The other day was the 100th anniversary of the Minimum Wage in Massachusetts.  I realized, thinking about it, that most people don’t really understand why the Minimum Wage is still such a hot-button issue.  Why is there still a Minimum Wage dilemma?

If we set aside the political arguments- “Starving Babies” vs. “Killing Jobs”, we are left with two core economic realities.  Both of these realities are undesirable.   On the one hand, setting an artificial price for anything tends to cause unforeseen and unwanted changes elsewhere in the economy.  On the other hand, if people cannot meet their basic needs, they will place economic burdens on the rest of us- either through crime or through social “safety net” programs.

Let’s start with the unwanted influences caused by setting an artificially high Minimum Wage.  In economics, this is an example of an “externality” in that the people who set the wages are not the people who are paying for them.  Both the employer and the customer are expected to pay for these costs even though they had, at best, indirect influence over the legislative process.

For instance, let’s say that BobMart can hire workers for $5 an hour and they need 20 workers per hour.  In order to break even, BobMart has to sell enough goods to make $100 in “gross profit” per hour, not counting costs for rent, electricity, and the like.  Let’s say that Bob has a 100% markup, as many businesses do, so Bob needs to sell $200 worth of stuff every hour just to pay his staff.

Please note that I am being very simplistic in order to keep the explanation from running on for several zillion pages.  I’d also like to note that Bob isn’t paying himself at that $200 level.  We’ll stick with the $200 number just to keep the illustration straightforward, though.

Alright, I’ll get back to the point- if the Daveachusetts legislature raises the Minimum Wage to $10 an hour, now BobMart needs to sell $300 worth of stuff each hour to pay the employees.  At this point, Bob has a choice- he can try to sell more stuff (a complex and difficult solution) or he can raise prices (also dangerous).  Chances are he will do both in some combination.   If he raises his prices by 25% ($200 to $250) and increases traffic by 20% ($250 to $300), he can continue to pay his workers.

So, where’s the downside?  Well, in addition to the increased costs putting Bob in a difficult position, the price hike also hurts BobMart’s customers.  Let’s say that Stan works for BobMart and took home $200 a week before the Minimum Wage hike and now gets $400 a week after the hike.  That’s great, right?

In some ways, yes; but, Stan is also now paying $5 for a tube of toothpaste that used to cost $4.  His actual buying power did not increase from $5 to $10, it increased from $5 to $7.50.

Now, let’s look at Julie, a single mom who was making $10 an hour before the Minimum Wage raise.  Did she get a raise?  No.  Julie already made the new Minimum Wage so she gets no adjustment.  Since all the prices have gone up, she actually took a pay CUT- her earnings lost value, going from $10 to $7.50 in purchasing power.  She and her family were hurt by the same law that helped Stan.

This is only one of the many ways that artificial price controls can impact people who had nothing to do with it.  Another very real possibility is that BobMart might have laid off workers to reduce costs, then pushed the other workers harder to do more work.  This sort of dance happens all the time.  It’s entirely possible that Stan’s earnings would have gone from $5 to $0 instead of $10.

Okay, so that’s the very simple version of why tampering with prices is at best a dicey business and often hits people like a snowball full of excrement rolling down the side of Mount Everest.

Now, let’s look at the other side of the equation.  If wages are too low, meaning that a “full-time” worker cannot support himself and his family (often her family), then the real costs of supporting those people gets passed on to society.  This is ALSO an “externality” in economic terms.

Let’s keep using Stan and Julie from the previous example.  When Julie suffers the major setback in purchasing power we described, she has trouble feeding her kids.  For awhile, she is able to dig into her meager savings but then she starts asking for help from her parents and/or a local food pantry.  The costs have now become separated from both Julie and her employer (and the employer’s customers).

Eventually, hearing about the plight of people like Julie, the Daveachusetts legislature sets up a program to provide Julie with food stamps.  The “external” cost of helping Julie to get by is now being paid by every Daveachusetts taxpayer, not just by Julie, her employer, and those members of her community who choose to help her out.

At the opposite end of the scale is Stan’s friend Greg.  While Stan kept his job at BobMart, Greg got laid off and is having a hard time finding a job.  Eventually, Greg decides to get back at Bob for letting him go and steals a shopping cart full of toothpaste.  Since toothpaste now costs $5 a tube, Greg figures he can sell them for $3 apiece and unload them quickly.  Bob, though he should be external to Greg’s personal economy, is now supporting him again (for a short time)

A few days later, Greg gets arrested by the police.  He’s already sold the toothpaste and spent the money on hamburgers, so Bob is out a bunch of money.  Greg goes to trial and gets a year in jail.  That year in jail is paid for by the Daveachusetts taxpayers.  Greg’s personal economy has also become an external cost to everyone else in the society.

There we have it- the Minimum Wage Dilemma in a nutshell.  Over here, economics shows us that setting artificial prices for things is dangerous and can often do as much harm as good.  Over there, we can see that when people can’t support themselves, they become a burden on everyone else.  Neither of these are desirable outcomes.

It is easy to say, “let `em starve!” or “tax the rich!”.  The reality is far more complex and subtle.  After all, if you were Bob, Stan, Julie, or Greg, you’d have a very valid perspective and personal self-interest that was at cross purposes to that of the other people in the example.  The key, in a republic like ours, is to study the problem objectively and to apply measurable, testable solutions- and then to keep refining them.

Most of the “Living Wage” arguments I’ve seen focus on a fixed target- some particular dollar amount that should be the new Minimum Wage.  Anyone who spends any time walking around the real-world equivalents of a BobMart can tell you that the Minimum Wage as we know it has failed.  Economies simply change too rapidly to be addressed by a static number that changes once every several years, if at all.

The only two solutions I’ve seen that address both the artificial pricing externality and the shared burden externality are “Dynamic Wages” and “Social Credit”.

Social credit is a model from the 1930s that relies on the bizarre nature of fiat currency to provide a minimum level of income to everyone in the society.  Essentially, new money is created centrally and distributed to individuals directly instead of banks creating the new money by lending it out.  This method requires a massive government bureaucracy, rivaling the Social Security Administration (or even repurposing it) and it is VERY, VERY sensitive.  If you create the money too fast, you get inflation, price spikes, and the like.  If you create money too slowly, the economy stagnates and people starve.

Dynamic Wages is similar to a fixed Minimum Wage except that it is based on the actual cost of living, adjusted annually for inflation.  Dynamic Wages also uses a sliding scale to adjust wages that are above the minimum but close to it.

For instance, the “state” of Daveachusetts might decide that the cost of living is based around modest housing, monthly bus passes, food, clothing, medical insurance, and simple sundries for one adult and one child.  Let’s say that right now, that all costs $2,000 a month.  By dividing this cost ($2,000) by 4 weeks of full-time work (160 hours) we get $12.50 a hour.  That of course, is a rough ballpark, but it’s a pretty accurate estimate for the actual cost of supporting an employee in the real state of Massachusetts.

Of course, the economy is always changing, so that $2,000 number has to be adjusted constantly.  If the following year, prices go up to $2,100 a month, the Minimum Wage goes up to $13.13 an hour.  If, by some act of God, the cost of living drops to $1,900 a month, the Minimum Wage goes to $11.88.

The key with Dynamic Wages is this annual adjustment, something that unionized workers often call “COLA” (“Cost Of Living Adjustment”), though in union contracts it’s usually only an upward adjustment.  One of the other hallmarks of Dynamic Wages is the adjustment of near-minimum pay by a similar amount.

For instance, let’s say that Stan’s making $12.50 an hour and Julie is making $15.  If the Minimum Wage goes up to $13 an hour (4% increase), then Julie would also go up by 4% to $15.60.  This percentage increase would drop off after some level, and then disappear completely.  So, Joseph who makes $20 an hour might get a 2% COLA to $20.40 an hour, while Roxanne who makes $30 might see no difference.

This, of course, is a statist approach.

Perhaps the best approach is information.  Maybe if instead of mandating a wage, we provided every employer with a poster that showed the current year’s Cost of Living (per hour) and required that it be posted where employees would see it daily and be printed on every pay stub…

Maybe then the market forces that are supposed to raise wages could work as intended.  Disparity of information is anathema to a free market.