Why Raising the Minimum Wage would Hurt Young People

The recession of 2008 has been compared to the Great Depression even though the level of financial damage done is not even close.  The stock market in 2008 declined about 40% and then recovered all of the losses the next year.  By contrast, the stock market in 1929 lost 90% of its value over the next three years and took 15 years to recover fully.  Unemployment rose to about 10% officially, and is probably something like 15% unofficially if you include the people who have stopped looking.  In the 1930’s it reached 25%.

While so far the current recession is nothing like the Great Depression, some government policy makers are trying their best to have a repeat of that awful time.  One of the reasons the Great Depression drug on for so long was that government regulations were put in place that made it difficult to lay anyone off and also set high wages in an effort to prevent the wage deflation that was underway.  This meant that if you had a job you were in great shape, but if you did not it was very unlikely that you could get one.  Employers knew that if they hired someone who did a poor job, or even did an average job but did not produce enough to justify their wage, they might be stuck with the employee and would need to continue to pay the high wage, perhaps paying out more in wages and benefits than they were making.  These types of policies were a big reason the Depression drug on for so long.  It only ended as regulations were relaxed to allow the manufacturing growth needed to supply WWII.

In the State of the Union Speech President Obama called for raising the minimum wage to $9.00 per hour.  While this might seem like it would help those at the bottom of the economic ladder, it would actually increase unemployment, particularly for high school students and those starting out in the workforce.  The reason is that by making starting wages artificially high, employers will not hire individuals for many jobs.  In cases where they absolutely needed to hire someone they will only hire the best workers (those who would have received $9.00 per hour anyway).  They will not hire those who they would hire at $7.25 per hour, or those they would hire for $5.00 per hour.  That is because some employees would not provide more than $9.00 per hour in value to the employer.  At $5.00 an hour, the employer could take the risk on a novice employee, but not at $9.00 per hour.

In some cases an employer might need to lay off workers or close up entirely.  The reason is not that employers are greedy, but simple economics.  For example, suppose you owned an ice cream shop.  You might sell your ice cream for $3.00 per scoop.  Let’s say that you have 20 customers per hour during peak times, and therefore make $60 per hour in revenue during peak times, 10 customers per hour during off-peak times, and therefore make $30 per hour off-peak, and get 5 customers per hour for a few hours per day, and therefore make $15 per hour during the times when business is dead.

Given that benefits and other costs are generally equal to pay, if an employee were making $5.00 per hour, the cost including benefits, insurance, and supplies would be about $10.00 per hour.  At $9.00 per hour, the cost would be about $18.00 per hour.  During peak times, the owner (you) would be making about $50 per hour with one employee working or $40 per hour with two working.  Assuming the product cost about $1 per serving, that leaves about $30 per hour revenue after personnel and supply costs with one employee or $20 per hour with two, before paying rent or anything else.   At $9.00 per hour, that becomes $22 per hour with one employee or $4 per hour with two employees.  At this rate of return, it is likely you will not have the second employee.

Here’s the profit before rent and utilities for all of the times:

                                 $5.00 per hour                   $ 9.00 per hour
Time       1 Employee       2 Employees   1 Employee       2 Employees
Peak             $30/hour         $20/hour      $22/hour             $4/hour
Off-Peak      $10/hour         $0/hour         $2/hour               -$16/hour
Dead Hours $0/hour          -$10/hour     -$8/hour            -$26/hour

As you can see, during peak hours at a $5 wage, the employer would be doing fairly well and might even bring on another employee to make the lines go faster and maybe pick up a few more customers.  At $9.00 per hour bringing on a second employee would nearly wipe out the profit entirely.  During off-peak hours the profit would be slim with one employee and there would be no profit with two employees even at $5 per hour, so you would probably have 1 employee.  At $9.00 per hour it would barely be worth staying open with one employee and  you’d be losing all of the profits you made during peak hours if you had two employees.   During the dead hours it might be worth having an employee there at $5 per hour as a service to your customers and in case you got a rush some nights, but it would not be affordable at $9.00 per hour.

So, at $5 per hour, the employer would probably have two employees working during peak times, one during off-peak times, and one during dead times.  At $9 per hour, you would probably only have one during peak times and one during off-peak times and be closed during the dead times.  This would mean you would have fewer employees.  If wages were high enough, you might just be open only during the hours you could sell the ice cream yourself and not have any employees.

These numbers may be a little off, but are not that unrealistic.  Most businesses operate on a thin profit margin where they are barely making any money except during peak times.  If the employer is required to pay more in wages they will only be open during the most profitable hours and will only hire the bare minimum amount of people.  Some jobs may not even provide enough additional revenue to be worth hiring people at all if the minimum wage is too high and therefore simply go unfilled.  This does not help the poor, and is especially hard on the teenagers who traditionally start out at minimum wage jobs.  Note that currently the unemployment rate among 16-24 year olds in the summer is near 50%.

Please contact me via vtsioriginal@yahoo.com or leave a comment.

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Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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