Wednesday, December 20, 2006

Oh, No, Not Again. Yes, Again.

According theAP, President Bush has decided to give Democrats a $2.10/hr minimum wage increase, tying it to tax breaks for small businesses.

I know increasing the minimum wage is popular. People think it's kind and good to force those mean old employers to pay an ever-increasing amount to bottom-rung hourly workers. Politicians tell everyone that the only way minimum wage workers can make more money is not for the workers to work hard and advance to higher-paying positions, but for the government to mandate it.

But in reality it's the worst thing we can do to the poorest among us.

(I'm not an economist, just a mathematician, and not really much of one of those. What follows is not meant to educate, but could be classed as thinking ablog.)

When an employer has a job that he wants done, he tries to get his existing work force to take it on. When it becomes necessary to add to that work force to accomplish his goals, he does the financial calculation to figure how many people, and of which skill sets, he will need to do the job. He has a certain amount of overhead, which is partially dependent on the number of people he employs. He has costs associated with materials. And he has labor costs, which are often the biggest piece of the pie.

Labor costs include wages, taxes and unemployment insurance, and whatever benefits he includes to attract workers, since it is often the case that an employer can provide his workers with a higher value in benefits than the workers could purchase individually if he simply paid them more. And it's a cultural thing: supplying benefits signifies a caring attitude, even where no such attitude underlies the decision to supply benefits.

But how much to pay?

From an employer's perspective, a worker is an investment, like a really productive desk or chair. Yes, there's more to the relationship, but at bottom it is the potential return on investment that makes employers willing to risk hiring someone. The calculation is the probability of reward function. If he pays wage W, will worker A provide the employer a return that is enough greater than his other costs so that he can pay those costs, A's wage W, and have a profit? If he pays less than wage W, attracting a less skilled or motivated worker, will that decrease his likely gross more than the savings? If he pays more than W, will his gross increase enough to cover the higher cost? That all glosses worker training and retention, saving money on labor but investing in an comfortable and ergonomic workplace, etc., but the gloss doesn't affect the employer's calculus.

Now consider a widget manufacturer with a process that he knows will require several tasks: loading and unloading stock and finished product from the widget machine, packing boxes for shipment, inspecting various stages of production, and so on. It's not as efficient to do all of these things serially, that is, one after another, but it's better to do them with a team working in parallel.

So this employer needs a team of more-or-less interchangeable people to perform his process. The work is complex enough to require some training, but a typical young adult will be able to do it. He calculates his fixed costs F: rent, utilities, security. Conveniently for us, the cost his of raw materials is indexed to inflation.

Materials I + overhead F + profit P + labor (N workers * production time T * hourly wage W) divided by number of widgets X = selling price per widget C

C = (I*X + F + P + (N * T * W)) / X

He would like to charge the typical commodity price for his widgets. He cannot charge much more than that, or no one will buy them; much less than that, and he loses profit. From experience, he knows that there is a range for the size N for his workforce. At the low end, his workers can't make widgets fast enough to cover costs. At the higher end, the extra workers can't produce enough more widgets to justify paying all of them: more workers don't help the process. Somewhere in between is the maximum profit, which is what he is targeting.

So he rearranges his formula and comes up with:
C*X = (I*X + F + P + (N * T * W))
C*X - I*X - F - P = N * T * W
(C*X - I*X - F - P)/(T*W) = N

That tells him that the number of workers he needs to hire is dependent on the selling price, material cost, and fixed costs, all of which are out his control. But the number of workers also depends on how many widgets will be produced and what wage he can pay. If he wants to pay higher wages to the same number of workers, either they need to produce more widgets or he has to take less profit. If they don't produce more, he has the choice of taking less profit or having fewer workers.

Now, along comes a law saying that while he has to pay higher wages, his taxes will be lower. But because liberals really hate businesses that pay minimum wage, the (temporary) tax breaks won't offset the increased costs. Our widget maker realizes that he has new choices:

  1. Take less profit (and get correspondingly less tax benefit)
  2. Raise prices and hope everyone else does, too (which will raise fixed costs)
  3. Get the workers he has to make more widgets
  4. Fire some workers and make the same number of widgets
  5. Outsource his widget operation to China or Mexico
Now since minimum wage earners pay almost no income tax, there will be a net decrease in Federal tax revenue. Guess what the Democrats will do? They will raise taxes on those same small business owners, making the first option, taking less profit, even less attractive.

So the net effect of this increase in the minimum wage and tax "break" for small businesses will to throw minimum wage earners out of work while raising prices on the things the now-unemployed people need.

Thank you, Democrats and Compassionate Conservatives. You're all heart.

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