Why are market-based wages superior to government-mandated minimum wages? There are many reasons, here are three

From Mark Perry.

"Here are three reasons that market-determined wages for unskilled, low-skilled and limited-experienced workers are superior to government-mandated minimum wages.

Market-determined wages: 1) are based on the unique market forces of supply and demand for entry-level workers that prevail in an individual geographical location and for a specific industry, 2) can easily be adjusted up or down dynamically in response to changes in market conditions for a given geographical area or for a given industry, and 3) require no costly bureaucratic enforcement mechanism. In contrast, government-mandated minimum wages: 1) are set arbitrarily based on political considerations, 2) remain fixed and static for long periods of time, and 3) require a costly enforcement bureaucracy. Here are more details of those three important differences that help us understand why market wages should be preferred to government-mandated minimum wages:

1a. Market Wages Reflect Economic Reality: When the Walmart in Williston, North Dakota advertises starting wages of $17 per hour (see photo above that I took on my recent Bakken trip), those wages are offered based on the market conditions for unskilled, limited-experience workers in that unique labor market. As an employer, Walmart is competing against dozens of other retailers who also seek to hire unskilled workers. In a competitive labor market like Williston, wages of $17 per hour emerge as competitive, market-determined wages based on the interaction of the demand for low-skilled workers and the supply of low-skilled workers for those labor markets at a given point in time. In other words, those wages, which are more than double the state minimum of $7.25 per hour in North Dakota and higher than the recently passed $15 minimum wages in Seattle, San Francisco and Los Angeles, have emerged to reflect unique local labor market conditions and market forces, and were not determined arbitrarily or randomly.

b. Government Wages Ignore Economic Realities and Instead Reflect Politics. I am not aware of any case of a new city minimum wage law being enacted (for example, $15 per hour in Seattle, San Francisco or LA), or a case of the federal minimum wage being increased, when the new government-mandated wage was determined based on any economic, scientific, or logical basis, or when some rigorous cost-benefit analysis was used to conclude that a $10.10 per hour or $15 per hour minimum wages generates the most benefits with the least costs. In almost every case, a minimum wage by government fiat is determined arbitrarily using the PFA method: “plucked from the air.”

For example, why a $10.10 per hour minimum wage as proposed by the Democrats and Obama with the Fair Minimum Wage Act? Well, according to Obama, one reason for a $10.10 an hour minimum wage is because he tells us that “ten-ten” is easy to remember (and that’s even in the name of bill – H.R. 1010). No economic or cost-benefit analysis, no economic logic, no economic reasoning, no empirical evidence; in other words, no systematic process of analysis that tells us that $10.10 per hour is somehow optimal or ideal, and is superior in some convincing way to a $9.10 or $11.10 per hour government-mandated minimum wage.

Why a $15 per hour minimum wage as advocated by former labor secretary Robert Reich in this video, and the new minimum wage that was recently adopted in West Coast cities like Seattle, San Francisco and Los Angeles? Again, there’s no economic analysis, economic logic or economic reasoning that supports $15 per hour, as the optimal or ideal wage for those cities, it’s another number that was apparently arbitrarily chosen politically using the PFA method, probably again because it’s another nice, round number that’s “easy to remember.”

Conclusion: The $17 starting wage at the Williston Walmart is a market-determined wage that accurately reflect the specific and unique market forces for limited-experience workers in that labor market, and is based on sound economic and business analysis and decision-making, probably some dynamic trial-and-error experimentation to determine the optimal wage for the local labor market; in other words that $17 per hour market wage is grounded in reason, logic, market forces and sound economics. In contrast, minimum wages by government fiat are grounded in politics and wishful thinking, not economic reality. Further, market-determined wages reflect the unique labor market conditions that might vary significantly both by geographical region and by industry, whereas the government typically imposes a “one-size-fits-all” minimum wage on all industries and all geographical regions (in the case of the federal minimum wage).

2a. Market Wages are Dynamic. It’s also important to remember that the current wage of $17 per hour at the Williston Walmart is much higher than it was before the oil boom in the Bakken area raised the demand for workers, both skilled and unskilled. In most areas of the country, Walmart has been paying starting wages of below $9 per hour and its average wage for associates was below $13 per hour until this year. But in a boom town like Williston, the local Walmart might have quickly learned that offering those wages in the Bakken area would have resulted in a significant shortage of workers, and it therefore had to roughly double its starting wages there to $17 per hour to attract enough workers. And because Walmart is in competition for workers in Williston with other retailers and restaurants there like McDonald’s, Home Depot, Menards, Buffalo Wild Wings, Famous Dave’s, and KFC, it’s likely that $17 per hour is the prevailing, market-determined entry-level starting wage for the entire Williston area. Higher even than $15 per hour in Seattle, with no legislation required – the market was responsible.

And that’s the important lesson here about a market-determined wage: It’s completely flexible, and can easily be adjusted up or down in response to changes in the market. If there’s a slowdown in the Williston area because of low oil prices, wages will likely fall at Walmart and other local retailers; if there’s a resurgence in the oil boom later this year from a rebound in oil prices, there could be upward pressure on Walmart’s starting wages (see my addition to the Walmart photo above).

b. Government Wages are Static. Minimum wages imposed by government fiat are fixed and static for long periods of time, and cannot easily be adjusted to respond quickly to unique or changing market conditions, or be adjusted upward for inflation in most cases. The federal minimum wage can also not be adjusted downward to reflect the market conditions in small towns where the cost of living is very low to account for the fact that a new $10.10 minimum wage (if passed) is too high for some local labor markets. In contrast, a major retailer like Walmart can easily customize its starting wages at thousands of locations nationwide to reflect the differences in labor market conditions and cost of living.

3a. Market Wages Require No Enforcement Mechanism. It obvious that when wages are market-determined by the forces of supply and demand, there is no enforcement mechanism or costly government bureaucracy required. In that sense, market wages are “free” since they impose no regulatory cost on taxpayers.

b. Government Wages Require a Costly Enforcement Mechanism. When a minimum wage is mandated by government fiat, a costly government bureaucracy is required to monitor and enforce the government wage mandate, respond to complaints, and impose penalties and fines on offenders. For example, after Seattle passed a $15 per hour minimum wage ordinance, the city had to next establish and fund a new Office of Labor Standards to oversee the city’s newly established minimum wage law. Earlier this month, the city appointed its new “Minimum Wage Czar” to head the new office. San Francisco has an Office of Labor Standards Enforcement (19 staff members and an annual budget of $3.7 million, of which about half goes to enforce the city’s minimum wage law), and the state of California has a Division of Labor Standards Enforcement to enforce the state minimum wage. An Office of Wage and Hour enforces the minimum wage law in Washington, D.C. at an annual cost of about $1.5 million for 11 full-time employees. San Diego estimates an annual cost to the city of $1.2 million during the first year to monitor and enforce a proposed hike in the city’s minimum wage above the state level (not yet finalized, a public vote may take place next year). Although it might be hard to estimate the exact cost to taxpayers for enforcement of city, state and federal minimum wage laws, it’s likely that the cost to taxpayers runs into the billions of dollars every year, and it’s a cost that can’t be ignored when comparing market wages to government-mandated minimum wages.

Bottom Line: Market wages for entry-level workers are: 1) determined by market forces and reflect regional and industry differences, 2) can easily and dynamically adjust on a continual basis to reflect changes in local labor market conditions, and 3) require no costly monitoring and enforcement bureaucracy. On the other hand, government-mandated minimum wages are: 1) determined arbitrarily by a politically-driven process that is divorced from economic reality, 2) based on a “one-size-fits-all” approach that can’t easily be adjusted for regional and industry differences, and can’t adjust dynamically to changing market conditions, and 3) costly to monitor and enforce. For those three reasons (along with many other important reasons), we can conclude that market-determined wages for unskilled and low-skilled workers when compared to government mandated minimum wages are far superior because they are more efficient and realistic, can be changed dynamically and don’t require costly bureaucratic enforcement."