Minimum Wage: Rational Employers are Not Job Creators

by Benjamin Studebaker

There is a huge, gaping hole in the response right-wing politicians are giving to demands that the minimum wage be raised in the United States–they are assuming that employers generally behave in an irrational, inefficient way. Here’s how.

Let’s get ourselves up to speed on what the popular arguments are when it comes to the minimum wage. The argument for raising the minimum wage centers on the productivity-wage gap:

As productivity rises, the economy is able to supply more and more goods and services with the same number of workers. However, increases in the capacity of the economy to supply goods and services are not sufficient to grow the economy–to do this, consumers must be able to purchase those additional goods and services. Until the 1970’s, consumers were able to do this because their wages rose alongside productivity. Instead of firing workers or reducing their hours and salaries, businesses in the 1950’s and 1960’s increased wages and worker benefits, allowing workers to purchase the goods and services they were producing. As a result, the economy expanded quite rapidly during that period. Productivity and wages helped one another in a virtuous cycle.

Business owners did not raise wages out of the kindness of their hearts or because they necessarily saw that raising wages would help expand markets for goods and services. They raised wages because the political environment of the 1950’s and 1960’s forced them to do so. Unions were strong, and the Cold War and capital controls sharply limited globalization and prevented companies from circumventing wage hikes with off-shoring. The minimum wage also played a critical role. Until 1968, the inflation-adjusted value of the minimum wage rose consistently:

However, we can see that after 1968, the minimum wage began to sag. This corresponds with the end of much of the system of capital controls in the 1970’s and the resultant increase in globalization.

From the 1970’s onward, wages remained stagnant in real terms while productivity continued to grow. This meant that the supply of goods and services was growing but the capacity of consumers to consume those additional goods and services was not, at least not through wages. This has harmed economic growth:

Growth Rate by Decade

The economy attempted to make up for the absent wage growth by making it much easier for consumers to borrow money. Instead of paying for goods and services with wages, consumers paid for these things with credit, which took the form of household debt:

As we can see in this chart, household debt stabilized post-WWII but took off beginning in the mid-70’s and accelerating drastically in the 1980’s. Ultimately, the economy could not sustain this level of rapidly rising debt. In  the wake of the global economic crisis, household debt has begun to fall. Without the ability to borrow cheaply, consumers have been unable to expand purchasing in line with increasing productivity. This means that businesses sit on their profits, unwilling to expand production because they are unable to locate markets for those additional goods and services. Most importantly, it has caused economic growth to be weak and the recovery to be both slow and mostly jobless.

However, conservatives don’t find this argument convincing. They believe that raising wages will make unemployment rise and depress growth further. Why do they believe this? They believe that employers and business owners are job creators. They argue that jobs exist because businessmen have created them through hard work, and that a rise in wages will reduce the total funds that businessmen have available to pay to workers, forcing them to hire fewer people and even to fire existing employees. To summarize the conservative argument:

This argument seems like common sense and is instinctively quite attractive. Nevertheless, it is completely mistaken in the worst way. The phrase “job creator” implies that a the rational businessman’s goal is to create jobs. This is not the rational employer’s goal. The rational businessman wants to generate profit for himself. Every person a businessman hires must be paid a wage that counts against those profits. The rational employer consequently always hires the minimum number of workers necessary to produce the supply of goods and services he wishes to sell. “Job creators” create jobs as a side-effect of maximizing their profits. It is not their primary objective.

For this reason, well-run businesses will always hire as few employees as they possibly can. This means that most businesses and corporations cannot eliminate positions in response to a wage hike. They must take the money out of their profit margins. Under ordinary circumstances, this could be problematic, because a reduction in corporate profits typically means a reduction in corporate investment. Companies need their profits to increase their production capacity and thereby expand the supply of goods and services. However, because wages have been stagnant for decades, there is little demand for additional goods and services. If businesses were to invest their profits in expanding supply, they would only drive down the price of their goods. They would not be able to increase total profits. Smart employers know this, and it is for this reason that they have been sitting on their profits rather than using them to hire more workers and build more capacity. Currently, profit margins as a percent of GDP are higher than they have ever been:

This means that there is lots of money businesses have available but are not putting into the economy. Individual businesses have good reasons for not making investments (as stated above, consumer demand does not make such investments profitable) and they have good reasons for not raising wages (it would shrink their profit margins relative to their competitors). However, if the government steps in and forces all businesses to compensate their workers better, individual businesses do not put themselves at a comparative disadvantage by raising wages. The result is that these large profit margins are readily transferred from the businesses that can find no use for them to the consumers who desperately need the funds to sustainably increase their purchasing without taking on additional debt and repeating the process that brought us to the crisis of 2008.

Conservative economists and writers are fond of making the assumption that economic actors are rational, that they maximize profits and always do what is best for themselves. Spectacularly, it is this very assumption that defeats their argument. Rational businessmen do not hire superfluous workers that they can readily do without. Hiring people is not a form of charity. Rational employers only hire when they absolutely have to, and for this reason we can and should expect employers to dip into their over-sized profit margins when confronted with rising wages.