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So, When DO Firms Start to Respond to Higher Costs?

Here’s a letter to an author who should win a prize for cramming such a large number of fallacies into a relatives small space.  In my letter I mention only a few of his fallacies.

Mr. Tim O’Reilly

Mr. O’Reilly:

Using dubious moves, you dismiss economists’ warnings that minimum wages reduce low-skilled workers’ employment opportunities (“We Can’t Wait for an Invisible Hand,” Evonomics, August 4).  First, citing only one (!) study that finds no correlation between higher minimum wages and employment levels, you fail to mention that there are many studies that do find negative consequences of minimum wages for low-skilled workers.*  Second, you argue that because Wal-Mart earns $25 billion in annual profits, its shareholders will simply absorb the 25 percent fall in profits that you calculate a $15 minimum wage would cost that company if it doesn’t reduce the number of low-skilled workers it employs.**

Let’s ignore, as you do, the reality that Wal-Mart is only one of thousands of employers of low-skilled workers.  And let’s also ignore, as you also ignore, the fact that the absolute dollar amount of profits is irrelevant.  (What is relevant is a company’s profit margin – and Wal-Mart’s profit margin is a razor-thin 2.66 percent.)

Instead, ponder this query: If Wal-Mart’s shareholders will merely shrug and absorb a 25 percent cut in profits, why would Wal-Mart obey the minimum-wage mandate to begin with?  Wouldn’t shareholders who are so indifferent to costs simply pay the fines and avoid the trouble of complying with the legislation?

You’ll respond “No!  We’ll set the penalties high enough to give Wal-Mart an incentive to comply.”  Perhaps.  But can you now help me to understand just when it is that businesses start responding predictably to higher costs?  If a hike in costs that causes a whopping 25 percent cut in profits is too small to elicit any response, when do cost increases finally become so large as to elicit responses?  The ‘logic’ of your argument gives us reason to question your implicit assumption that legislating a higher minimum wage will necessarily prompt Wal-Mart to comply with that diktat rather than simply absorb the costs of the penalties for non-compliance.

Donald J. Boudreaux
Professor of Economics
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercator Center
George Mason University
Fairfax, VA  22030

* See, for example, David Neumark and William Wascher, Minimum Wages (Cambridge: MIT Press, 2008).

** O’Reilly is weak at arithmetic.  He calculates that $5 billion is 25 percent of Wal-Mart’s $25 billion annual profits.  But as with so many other errors strewn throughout his essay, I ignore this one.

I had no space in my letter to make the following point, but it’s worth here calling out O’Reilly’s favorable quotation of Nick Hanauer’s obscene response to economists who point out that minimum wages diminish employment options for low-skilled workers.  Hanauer – as quoted by O’Reilly – says “That’s an intimidation tactic masquerading as an economic theory.”  Get it?  Making an intellectual argument grounded solidly in well-accepted science – the law of demand is the core of economics – is “intimidation,” while forcibly prohibiting low-skilled workers from competing for jobs by offering to work at hourly wages below that which is deemed minimally acceptable by politicians and economically ignorant billionaires is peaceful and sweet.  Hanauer’s accusation is, I repeat, obscene.

(I thank Dean Collins for the pointer to O’Reilly’s essay.)