Why Raising the Minimum Wage Raises Unemployment, Too


Minimum wage workers around the country, including workers in South Carolina, made headlines recently when they protested in favor of higher wages. “America can’t survive on $7.25,” many of the signs read. The signs were of course in reference to America’s federally mandated minimum wage. While many states have enacted state minimum wage laws above the federal minimum, South Carolina (like many others) has not. There are, however, efforts underway in South Carolina to raise the state’s minimum wage. Several representatives have introduced a bill to raise South Carolina’s minimum wage to $10 an hour.

In any case, it’s worth considering the reasons why state has chosen (up to this point) not to further increase the minimum wage.

To understand the indirect effects of the minimum wage, we first have to understand the one direct, legally enforced, effect of the policy. The minimum wage is not a legally enforced pay raise for anyone. The only direct effect of the minimum wage is to prohibit voluntary employment at a wage rate below the minimum. With the minimum wage law in existence some potential employer and employee will be unable to enter into relationships that would benefit them both. The indirect effect of a minimum wage or minimum wage increase, then, is to increase unemployment by removing opportunities. With this in view, we can start to trace the reasons for the indirect effects of the policy.

In the free market, workers are paid according to the value they produce and they will tend to be paid right at this value level. This is due to the fact that if one company pays an employee for less than his or her productivity warrants, another competitor will bid that employee away with a higher wage. Just as the market will help to ensure that workers are not long paid below their productivity, so it ensures that workers are not paid above this level. When a minimum wage law or increase of an existing minimum wage comes into effect, it will effectively price out of the market all potential workers who are able to create less value than the mandated wage. Businesses are not charities and will not voluntarily incur reduced profits or losses (and lower consumer satisfaction, which is indicated by profits and losses) simply to pay workers more than their productivity warrants. Any business that did take such a course would not be able to compete successfully in the long term against rivals that paid workers based on their true productivity.

Depending on the extent to which they are dependent on minimum wage labor, companies faced with an increasing minimum wage may begin to invest more in capital (machines) than labor (workers) to do the same tasks that labor once did. Alternatively some companies may simply be forced to downsize or even shut down due to their inability to absorb the new imposed costs.

The minimum wage indirectly increases unemployment by depriving low skilled workers (a group which includes the youth who have not yet had time to acquire skills) of opportunities to work at wages justified by their productivity. This removal of opportunities has the further effect of perpetuating lifetime cycles of poverty. Minimum wage laws, by prohibiting employment at certain wages, keep the young and relatively uneducated (often overlapping groups) from acquiring real-world skills that they could then put to use to justify pay increases. Some of the most comprehensive reviews of the economic literature have revealed a near unanimous consensus on these negative effects of increasing the minimum wage.

Some may object that businesses could increase their wages simply by raising the price of their products. Leaving aside the fact that companies that pay minimum wage are also often those where minimum wage earners shop – meaning that a price increase would cancel out the wage increase – such a shift is not possible. Businesses set their prices at a profit maximizing point where supply meets demand. If businesses decided or were forced to raise their prices from this point, the loss of consumer demand (sales) would outweigh any gains from increased profit per item/unit of service. We have to remember businesses exist (from the owners’ point of view) to make profits: if a business could raise its prices without hurting profits, it would do so without waiting for any legislatively imposed cost increase.

Even those who don’t believe in the unemployment effects of a minimum wage increase implicitly admit its logic. If raising the minimum wage wouldn’t cause unemployment and would improve the lives of the poor, why should we be content with $10 an hour? Why not $20 an hour or $50 an hour? The answer, of course, is that companies wouldn’t hire many low-skilled workers at these wages. If a company is faced with the choice between hiring a relatively unproductive worker at a wage above his or her value, or not hire that worker at all, the company is far more likely to do the latter.

All of the economic laws laid out here apply in South Carolina just as they do anywhere else. The higher the imposed minimum wage, the greater the degree of governmentally imposed unemployment will be. As South Carolina is in the top half of states when it comes to the percent of employees making minimum wage, it would suffer greater negative employment effects than many other states were it to further increase the minimum wage.

A better choice than raising the minimum wage would be to abolish it altogether.

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