Minimum Wage Increases: Bad for Business?

Written by Doug and Polly White

As of January, the minimum wage in San Francisco increased to $10.24 per hour―about $3.00 above the Federal rate. This is a well-intended move. San Francisco is expensive. It ranks third in Kiplinger’s list of most expensive places to live in the US, behind only New York City and Honolulu. Giving those at the bottom end of the income scale a bit of a boost seems only fair―it’s right thing to do. Unfortunately, when government bureaucrats rather than the free market determine wages, there are negative, if unintended, consequences.

First Order Effects – Jobs will leave the city and unemployment will rise. Think about it. You’re a widget manufacturer in San Francisco. You need many low skilled labors. In most locations, you could hire this labor for $7.25 per hour. In San Francisco, the law forces you, to pay a 41 percent premium. You won’t be able to compete. You’ll have to move out of San Francisco, or shut your doors. Either way, the jobs are gone. Those who might have held these positions will be unemployed. The cost of government entitlements will increase (e.g., welfare, food stamps, unemployment compensation, and Medicaid). Ultimately, these higher costs will be borne by taxpayers.

Second Order Effects – Fewer new jobs will come to the city. Here’s why. Jobs at the lower end of the wage scale that are mobile will leave. However, many jobs are not mobile. Fast food restaurant workers, those who clean hotel rooms, and retail store clerks are examples. They’ll see an increase in their take home pay. That was the intent. Some currently making more than $10.24 will see increases. When low wageworkers get increases, some of those above them in the economic pecking order will be paid more to maintain their relative position.

Unfortunately, the story doesn’t end here. Shareholders legitimately demand a return on their investment. Employers can’t accept lower profits. The cost increases will be passed on to consumers. The cost of living and working in San Francisco will increase further. Companies thinking about relocating executive offices to the city will reconsider. Associations deciding where to hold national meetings will conclude that the cost in San Francisco is prohibitive. Developers will put plans for new hotels and office buildings on hold―engineers, architects and contractors will suffer. We could go on. Second order effects will mean fewer new jobs in San Francisco at every point on the income scale.

Third Order Effects – Even those who seemingly benefit from the new higher minimum wage won’t see improved lifestyles for long. The cost of living and working in San Francisco will go up. Purchasing power will be reduced―$10.24 per hour won’t buy what it used to. Eventually, people at the low end of the wage scale will have no more purchasing power than they did to start with. Cries will again go out to increase the minimum wage. The job destroying cycle will begin anew. The government can’t legislate a better lifestyle.

Still think that a government mandated minimum wage is a good idea? We have a question. If $10.24 per hour is good, wouldn’t $15, $20 or even $30 per hour be better? Of course, it wouldn’t! All of the things outlined above would happen―at an accelerated rate. This would make the inherent flaws in a government-mandated minimum wage patently obvious.

There is an alternative. Let the free market set wages. Employers will pay what’s required to fill jobs. For years, the Federal minimum wage was $5.15 per hour. However, by 2000 even McDonalds paid significantly more for entry-level jobs, because to fill positions, they had to. A government-mandated minimum wage may seem like a good idea and it may be politically expedient. Unfortunately, it does more harm than good.

About the Authors: Doug and Polly White are Principals at Whitestone Partners; a management-consulting firm that helps small businesses build the infrastructure they need to grow profitably. They are also coauthors of the groundbreaking new book, Let Go to GROW; why some businesses thrive and others fail to reach their potential (Palari Publishing 2011). The National Federation of Independent Business named it one of the best business books of 2011. The book explains how entrepreneurs can avoid the most common pitfalls as their businesses grow and is available at www.WhitestonePartnersInc.com