Seattle residency. To begin, wages are a result of a workers Marginal Revenue Product or MRP. That is, the measurable change in Total Revenue Product when one more worker is hired. If a Total Revenue Product of 100 employees is $10,000/hr and by hiring an additional employee is rises to $10,005/hr then the Marginal Revenue Product for an employee, in this case, would be $5/hr. The additional employee has added $5/hr of production to the firm’s revenue.
In a world where minimum or living wages are not enforced, the employer would offer as low of a wage as possible to increase profits. The risk here is that a competitor may offer a higher wage to bid away the employee. Also, through word of mouth, an employee may learn that his friend gets paid more at another firm and can add competitive pressure by seeking employment at the other firm. They may even ask their employer to be paid a wage commensurate to other workers in the industry. Inevitably, all things being equal, through market competition the employee will arrive at a wage that is pretty close to their MRP.
But we don’t live in a world where minimum or living wages aren’t enforced. In Seattle’s case, a $15 per hour minimum would certainly spell unemployment for the employee in our example. A business would go broke paying workers above their MRP. As in most of the restaurant industry, Seattle-based restaurants operate at a very low marginal profit level. Somewhere at or below 4%. The only way to offset such a large labor cost would be to either automate or raise prices. Full-service restaurants are almost impossible to automate at our current technological level and the sharp rise in menu prices would certainly discourage customers from patronizing the business. It would be disastrous for the middle or lower class who already find it increasingly harder to find affordable dining in Seattle. Their options would become ever more limited.
Not only the Seattle dining industry but small business will suffer as well. Most retailers operate at low marginal profit rates as well due to tight competition. Consumers are very price sensitive. When a retailer begins to raise prices to offset the additional labor cost, consumers will go elsewhere for their purchases. Those businesses that already pay at or above the new living wage requirement will be in the best position to capitalize on the failing smaller competition. The end effect being higher prices, fewer businesses and thus employment opportunities and fewer choices for consumers. It’s hard to find any net benefit in all of this market intervention.
Advocates for minimum or living wages say they are acting out of compassion for low-skilled workers. Seattle won’t appear to be very compassionate after throngs of lower-skilled workers, many of which are young people, begin to lose their jobs. In the long term, this may be a net positive for the surrounding communities. The outlying suburbs are now in a position to pick up the businesses that end up leaving the city in search for a more friendly business environment. At any rate, free market advocates will be watching Seattle with bated breath as the living wage becomes a hard hitting reality. We certainly haven’t heard the last of it.
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