Hiking Minimum Wage Seems Simple, But It’s Not

If a person works hard and adds value to the organization for which they work, would anyone argue the person is not entitled to a livable wage in the United States today?

Most people in America believe this person should have at least a baseline economic life in which they can readily pay their bills, have access to decent health care, and go on a vacation once or twice a year. It is easy to agree that this person should not live in scarcity.

In the debate about increasing the minimum wage, there is the perception that if you are not in favor of a $15 per hour minimum wage, you are against working folks. The truth is that the minimum wage argument is much more complex than it appears on the surface. It is an issue that requires thought and analysis, which is not necessarily the highest skill of politicians, whose currency is popularity, not necessarily accuracy, or even justice.

The average net profit margin of most companies in America is about between 3 percent and 6 percent. This means that, for every dollar of product or service sold, companies earn around 3 cents to 6 cents. Additionally, the highest cost to running any company is always labor costs or salaries (we will call them people costs); this is even true in businesses that are highly automated. It is very typical for a company to spend at least 50 percent or 60 percent of its revenues on labor.

Let’s look at a couple examples.

The first is a situation where all or most employees at a small business are only earning a minimum wage. In this example, the company has annual sales of $2 million and a net profit margin of 5 percent (i.e., the owner takes home $100,000). This means the company’s total costs are $1.9 million, and about $1 million of that is spent on people (we assume that people or labor costs are 50 percent of sales). At such an organization, if you increase the minimum wage to $15 per hour, where the average minimum wage today is $7.25, that’s about a100 percent increase in people costs.

If people costs increase by 100 percent at this business, then costs for just people rise to $2 million per year (up from $1 million), and total costs would be about $2.9 million. The company is now losing $900,000 a year. For this small business, the owner was making $100,000 before wages increased.

Is the owner willing to take on the risk of owning and running that business if it is unclear whether they can make any profit at all? He or she may not be willing to do that. I would not. You might not. Most reasonable people will see that the risk is too high.

Let’s take one more hypothetical example. In this example, all of a business’s employees are already being paid above $15 per hour. An increase in the minimum wage does not affect this business or its profits.

Some of these businesses may include software or pharmaceutical companies, or other businesses with higher net profit margins. I ran one of these as recently as last year.

Unfortunately, there are way more small businesses than there are high tech, highly profitable businesses. As such, a higher minimum wage hurts small businesses in lower margin industries.

Finally, at root, how does a minimum wage increase manifest itself in reality? Some businesses may be able to increase the prices of their products or services and apply them to us, the customers. However, even this is not a given, and it may take time. In very low-margin small businesses that are barely hanging on, owners cannot always simply increase prices.

For these reasons, the minimum wage argument is convenient political fodder for some, but it is not a simple issue. We know that capitalism in the free enterprise system, if left unchecked, leads to externalities such as poverty, which nobody wants. However, increased regulation applied the wrong way, like a national increase in the minimum wage, has serious social consequences that could end up hurting everyone.

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