California’s Minimum Wage Law Hurts More Than It Helps

The working poor, businesses and consumers will be hit by consequences of wage hike

Gov. Arnold Schwarzenegger’s recent signing of a bill to increase California’s minimum wage is being hailed by supporters as a victory for the poor, but economic realities tell us that this will not be the case for many poor families.

The bill increases the state’s minimum wage by 18.5 percent, from $6.75 an hour to $7.50 an hour beginning January 2007, and to $8 an hour in January 2008, making it the highest in the nation.

The bill codified an agreement recently announced, to much fanfare, between Gov. Schwarzenegger and Democrats in the State Legislature. According to Assembly Speaker Fabian Nunez, the deal sends the message to poor families that “we are continuing to move the ball down the field, to improve their quality of life.” But legislators cannot simply increase wealth by passing a bill, and the effects of the mandatory wage increase are sure to disappoint.

Those forced into unemployment by the proposed minimum wage increase will certainly not have an improved quality of life. In 2004, the California legislature passed a measure to increase the minimum wage by one dollar an hour. The increase would have imposed an estimated $2 billion in costs on businesses statewide, and a study by the Employment Policies Institute estimated that it would have resulted in the loss of nearly 19,000 jobs the year after it was to be enacted. The new $1.25 an hour increase will result in even higher costs and job losses.

To assess the merits of minimum wage advocates’ arguments, all you need to do is take them to their logical extremes. If all it takes to lift people out of poverty is increasing the minimum wage, then why stop at $8 an hour? Indeed, some have called for raising it to $10 an hour or $11 an hour. But why set your sights so low as to just get full-time minimum wage earners slightly above the poverty line? Why not raise it to $20 an hour and make them members of the middle class?

Clearly, economics doesn’t work that way. When the minimum wage is increased, employers with minimum-wage workers are instantly burdened by higher costs. To compensate, they may lay off some employees, cut employees’ hours or benefits, increase prices to consumers, and/or put off planned investment and growth in their businesses.

Minimum wage increases actually harm many of the working poor they are supposed to help. Consider two employers hiring for the same job. One is willing to pay $40,000 per year and the other is only offering $20,000 per year. Competition for the $40,000 a year job is plainly going to be fiercer than for the $20,000 a year job.

Now assume that a minimum wage bill is passed that mandates compensation of at least $40,000 a year. The $40,000 a year employee is unaffected, but the $20,000 a year employee will probably be replaced by someone with greater qualifications because the employer wants to get his money’s worth. Worse still, the employee with $20,000-a-year skills has just become unemployable because he does not yet have the skills to compete for a $40,000 a year job.

Value is not arbitrary. It cannot be set by decree. An employee’s value is what an employer is willing to pay him based on the employee’s knowledge, experience, reputation, and other skills. In short, it is based on what the employee can bring to the table and how much he can contribute to the business, not on a politician’s arbitrary mandate.

The effects of the minimum wage are the same whether the minimum wage is set at $40,000 a year or $8 an hour. Those employees that are worth less than $8 an hour who are not laid off will, indeed, be a little better off. But those worth between $6.75 an hour and $8 an hour who are laid off and those who are unemployed will find it even harder to compete for $8 an hour jobs because they simply don’t have the skills yet, and now they don’t have the means to work their way up to $8 an hour or more.

The minimum wage is harmful to businesses, consumers, and even many of the working poor advocates claim to want to help. If Gov. Schwarzenegger really wants to improve economic opportunities and California’s woeful business climate, he should focus on measures that reduce government regulations and allow businesses to grow and add jobs.

Adam B. Summers is a policy analyst at Reason Foundation. You can find an archive of his work here. Reason’s California-related research and commentary is here.