Minimum Wage Drives Inflation

Many years ago, I was attending the Alaska State Fair with a friend.  One of the buildings was full of booths for various organizations: mostly businesses, with a few political organizations.  One booth was run by an organization campaigning for increasing minimum wage (I no longer recall if it was State or Federal).  My friend decided to tell them why minimum wage should not be increased.  He told them that increasing minimum wage would drive inflation.  The two people in the booth quickly and deftly tore his argument to shreds.  My friend did not loose the argument because he was wrong though.  He lost it because he did not have a strong enough understanding of economics to back his claim.  His argument is actually supported by a great deal of evidence, and even a simple philosophical argument can show that it must be true.

Our philosophical argument starts with the obvious fact that businesses must raise prices when costs increase.  If a business has a large amount of money or resources saved, it might be able to delay raising prices, but most businesses either do not have much savings, or just do not choose to delay price increases for very long.  The only exception to this rule is a business that can find some way of offsetting cost increases by cutting costs elsewhere (but then, net costs did not actually increase, did they).  You might argue that some businesses are already charging high enough prices that an increase in costs would not force them to raise prices.  If you did, I would argue that such businesses have already pre-emptively raised their prices for that particular cost increase (and, even these businesses will probably raise their prices at a cost increase, to maintain their high profit margin).

Employee wages are a cost.  I would love to see anyone try to argue against this claim.  So, given this and the fact that businesses raise prices when costs increase, if wages increase, then prices will increase.  From this it follows that if minimum wage increases, then prices will increase.  (There is an exception to this as well.  If all businesses pay enough more than minimum wage that none are affected by an increase, then prices may not increase.  If even a few percent of employees have wage increases though, ripple effects will raise prices for all businesses.)  When average prices increase, we call this inflation.  Thus, increasing minimum wage drives inflation.  This is our philosophical argument showing that minimum wage drives inflation.

Besides this, we have plenty of evidence that supports this claim.  I am not going to build a strong case for this, but I will quote some statistics that support the claim that increasing minimum wage does not improve the situation.  I wrote a paper last year comparing compensation of average US workers with the compensation of slaves in various ancient and older civilizations.  During my research for this paper, I found that from 1960 to 2010, wage increases for the lower 99% of US wage earners averaged to around 75% (the upper 1% wages increased by 250%, which comes out to almost 77% for all wage earners), while average inflation was 659%.  These figures do not necessarily imply that minimum wage increases were responsible for the disparity, but they do clearly show that increases in minimum wage were nowhere near enough to keep wages fair.

Our philosophical argument clearly supports the claim that minimum wage increases drive inflation.  The empirical evidence that I presented clearly shows that minimum wage increases have not significantly improved the situation of US wage earners over the last 50 years.  From this it is clear that increasing minimum wage is not enough to keep US workers out of poverty, because businesses will just raise their prices to compensate and then use the added costs as an excuse to raise them a bit a more.

I also wanted to discuss unions driving wage increases, but I do not have much time.  Unions driving wage increases is straight up harmful.  The US steel workers union has pushed up wages for steel workers and has demanded longer paid breaks to a point that it is cheaper to import steel (which is extremely heavy and thus costly to ship) than to buy domestic steel.  Unions increase wages of small pockets of the population, and the rest of the population ends up paying for it.  Steel workers comprise a very small percentage of the US population, but their absurdly high wages cost everyone in the US, because steel is used in a great deal of our products.  Besides this, union officials also take wages from union dues, which further add to the cost of unions.  I would spend more time in this if I had it, but I think this should get my point across.

Anyhow, minimum wage increases, or any kind of forced wage increases, drive inflation.  The economics of this is not as complex as people imagine, but most people either believe this or not, without actually looking at the numbers or the logic behind it (even our government representatives do this).  The solution to this should be fairly obvious to an economist.  For any product (including labor), a supply and demand chart can be drawn.  On the chart, there is a point where supply and demand cross.  This point is the equilibrium point, where both supply and demand will tend strongly towards.  Artificially increasing or decreasing the price of a commodity (labor, in this case) will alter the balance.  Setting a price floor (minimum wage) will increase supply, but decrease demand, resulting in surplus (unemployment, for labor).  Setting a price ceiling will do the opposite, raise demand, and lower supply.  It is obvious that the government has a responsibility to make sure that businesses are paying people fairly, and minimum wage is an obvious solution to this, but this necessarily causes unemployment and, as shown above, drives inflation, because of the imbalance it causes in supply and demand.  The obvious solution is to set a price ceiling on labor (a maximum wage) that counteracts the effect of the minimum wage.  If we did this, we could increase minimum wage, and decrease maximum wage to a point where everyone is paid fairly.  This will ensure that everyone gets a wage that they can live on, but will also leave a range of possible wages so that more valuable workers can be paid more for their work.  CEOs that currently make $5,000 an hour won't like this, but I would guess that a vast majority of Americans would be happy to see these leeches get what they deserve (which is more like $50 or $100 an hour, if that).

Lord Rybec