Employment, Wages, Opportunity -- And How to Raise Wages

It seems not uncommon that the mindset about employers is that they have a moral duty to provide some level of "reasonable" wages for their employees (and, as we can see in aspects like healthcare, we also think of employers as these very paternal organizations that are responsible for providing for our entire well-being, which terrifies me in its own right). I also understand that many very smart people I know hold an implicit belief that there are various forces of this reasonableness that are at work when workers are indeed paid these "fair" wages and benefits. Such forces include good will, societal pressure, union pressure, and when necessary, law.

This is, of course, particularly true in the case of minimum wage.

To begin our discussion, let's look at the opposite end of the spectrum, as I'd like to lay a foundation here. We won't look at CEOs, as we generally get the impression that their wages follow a different set of rules. Instead, let's look at Google employees, shall we? (Before you roll their eyes, I know there are differences between them and minimum wage workers, and I'll try to be clear about those.)

According to GlassDoor, Google engineers make an average of $128,000/yr. Benefits are also like something out of a dream--read for yourself.

So in this case, would we expect any of these forces of "being reasonable" to drive up prices? Maybe one could argue that Google are just "good guys," but the market average in the US has software developers getting paid an average of well over $90k, and this includes all the more "low-skill" software developers (Google needs the cream of the crop so it pays for them). There are no laws or social pressure demanding that Google or other software employees get paid more--in fact, they're making so much money that they've achieved the threshold of having rocks thrown at them for making too much, so if anything, there's a lot of social pressure to pay them less. Something's driving these wages up, and what is it?

If you've studied economics, you probably know where I'm going with this. The key here is, of course, supply and demand. Let's look at both:

Supply: Software developers have a frighteningly low unemployment rate of 2.8%. As someone trying to recruit a software developer on a startup budget, believe you me, this is so low it is almost choking the industry. (An interesting digression would be discussing why unemployment that's too low is terrible for economic growth, but we'll save that for another time and leave it as the dreaded "exercise for the reader" for the moment.)

Demand: This already-strong demand is predicted to grow at a mind-boggling 22% per year, according to the BLS. 

So you've got tons of companies scrambling to find an itty-bitty pool of software engineers. The key point here is that what drives wages up is high demand and low supply. 

What's This Mean for The Rest of Us?

In the US (as of July 2014), unemployment is at 6.1%. That sounds alright (we had 6% unemployment back in 2004), but it's highly misleading. Getting the "real" %'s is hard, but Forbes suggests over 14% of Americans that want full-time jobs are either totally unemployed, or have marginal/part-time jobs. If you're into this stuff, you've probably been reading about the problem that most new jobs are part-time, and you've probably also heard speculation that the full-timer mandate of Obamacare might be causing a shift to part-time jobs, as it makes full-timers comparatively more expensive. It's hard to know for sure (it's only been 7 months of implementation) and there are lots and lots of confounding factors going on--if you're right-leaning, you're probably jumping on this data; if you're left-leaning, you're probably rejecting it. 

But either way, we've got lots of unemployed and lots of under-employed. Those under-employed are part of the pool of "supply;" they're hungry for full-time work.

So what this means--as is the opposite of the software developer sub-economy--is that we have very high supply. 

And what about demand? Well, the US economy is--at best--crawling out of the recession, rather than rocketing. We've been looking at some 2% growth since the recession (we're accustomed to 4%-6% growth rates in recoveries), and Q1 2014 actually saw a 3% contraction. Bad news. It means low demand. Keen readers will say, "this is over-simplistic!" and it is, when one is trying to calculate demand (there's a lot of other stuff going on), but higher GDP growth trends with hiring, even when much of that GDP growth has been driven by stuff like automation. 

So: high supply, low demand. 

Quick Economics of Supply & Demand:

If it's not obvious that supply and demand drive price in general, I will refer the reader to Wikipedia for a quick catchup. It's most obvious in commodities (like metal, pigs, oil, whatever), where if there is a glut of supply, price goes down, and if supply crashes (like there's a famine, or a mine shuts down, or a war interrupts trade), price goes through the roof. In commodity trading, the future predicted supply and demand is really important, which is why the price of oil has gone up way more than one might expect, because the future supply of oil doesn't look like it's going to grow, where growing countries like China and India are going to be consuming a whole lot more oil. (Another digression: this is actually a good thing from a sustainability perspective, because that high price is making alternative sources of energy economically viable long before the "oil crisis" occurs.)

Labor Recoveries Mean Low Wages:

So low wages are going to be a hallmark of labor recoveries--that is, periods when there is a large excess of labor are going to have low wages, because--essentially--companies don't have to pay to compete for a limited supply, the way that they currently have to for software engineers. (If one software engineer is getting 8 offers, they can pick-and-choose whoever is willing to offer the best package, where if one retail job has 40 applicants, the employer gets to choose whoever is willing to do the best work for the lowest price.)

It's not a happy picture, but at the moment, it's reality. 

Let's talk about what well-intentioned stuff we do that is counter-productive, and then what we have to do to make the situation better.

What Not to Do: Artificially Raise Wages

It's so very tempting to raise wages artificially by increasing minimum wage, or adding mandated benefits (like healthcare). So. Tempting. It's so tempting that sometimes I find myself wanting to do it. It takes a mind-boggling amount of cold discipline to avoid the temptation, but politics doesn't work like that.

But "why's it a bad idea, Erik?" 

In the case that a potash company (I use this example because it's a quick case study of Potash Corp in the past few years due to--of all things--weird politics in Poland and Russia) has a huge glut of mined potash and there's not much demand for it, it could do one of two things:

1) Drop the price, and other businesses would buy more, either because they want to hold onto it at a lower price for when they'll need it, or because the lower price allows them to profitably use that potash in a way that the higher price didn't let them (there are certain farming applications where this is the case). 

2) Keep the price steady, and hold onto the spare supply for later. Potash actually chose to do this, predicting that the market would pick back up.

This case follows those basic laws of supply and demand, and shows us what happens when we raise the price of labor: the supply is consumed more slowly than it would otherwise be, if "the market" let the prices drop even lower. 

Some smart people will, at this point, start pulling out all sorts of studies that show that increasing the minimum wage doesn't cause job cuts, or even doesn't stop unemployment from decreasing. 

No reason to say that this isn't true. Businesses already invested in a certain model aren't going to just give up because margins are thinning ("I'm not making as much  money from this employee so I'm just going to fire him and give up on the endeavor"). There's also no reason to think that businesses would just up and stop hiring--most employees don't work minimum wage jobs, and in those that do, there are still going to be applications where those higher-priced minimum wage jobs are still profitable.

This is a good counter to a fundamentally faulty (and frankly, lazy) argument that "lots of minimum wage employment is barely-profitable, so raising the minimum wage is going to make them necessarily unprofitable." Poppycock. Corporate profits are at a record high. Corporations aren't going to suddenly become unprofitable. This sortof "traditional" argument that raising unemployment will lead to mass layoffs is just silly.

(There is a key exception to this, which I'll explain in the next section.)

So you might be saying, "Erik, there's tons of room to increase wages!" It might be tempting to think that these high profits mean that, by jove, we should absolutely be artificially increasing wages, and that the economy won't even see a hiccup. 

But--hate to say it--high corporate profits actually mean an even bigger problem for raising minimum wage, and I'll explain why below.

Limited Capital and ROI:

Businesses are constantly looking for new ways to make more money--this is self-evident.

High profits mean that there are a lot of high-profit ways to invest fundamentally limited capital out there already. In short, what I mean is that companies have a limited amount of money to invest in new profitable ventures (which drive growth), made up of cash sitting around from profits and investment, and that they can take in from loans (their debt can only be so high). This applies to the mega-corps and the corner stores alike. The measurements they use are Return on Investment (ROI), Internal Rate of Return (IRR), and Net Present Value (NPV) of different investments, which are all essentially ways of measuring how much money you're likely to make on what you invest. 

With that money, they are going to seek out the most profitable ways of spending that limited amount of money. In a sense, they're going to look at a bunch of options, rank them in terms of likely profitability, and then pursue items from the top until they run out of money. What we want is for labor-heavy investment opportunities to be at the top of this list so companies pursue them. As wages go up, the labor-heavy opportunities start to slide down that list and are less likely to get more investment--which means less hiring, not none (or negative). 

There are some businesses that are exclusively labor-driven and have very high margins on that labor--software happens to be one of them. So software development companies don't have a choice if they want to grow--they have to hire people. Even here, very high wages are going to mean that the lowest-profit or highest-risk software ventures just won't be able to move forward, because they're not able to handle the high price of these software developers. If there were more software developers, the high potential demand for them would just slurp up the labor pretty much immediately. 

In businesses with lots of options--especially if one of those is low-skill labor--they are going to seek other options in a rate commiserate with the price of labor. These include outsourcing (in the case of manufacturing), automation (in the case of low-service retail, seeing more self-checkouts), or pursuing other lower-labor ventures entirely. Some of these, by the way, are a few of the cases where you'd actually see layoffs, but these layoffs have been comparatively small potatoes in the past. I've been a consultant that helps find opportunities to reduce headcount by improving manufacturing efficiency--this should be something companies do all the time (if they're purely rational) but it tends to happen when they get worried that their profit margins are shrinking too much, which happens in a recession more than it does a recovery with high profit margins (unless, of course, wages go through the roof very suddenly).

In short, raising minimum wage will slow job growth, not reverse it. 

The most obvious illustrative example is looking to Europe. Again, there are lots of confounding factors here, but "peer" countries with low (or no) minimum wage have lower unemployment, and those with very high minimum wage, mandatory benefits, and other "pro-labor" regulations that make it hard to hire people (like making it basically impossible to fire people, or tons of mandatory vacation, or high payroll taxes, etc etc) have persistently high and growing unemployment.

(Reader Katy points out, brilliantly, that we saw these very same troubled countries--particularly Spain and Ireland--see huuuuge drops in unemployment in the 90's, and I don't know for sure why).

"What about Germany?" Until about a month ago, Germany had no minimum wage at all (I, too, was surprised when I learned this), and it's one of the most economically free states in Europe (it's famous for its "Social Market" economy, or Soziale Marktwirtschaft, which has a very free market and lots of social services/welfare).

There's a looooot more going on than just unemployment, and my argument here isn't just "don't raise minimum wage." I'm going to discuss below how to drive down unemployment beyond having free-adjusting wages, but let's just say that "France, Italy, and Spain aren't suffering from too much capitalism." They're going to have persistent unemployment for a very long time unless they make dramatic adjustments to a freer market. 

And Persistent Unemployment Means...

Right, persistent low wages. And, in the case of the unemployed, no wages. Think back to that 14.3%--it might be great that they're getting $10/hr rather than $8/hr, but if they're only working 20 hours/week, they're still quite poor. 

The enemy is unemployment. Persistent unemployment is terrible for both the unemployed and also low-skill labor, and that's the thing we have to fix. Bring that employment rate up, and companies have to start competing, so they have to start raising their wages. Main Street wins.

The Terrible Irony:

The worst part about this is that what we want to do--with the best of intentions--to help the under-paid worker is hurting them (and particularly hurting the unemployed worker). By introducing "forced" higher wages, benefits, and other protective controls to "help labor," we make it harder to hire labor, and when it's harder to hire labor, unemployment is higher, and average labor wages go down (not to mention those off work for years). It is painful, it is very hard to accept, and we rage so much against the idea that even I am sometimes tempted to support raising the minimum wage because I hate so much seeing people suffer in these labor recovery periods.

Temporary Relief:

The best forms of temporary relief are those that don't interfere with the labor market--generally, forms of welfare or some sort of "universal basic income." People don't like this because it means that the taxpayer is subsidizing companies "under-paying" employees, and this seems unfair. Generally, in a progressive system, corporate taxes (I know, in the US corporations are able to frequently dodge these, but that's a separate problem) and taxes on the wealthy (the top 10% earners cover 68% of federal income taxes in the US) cover these payments.

(Another reader points out a "tax on automation" may help out to cover UBI/welfare, as well, but maybe there are some incentive problems here.)

So coincidentally, it comes out of the pockets of those profiting most from these low wages, so it seems like an interesting avenue to explore. More on this another time, but those looking to provide relief should be looking here, and we'll have to discuss the issue of managing incentives (that is, "if I'm getting all this free money, why get a job?") another time--suffice for now to agree that in our current state, unemployed people have no opportunity to get a job, and the "laziness" myth just doesn't apply at all. Milton Freedman has a great model where your government-supplied income could drop by $0.5 for every $1 you make, so you have the incentive to make more.

The Only Way to Real Wage Growth is to Reduce Unemployment:

Let's rally around raising wages and getting people back to work. We want to relieve the pain now, but let's do it in ways other than implementing changes that slow hiring.

We must reduce unemployment. Look back again to the case of the software developer: when (and only when) unemployment in a certain sector is low, businesses will have to start hiking wages to compete for the shrinking pool of employment. That's it, it's simple. More people will be at work, and they'll get paid more.

So, going back to supply and demand, we need to get this in line. Because we can't just get rid of people in the labor pool, the thing we need to do is increase demand. So let's talk about how to do that. 

Increasing Demand for Labor:

Eliminating unemployment is one way to increase demand for labor, as low wages will make certain labor-heavy ventures really profitable (compared to others), and so capital will flow to those. This is politically impossible and emotionally distasteful, so let's ignore it because it's just not going to happen. Even Germany abandoned its brilliant no-minimum-wage policy (will be a great case study), and it's just never going to happen in an economy where people are working full-time and not making enough to feed their families. 

So what can we do?

• Take the risk away from hiring. Barriers to firing people mean it's really bloody risky to hire them, and impossible to motivate them (particularly if they're part of the unskilled group). Ask frustrated businessmen in Spain and France (which I have), and they'll tell you they're pulling their hair out with current employees, and just plain refusing to hire more... and, by the way, they're outsourcing their work to Eastern Europe, not only for lower wages, but because it's easier to motivate and fire a contractor than it is an employee who is impossible to fire. In my personal experience with heavy industry, I've seen literally dozens of cases in which union employees were operating heavy machinery under the influence of drugs, or literally sleeping on the job, or showing up chronically late, and just couldn't be fired. 
• Make it easier to hire people. As a guy trying to run my own small business, I can attest that it's a major headache to bring people on board. The paperwork almost requires a new position
• Invest in infrastructure--intelligently. My Austrian friends will kill me for this, but there are smart ways to use very certain forms of deficit spending to grow employment in the right way. There is stuff that has to get built (the US has a rather terrifyingly decaying infrastructure) and we're not building it. As a free-marketeer, I will claim that the best way to do this is release the infrastructure development to the free market (Google Fiber installations are great example of it being done intelligently and profitably, and those market incentives are, as always, good guides to what's intelligent investment), but in places where it's politically unfeasible (like roads), there is work to be done. We must be careful not to have the "bridge to nowhere" or "digging holes and filling them" fallacy capture us ("just building things" for the sake of building them is wasteful, not helpful). But when we create infrastructure (that in current political conditions only the government can build) that creates further economic growth, it's a perfect time to invest that will create jobs and pay off. The best-ever example in my book was the Eisenhower Interstate Highway System, which employed just-returned war veterans, and stimulated huge economic growth by providing trade infrastructure (it has its own major problems that make the free-marketeer cringe). 
• Tear down the barriers to competition. This is worthy of its own volume of books, but "regulatory capture" creates crippling monopolies that stifle growth and job creation, and our economy is rife with these industries (Europe is much worse). The worst of these are the industries we feel most need to be regulated--utilities, telecom, medical drugs and devices, etc. 
• Make it crazy-easy to start businesses. Similar to my experience hiring--but way, way worse--the amount of paperwork and money involved in starting a business is dizzying. I am constantly blown away that corner stores and pizza parlors even manage to get off the ground without huge capital investment. We don't do a great job of making young businesses exempt from the (already overbearing) rules of mega-businesses, the latter of which hire batteries of people just to deal with the paperwork and other activities of legal compliance. 
• Bring on the immigrants! The knee-jerk reaction is, "we need to limit the supply of labor for it to be consumed," but all evidence points against this--particularly if the immigrants are highly educated. Highly-educated immigrants create way more jobs than they "consume," particularly through innovation (new products need new labor). Immigrants probably also tend to be more entrepreneurial / daring than native-borns (by selection bias--those willing to uproot and move to a new country tend to be of that nature). Our brutal limits on immigration (we only give out 50,000 employment-based green cards per year and 140,000 employment-based visas) mean we're turning away hundreds of thousands of job-creating machines every year. It's just absolutely bonkers, and another example of how well-intentioned moves to "protect American labor" are creating unemployment and poverty.

I could go on. The short version is we need to drive growth, and we have tons of artificial barriers to it. Taking those barriers down will mean new ventures, expansions of current ventures, and more hiring. More hiring means lower unemployment, lower unemployment means more competition for the pool of labor, and that means higher wages.

Minimum wage may not hurt the picture as much as its knee-jerk opponents think (and in different ways than they think), but when we have 30 million people unemployed or under-employed, focusing on artificially raising wages instead of letting the economy grow to consume this pool of surplus labor is bonkers. No matter what we do to minimum wage, we won't see wage growth in the US return until that labor supply is consumed, and we're doing nothing clever to make that happen.