The Rising Minimum Wage

As an increase in the minimum wage in 20 states and more than 20 individual cities takes effect, according to the AP, this is an excellent time to review economic understanding.

My two primary rules of thumb about economics are: only people really have money and there is no magic money tree.

The idea that only people have money helps trace the flow of dollars back to our own wallets and helps to anticipate unexpected consequences of changes. Most people think the government and businesses also have money, but where do they get their money? They collect from people, their taxpayers and customers. Then they hold the money and eventually spend it. Governments have budgets for spending on employee pay and their various services and grants. Companies pay employees, buy raw materials or otherwise spend it to keep the business functioning. If they need more, they either borrow or raise taxes or raise prices or try to be more efficient. Except for the government printing more money, which affects people by lowering the value of the money they hold; the needed money always comes from people.

The second idea is related: there is no magic money tree. Money must come from somewhere. It doesn’t materialize out of thin air.

So the AP piece about the minimum wage starts with a story of a small restaurant in Missouri anticipating the need to raise prices slightly to account for the minimum wage increase. As the owner rightly says, “For us it’s very simple. There’s no big pot of money out there to get the money out of.” The companies that sell them food or napkins will not decide to just charge them less. The utilities will not lower water and electricity rates. It must come from the customers as 5 cents here and 10 cents there. The wait staff worries that patrons will notice, and compensate with lower tips or stop in less often. 

That is typically the way it works, prices go up or businesses make other changes. Again from the AP article, “Economic studies on minimum wage increases have shown that some workers do benefit, while others might see their work hours reduced. Businesses may place a higher value on experienced workers, making it more challenging for entry-level employees to find jobs.”

Some studies focusing on Seattle, an early adopter of minimum wage increases, have shown mixed results. There was little effect from a 2015 increase to $11 and conflicting reports on subsequent increases. Defenders of the increase rely on a later study showing only a modest reduction in hours and a small increase in take-home pay. In this case economic understanding urges us not to pass off any increase as harmless, but instead to ask what other factors may have been at work, and will these other factors be able to similarly moderate future increases or will there be a tipping point? It can't go on indefinitely with no effect unless everyone is already earning above the minimum wage.

We know there is no magic money tree. Only people have money. And when the prices go up (or the portion sizes go down like they do on many grocery store items) to cover the increased cost of business, the customers will make decisions – pay more or patronize less. If they pay more, they will have less money to spend elsewhere. If they patronize less the workers will feel the effects of less business. It’s a pretty simple choice.