Progressive political pundits will often push for mandatory higher “living wages”, which tends to be a very popular political strategy… And certainly, why wouldn’t it be popular? After all, what man doesn’t seek to improve his relative standing in life, it would be unnatural not to wish for more of the comforts that make living enjoyable, though perhaps this has some diminishing returns.
As we’ve briefly touched on before, and will continue to expand on in future posts, there is an asymmetric risk return profile for the entrepreneur. The bottom line for any entrepreneur is this: risk previously accumulated capital in the hopes of profitably satisfying future human demand for goods or services. Capital reinvested into operational efficiency ideally leads to better margin as more goods can be produce and/or at a cheaper cost. The entrepreneur is the backbone of industry, oftentimes carving out second or third order goods and services where previously there were none, and in the process providing jobs and consumer goods which are a net benefit to everyone.
A text book example of a great entrepreneur is Henry Ford. If you study his life and career carefully, you will find patterns in his behavior. Patterns which outline the steps necessary for an entrepreneur to successfully navigate the markets. Not only was he constantly searching for ways to make his production of vehicles cheaper and faster, but he also understood that higher wages for his technically skilled employees was better for his retention and ultimately better for his bottom line.
It should give one pause for consideration that the majority of Ford’s illustrious career took place prior to the advent of minimum wage in the united states (FDR instituted the minimum wage policy in 1938 at $0.25 per hour). Ford was a big critic of the new deal era policy making, with which FDR rose to critical acclaim.
The reasons for this are quite simple. Entrepreneurs have a bottom line. If they fail to meet that bottom line, they have the potential to lose much if not all of the capital they have risked in their ventures. Ford was a market leader for so long because of a vigilant prudence that kept him on the edge of profitable market operation. But less savvy businessmen can be quickly replaced by their betters when the free market is allowed to run its course. Minimum wage disrupts this process of price discovery for labor.
An interesting, and uniquely isolated example of how damaging this policy can be, happened in the lesser known American territory, American Samoa. The tuna canning industry, which is the largest private industry on the island, was thriving under two companies Starkist and Chicken of the sea. In 2007 the fair minimum wage act sought to bring the American Samoa minimum wage up to the federal standard of $7.25 per hour over a period of several years.
“In response to the minimum wage increase, the Chicken of the Sea tuna canning plant was shut down in 2009 and 2,041 employees were laid off in the process. The other major tuna canning plant in American Samoa is StarKist, which began laying off workers in August 2010, with plans to lay off a total of 800 workers due to the minimum wage increases and other rising operation costs.”
All of these layoffs and eventually a shutdown of one of the factories entirely, came despite American Samoa Governor Togiola Tulafono’s helpful suggestion, “that, rather than laying off minimum wage workers, the companies could reduce salaries and bonuses of top-tier employees.”
Certainly the employees who were able to keep their jobs obtained somewhat of a higher standard of living through their newfound purchasing power, but at what cost? Now members of their communities had lost their jobs. This is a net negative for everyone on the island as these people now must require subsidy at the cost of their community in order to survive. Perhaps employees who preferred to work for Chicken of the Sea (due to a better work environment or other forms of compensation) were now forced to work for Starkist. Innovation and competition on the island were stifled. In fact, if we were to follow this legislation to its logical conclusion, increasingly the minimum wage enough could eventually wipe out the largest industry on the island entirely.
This is just one example, but it is useful because it is as close to vacuum as we can get for studying the effects of policy making. It is often very difficult to anticipate the second and third order effects of central planning in economic systems. This is why the first principles of free market operations are always preferable, no matter how benevolent the intention.
Book of the Month:The Dao of Capital: Austrian Investing in a Distorted World
-“Years later, Mises would take on the historicists in his book, Theory and History, countering their view that economic theorems are void because they rely on a priori reasoning and that only historical experience is valid. As he wrote: “Such historical experience does not give the observer facts in the sense in which the natural sciences apply this term to the results obtained in laboratory experiments.” He further criticized those “who call their offices, studies, and libraries ‘laboratories’ for research in economics, statistics, or the social sciences” as being “hopelessly muddleheaded.” Mises stated, “Historical facts need to be interpreted on the ground of previously available theorems.”
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