Minimum Wage Fallacy

Most developed countries in the world have a minimum wage act. This means that there exist legislations in those countries which make it illegal to hire anybody to do any kind of work unless they are paid at least a certain stipulated amount per hour of their labor. These laws have created immense debates as to whether they are good for the economy as a whole or even the very people that they are intended to benefit?

The prevalent view was that minimum wage laws act in the laborers favor. The short sighted logic aims to emphasize what can be immediately seen i.e. higher wages for people who are employed in jobs now. It fails to take notice of how the situation would turn out in case these laws were kept in place for an extended period of time.

Of late, economists like Nobel Prize winner Milton Friedman have explained the long term effects of these laws. In this article, we will understand the common sense viewpoint and then we will debunk the myth using Milton Friedman’s explanation.

Common Person’s Viewpoint

The common person believes that if the laborer were paid a certain minimum wage they would become prosperous. This is rooted in the communist ideology which views capitalists as profit mongers. The idea is to create a statute which makes it necessary for capitalists to distribute the wealth fairly amongst their workers. The belief held by the common man is that these laws prevent the 1% from gaining at the expense of the 99% and that they are in support of the laborers.

Milton Friedman’s Viewpoint

Nobel Prize winning economist Milton Friedman and many others have a very different opinion on the issue. Milton Friedman has once stated that the minimum wage laws are the most anti labor piece of legislation in America. The basis for his argument is as follows:

  • In the capitalist system, human laborers are used as sources of energy i.e. their purpose is to use physical force and perform certain mechanical or mental tasks. In the assembly line kind of set-up, these tasks are usually pre-defined.

  • With the advances in technology, a lot of these tasks which were earlier performed exclusively by humans are now being performed by machines. Hence human laborers are not only facing competition from humans but they are also facing competition from machines.

  • In such a hyper competitive environment, fixing a minimum wage i.e. a minimum rate at which labor will be sold to the capitalists’ works against the laborers.

  • The capitalist simply compares the rate at which humans can perform the task and the rate at which machines can perform it. If the machines have a favorable proposition, capitalists simply mechanize the entire operation. Hence, if the government makes it illegal to hire a janitor for less than $20 per hour, but a machine can perform the same task for $12 an hour, many capitalists will simply switch over to the mechanized option. Thus the creation of an artificially high wage rate works against the workers as opposed to being in their favor.

Since humans no longer hold the monopoly over performing these energy extensive labor tasks, an attempt to create a cartel by introducing minimum wage laws works against the laborers and all the laborers which have skills that are worth below the minimum wage rate become unemployed. Thus, minimum wages can cause and do cause systematic and institutional unemployment.

Outsourcing: By Product of Minimum Wages

The Milton Friedman logic holds true in the modern era of outsourcing as well. Most of the outsourcing from the developed world to the developing economies today is happening because of what is called the labor cost arbitrage. Labor cost arbitrage is nothing but the fact that workers in developing countries are much cheaper to hire as compared to workers in developed countries.

Developed countries usually have minimum wage laws which make it unlawful for employers to pay below a certain wage rate. Developing countries, on the other hand, do not have such laws. Hence, businesses find it cheaper and more convenient to set up shop overseas. Couple this with the fact that multinational corporations are now the norm and that expanding overseas is as easy if not easier than expanding in your own country and we have a recipe for mass unemployment in countries enacting minimum wage laws.

In a free market economy this would cause the wages of laborers in the developing world to rise while simultaneously causing a fall in the wages of laborers in developed nations until the arbitrage no longer exists. However, the fall of wages in developed nations is not permitted by law. Hence, the outsourcing trend continues. Corporations from countries like America are laying off workers by the thousands in America while simultaneously adding more thousands in China and India!

Conclusion

While it may be too outrageous a comment to make, “Minimum wage laws do seem to be working against the laborers of the country which imposes them”. Workers of such countries find themselves facing competition from the global workforce as well as from advances in technology. None of these factors can be contained by the authorities that enact the wage laws.

The record of history is clear in this regard. Countries that have enacted minimum wage laws have invariably seen a fall in the employment rates.


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