Wednesday, May 27, 2015

A higher minimum wage in one area may harm low-skill workers in other areas

The Los Angeles' city council recently passed a anti low-skill worker bill minimum wage increase that will increase the city's minimum wage from $9/hour to $15/hour. This ill-advised, and I would argue cruel, increase in the minimum wage will banish the least productive workers of LA - teens, the undereducated, the elderly - from the labor market. For LA teenagers in particular it will now be more difficult to find their first job. In light of LA's actions, Don Boudreaux at Cafe Hayek asks all minimum wage supporters a very appropriate question: if the minimum wage was enforced by fining and arresting employees who voluntarily work for less than the government mandated wage rather than the employers who pay them, would you still support it? He states that:

"If a minimum-wage policy is both economically justified and morally acceptable, you should have no problem with this manner of enforcement."

I agree with him. And when the question is phrased in the way he poses it a minimum wage sounds even worse.

And if punishing LA's low-skill workers by preventing them from negotiating their own wage with employers isn't bad enough, there is reason to believe that a higher minimum wage in places like LA, Seattle, and San Francisco will also eventually affect the employment opportunities of low-skill workers in other areas of the country.

Profit maximizing firms are always on the lookout for ways to reduce costs holding quality constant (or in the best case scenario to reduce costs and increase quality). Since there are many different ways to produce the same good, if one of the factors of production, say labor, increases, firms will have an incentive to use less of that factor and more of something else in their production process. For example, if the price of low-skill workers increases relative to the cost of a machine that can do the same job firms will have an incentive to switch to the machine. It is easier to demonstrate this using some simple math.

To set the stage for this post, lets think about a real life example; touch screen ordering. McDonald's is currently installing some touch screens for patrons to order their meals and at Clemson University one of the food courts also has a touch screen ordering system for the grill portion of the restaurant. The choice facing a restaurant is touch screen or cashier. If a restaurant is currently using a cashier and paying them a wage, they will only switch to the touch screen if the cost of switching and the future discounted costs of operating and maintaining the touch screen device are less than the future discounted costs of using workers and paying them a wage. We can write this as

D + K + I + RK  < WL

Where D represents the development costs of creating and perfecting the device, K represents the costs of working out the kinks/the trial run/adjustment costs, I represents the installation costs, and RK represents the net present value of the operating and maintenance costs. On the other side of the inequality WL represents the net present value of the labor costs. (In math terms RK and WL are: RK = [ (rk) / (1+i)^n from n=0 to N ] where r is the rental rare of a unit of capital, k is the number of units of capital, and i is the interest rate and WL = [ (wl) / (1+i)^n from n=0 to N ] where w is the wage and l is the amount of labor hours. But if this looks messy and confusing to you don't worry about it as it's not crucial for the example.)

The owner of a restaurant will only switch to a touch screen device rather than a cashier if the left side of the above inequality is less than the right side, since in that case the owner's costs will be lower and they will earn a larger profit.

If the cashier is earning the minimum wage or something close to it and the minimum wage is increased, say from $9 to $15, the right side of the above inequality will increase while the left side will stay the same (the w part of WL is going up).  If the increase in the wage is enough to make the right side larger than the left side the firm will switch from a cashier to a touch screen. Suppose that an increase from $9 to $15 does induce a switch to touch screen devices in LA McDonald's restaurants. Can this impact McDonald's restaurants in areas where the minimum wage doesn't increase? In theory yes.

Once some McDonald's restaurants make the switch, the costs for other McDonald's to switch will be lower. The reason for this is that the McDonald's who switch later will not have to pay the D or K costs: the development or kinks/trial run/adjustment costs. Once the technology is developed and perfected the late-adopting McDonald's can just copy what has already been done. So after the McDonald's restaurants in high wage areas install and perfect touch screen devices for ordering, the other McDonald's face the decision of

I + RK < WL

This means that it may make sense to adopt the technology once it has been developed and perfected even if the wage in the lower wage areas does not change. In this scenario the left side decreases as D and K go to 0 while the right side stays the same. In fact, one could argue that the RK will decline for late-adopting restaurants as well as the maintenance costs decline over time as more technicians are trained and the reliability and performance of the software and hardware increase over time.

What this means is that higher minimum wages in areas like Seattle, LA, and San Francisco can lead to a decline in low-skill employment opportunities in places like Greenville, SC and Dayton, OH as the technology employed to offset the higher labor costs in the former cities spread to the latter.

Also, firm owners and operators live in the real world. They see other cities and local governments raising their minimum wage and they start to think that it could happen in their area too. This also gives them an incentive to switch since in expectation labor costs are going up. If more cities make the same bad policy choice as LA and Seattle firm owners around the country may start to think that resistance is futile and that it is best just to adapt in advance of a minimum wage increase by preemptively switching to more capital.

And if you think that touch screen ordering machines aren't a good example, here is a link to an article about an automated burger-making machine. The company that created it plans on starting a chain of restaurants that use the machine. Once all of the bugs are worked out how high does the minimum wage need to be before other companies license the technology or create their own by copying what has already been done?

This is just one more way that a higher minimum wage negatively impacts low-skill workers, even if the workers don't live in an area that has a relatively high minimum wage.

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