Feature Article: The predictable consequences of minimum wage laws

Public policy affects people.  While the motivations behind policies may be good and noble, the consequences may not be the ones that were intended, and a vast number of people may be harmed by drastic, unintended consequences.  Therefore, when any policy is introduced, altered, or defended, it is of the utmost importance that its consequences be subjected to critical scrutiny because at the end of the day, it is not the intentions but the consequences that matter. 

The question of minimum wage laws is a case in point.  Minimum wage laws are intended to protect the earnings of certain categories of employees in specific industries.  However, minimum wage laws result in unemployment that affects especially, the young, inexperienced and unskilled individuals. This assertion is backed by years of empirical evidence and economic argument.

When the federal minimum wage law (the Davis-Bacon Act of 1931) was applied as a basis for a mandatory increase in wages in 1938 in the still unincorporated US territory of Puerto Rico, about 120, 000 workers in that territory lost their jobs and pushed the unemployment rate in Puerto Rico to nearly 50%.

More recently, the effects of increased minimum wages in another unincorporated territory, American Samoa, were so pronounced that President Barrack Obama enacted into law a bill that proposed the postponement of increases in the minimum wage scheduled for 2010 -11.  Togiola Tulafono, Governor of American Samoa, told the US Congress in September 2011: “We are watching our economy burn down.  We know what to do to stop it.  We need to bring the aggressive wage costs decreed by the Federal government under control … Our job market is being torched.  Our businesses are being depressed.  Our hope for growth has been driven away.”

In South Africa, where the unemployment rate is 35.9% of the population (7.6 million people), and where 70% of the unemployed are younger than 35, the implementation of minimum wage laws does not make sense.  After the  grudging acknowledgement by the Minister of Labour that  the upwards revision of the South African agriculture minimum wage in March 2013 had resulted in the loss of 2000 jobs with still more job losses forecast, it should be clear that  the country can ill afford minimum wage laws.  This is especially true with respect to agriculture, which is one of the few sectors of the economy which absorbs a lot of unskilled labour.

Businesses faced with mandatory minimum wage laws have few options open to them.  Some may find a way to absorb the costs, but others will have to pass them on to the consumer.  Here, however, they do not have much leeway, because consumers will source competitively priced or alternative products elsewhere, either locally or abroad.  Businesses may also lay off employees and keep only the skilled and experienced ones in order to contain their costs; they may contemplate investing in capital (mechanisation) at the expense of labour. In some cases the owners will decide to sell the business.  The worst case scenario is that the whole enterprise goes bust.

The only saving grace with regard to minimum wage laws is that they protect or raise the wages of the skilled and experienced employees who survive the effects of these economically irrational laws and retain their jobs. The casualties simply disappear into the unemployment statistic and are forgotten.

Because of the minimum wage laws, these fellow human-beings are now denied an opportunity to improve their socio-economic circumstances. They are no longer earning an income, and there is no obvious new source of income on the horizon.  They face starvation, loss of self-respect, low self-esteem and desperation.  A cruel abyss of misery leads desperate people to contemplate desperate things.  

Furthermore, in the process, personal and contractual relationships between employers and employees are undermined by third party interference.  Minimum wage laws violate and undermine the economic freedom of employers and employees to enter into voluntary contractual arrangements. Employees no longer see themselves primarily as an integral part of a business in competition with others.   Statutory measures, such as minimum wages, throughout a whole sector of the economy encourages employees to look to external (state) intervention when they seek to improve their wages and conditions rather than through the pursuit of higher productivity to develop a more effective co-operation and collaboration within the enterprise.   The logic of business becomes compromised and the motivation of entrepreneurs fades.

Developing countries should study the economic policies which enabled countries to mature into developed economies as well as the policies adopted by countries that are fast transforming into developed economies.  It will be found that in both cases economic freedom, which means, above all, a free market, is the common factor that explains their achievement.  In other words, countries with the least government interference in the economy (and therefore the highest levels of economic freedom) are the ones which have already made, or are making phenomenal strides in economic growth and development.  This point is underscored by the empirical studies contained in the annual publications, Economic Freedom of the World (EFW) and the Index of Economic Freedom (IEF)which are published respectively by the Fraser Institute in Canada and the Heritage Foundation in the USA.  High growth economies identified in these publications, such as the United States and Germany until recently, and currently Hong Kong, Singapore, Turkey and Mauritius, have very high scores on the indices of economic freedom. 

Economic freedom also explains the economic success of post-war Germany, which strongly asserted itself as Europe’s biggest economy during the 1950s and 1960s and continues so to the present day.  It is enlightening that cumulatively Germany received $1,448 million, France $2,296 million and the UK $3,297 million in terms of the Marshall Plan. This shows that while the Marshall Plan assisted Germany’s recovery from the devastation wreaked by the Second World War, it was the free market economy that was the bedrock for its recovery.

Economic freedom also explains the meteoric rise of Japan which became the second biggest economy in the world in the 1980s and remained so until surpassed only recently by China.  It is an empirically demonstrable fact that Japan developed not because of government intervention through its Ministry of Trade and Industry, but in spite of it. 

It is not true, as some advocates of interventionism allege, that the phenomenal success of these economies can be ascribed to the interventions of a ‘developmental state’. This claim is effectively rebutted by the EFW and IEF studies among others.  Most economically successful countries embarked on radical free market reforms during or prior to their periods of high growth.  A developmental state, so-called ‘state capitalism’ or state-directed capitalism (a contradiction in terms), the thinly veiled façade which gives some degree of credibility to statist, dirigiste and quasi-socialist policies, have already been discredited by history.   

The road to rapid economic development is predicated upon high economic growth. There is no mystery about this.  High economic growth leads to accelerated economic development and the success or failure of economic development in any country is a consequence of government policy. 

Sustainable wealth and employment are created by private individuals and private firms.  A country which aspires to achieve socio-economic progress for the greatest number of its people in the shortest possible time should pursue policies which enhance economic freedom and desist from implementing policies which curtail it.  A useful and practical start would be to expunge the offending policies - those which encumber the spirit of free enterprise - from the statute books.

In conclusion, it is obvious that if South Africa with its cataclysmic levels of unemployment, prescribes minimum wage laws, the direct consequence will be the institutionalised unemployment of the young, inexperienced and unskilled among the labour force.  Advocacy of minimum wage laws is definitely the moral low ground.  The moral high ground is simply to allow people to exercise their right to choose whether or not to accept work at a given rate, or to try to negotiate a higher rate, or not to work at all.  In the final analysis no amount of altruistic argumentation or fanatical adherence to ideological positions can mitigate the negative effects of minimum wage laws.

Source:This article may be republished without prior consent but with acknowledgement to the author. The views expressed in the article are the authors’ and are not necessarily shared by the members of the Foundation.

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