Sunday, July 27, 2008

Unintended Consequences

You may not have noticed in all of the Obamamania last week, but the government has acted decisively to end the threat of minority teenagers getting jobs.

The minimum wage increased by $0.70 per hour to $6.55. That’s a 12% increase, not bad for an economy teetering on the brink of recession.

Unless, of course, you either a) lose your job, or b) can’t find one. Unfortunately, most of this burden falls on teenagers, especially ones just trying to get their first job.

One of the key mistakes in economic policy is to get confused by the different names that economists use for the prices of the factors of production. Wages paid to labor, interest to capital, rents to land, and profits to entrepreneurship. This has lead to the mistaken notion that the laws of supply and demand do not govern these prices.

Wages are simply the price paid to labor. To the extent that government mandates a price above the market, businesses reduce their consumption of labor hours. Additionally, minimum wage laws introduce rigidity in the market, resulting in more unemployment if the economy goes into recession, and wage rates cannot be adjusted downward.

Wage rates are always determined by the supply of labor, and employer’s ability to use that labor to create value greater than the costs of employment. Artificially increasing the costs reduces the demand.

The laws of economics can no more be repealed than the laws of physics.