Sunday, May 13, 2007

Why minimum wage is bad for the little guy

Minimum wage and other worker protection schemes are put in place by politicians with seemingly good intentions. Even if the intentions are good, I don't believe it's good for the economy. Let me try to demonstrate:

Imagine you have lost your job and decided to start a hot dog stand. You get a stand and set it up at a busy location and hot dogs sell quite well. Business is going well, but with the money you make you can't send your kids to university, so you want to start a second stand.

First you have to save up for a second stand, or more likely you have to convince a bank to lend you money to buy the second stand. Then since you can't clone yourself, you also have to find someone to man the second stand. You now have a loan to pay off for the second stand, so you're a bit low on cash to pay the guy who mans the second stand. You make him a deal, you pay him very little, but for each hot dog he sells, he gets some money. He figures he'll take the risk, even though at worst it barely covers his bills, at the best he can do quite well. If it sucks, he can quit.

On a good day he can do very well. Also since you've given him an incentive scheme he puts in that extra effort in being nice to passers by and it's good for business. Imagine the second stand works out, both of you make money, the loan to the bank gets paid off, then you start earning enough money to risk a third stand, everyone lives happily ever after.

Unfortunately, when starting the second stand, there's no guarantee that it will make money. It is not like getting a job and knowing you'll get your paycheck at the end of the month. It's possible that the first location you try to sell hot dogs with the second stand have no one willing to buy, and you have to change locations for a while until you find a good place. Or it might be that in the entire region there's no more demand for hot dogs than at your first stand.

Imagine instead of it going well, it turned out to be a bad plan. In this case you sell the hot dog van (at a slight loss) and let your employee go. All you've lost is the loss of selling the van in a used condition along with the small salary you paid him. You haven't lost that much, a bit of saving and you've recovered. Now you can try an ice cream van, maybe the guy that worked for you before is keen on working for you on the same terms, maybe not. In the end you will find something that works, and you've created a job. You can keep on expanding and create more and more jobs.

Let's change the story. Bring in minimum wage controls and other forms of labour protection legislation. You still want to start a second hot dog stand. You borrow money from the bank for it, and you have to employ someone on a minimum wage to work for you. If the second stand works out, fine, everyone makes money and you live happily ever after.

Imagine it doesn't work out, which is more realistic because business isn't easy and you're rarely that lucky the first time with everything. This time, your employee is also on minimum wage. You also couldn't afford to give him an incentive structure on top of his minimum wage. Now there's no motivation for him to sell more since he knows he's guaranteed to get paid his minimum wage. Regardless of this, let's say the stand doesn't work out anyway, there's no one elsewhere willing to buy enough hot dogs to make it viable.

In this situation, you have to stop the venture, close the stand, and retrench the employee. He has all sorts of rights so you will have to offer him a retrenchment package. Your losses are now say a loss on selling the van, a few months worth of minimum wage, and the retrenchment package.

With minimum wage and labour controls, you've basically made the risk and the cost of opening a second stand go up significantly. This counts for all business, if you make it harder for businesses to expand then you kill job creation for the small business.

By making the risk more expensive, you're protecting the big business, since the hot dog stands can't ever grow to compete with McDonalds, but McDonalds can risk opening another branch and if it fails they can absorb the losses through their organisation.

People who defend minimum wage are either politicians who want to gain votes by it, and members of the public who's never done anything other than being an employee and at most has had to take on employees on their superior's budget. Apart from this, large companies, even Wal-mart, openly state they like to see a raise in the government mandated minimum wage.

If you look at the UK, a country traditionally filled with many small shops in the villages. This is disappearing. The English run Fish & Chips shops have mostly disappeared, it's mostly Kebab shops run by Turkish immigrants or the likes, and corner stores by Pakistanis, Chinese take aways. The rest are brands run by big companies. People are blaming the biggest supermarket retailer Tesco for killing the characterful shops on the high street.

The reason why the Chinese, Turkish and Pakistanis can operate their shops is because it's family run. That means when they start the business they employ their family members. They employ them with no contracts, no retrenchment options, and most importantly they certainly pay them less than minimum wage. They probably don't even pay them for the first few years. These small businesses can only grow as large as their family is. The few that makes huge profits while competing with large corporations, are lucky enough to take the risk on to expand and succeed, the rest will always stay small until their children has received and education and moved on to work for big corporations themselves.

If it wasn't for these families, the beer binge-drinkers would be getting their food from McDonalds after a night at the pub. The pub would also be part of a big corporation. All the corner stores will be Tesco Express. Big corporations would have won, all because everyone now obediently pay the minimum wage.

Image of the hot dog stand from the Museum of the City of New York www.mcny.org

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