A: Most of the other responses to this question correctly point out that prices climb when businesses pay more for “raw materials”. Since labor is no different than any other raw material, this would tend to be true for minimum wage hikes. It’s economics 101 and supply and demand.
Still, this isn’t the entire story. If you dig a little deeper, you’ll find that there are in fact a few other outcomes we don’t often talk about. When labor gets more expensive, businesses can typically do three things:
- Raise prices, as has been suggested.
- Use less labor.
- Fold.
The problem with raising prices is that doing so presumes the market is able to absorb a price increase - and quite often, that’s not true. In any market, there’s an optimum price point that yields maximum revenue…raise prices above this level, and you actually take in less revenue because consumers resist paying and seek other alternatives.
Thus, the first challenge is that raising prices suggests there’s “room” in the market for higher prices, and that raising prices will actually result in higher revenues for the business. The limits of this “price elasticity” depend on many factors: nature of your product, competition, availability of alternatives, etc. But as a general rule, all businesses seek the optimum price for their products, and a spike in the minimum wage doesn’t necessarily change the optimum price point businesses can charge.
Now, stop and think about that for a moment…
If consumers would willingly pay higher prices, then what we’re suggesting is that the business owner is an idiot. If market permission exists, then he could charge those higher prices today and improve the profitability of his current business. In other words, if we’re to believe a business owner could simply raise prices to cover the increased cost of labor, we have to conclude that the business owner currently prices his products below their optimum value. Clearly, that would be a pretty stupid business owner.
Thus, quite often we see businesses react to a spike in labor expense by raising prices, and the result is that they sell fewer products at the higher price. Overall revenues very likely won’t grow to the extent that the business owner expects, and very often, this becomes a race to the bottom: raise prices, revenues doesn’t keep up, so prices are raised again. This is a death spiral for many businesses.
Moving on, option #2 from my list above is actually where many businesses end up.
If you’re maybe a fast-food franchise and labor costs suddenly spike, the most obvious thing you can do is to use less labor. That might mean restructuring jobs, hiring fewer but more qualified workers, cutting back on operating hours - and the big one, turning to automation. These are attempts to raise worker productivity so that you need less labor overall. If you can replace half your staff with computerized kiosks and a mobile app, then the spike in labor cost doesn’t hurt your business nearly as much.
In other industries, instead of automation, you might move jobs offshore, or consolidate with your competitors into one larger entity instead of lots of small ones. All of these strategies reduce the need for labor - and none of them involve price increases to consumers. In fact, replacing an American worker costing $30–40/hour (that’s wages, benefits, taxes, etc) with an offshore worker costing $15/hour might actually result in price reductions for the consumer, not increases.
Finally, there’s option #3 - the business dies. Many labor-intensive businesses that are viable when labor costs $8/hour simply aren’t viable when labor costs $15/hour. These will be businesses where there aren’t offshoring or automation options, and where perhaps 60–80% of revenues represent a labor expense. The simple truth is that these firms will very likely fail in response to a labor price increase.
The punchline is that business figures all this stuff out.
Depending on the nature of the business, you’ll very likely see one (or combinations) of the scenarios I describe above, so it’s not a foregone conclusion that minimum wage hikes are always bad for the consumer. In fact, by incenting businesses to seek out more productive approaches, businesses actually can be more efficient over time - consumers and investors win this way. That is, so long as the business survives…
In fact, the ones that are almost always guaranteed to be hurt by minimum wage increases are the low-skilled workers we claim to want to help. Yes, a small number of them may see wage increases - but there are plenty that will find themselves unemployed…this is one of the key reasons for the change we’ve seen over the past few decades: in 1970, almost 15% of all hourly-paid workers were paid at the minimum wage…today, it’s about 2%.
Government plays to largely economically illiterate voters, businesses figure out other alternatives, and the low-skilled we’re allegedly trying to “help” get crushed. If we think a minimum wage hike is going to improve, say, unemployment among younger Americans or in the inner city, we’ll be forced to learn these lessons all over again.
~ Valerie Rhea, Quora, August 7, 2021
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