07 August 2006

Executive salaries and the minimum wage (2)

Why Congress itself may be the problem

In my previous post, I intimated that Congress might be at fault for the fact that the minimum wage is not keeping pace with executive salaries. For purposes of discussion, I accepted as true Byron Dorgan’s claim that if the minimum wage kept pace with executive salary growth it would be about $23.00 per hour. I don’t know that this is true. But it doesn’t matter, because it won’t affect my argument. (It also doesn’t affect my argument that the legislation has now failed. We’ll be having this discussion again soon enough.)

My argument is that the solution to the problem (that the minimum wage does not pace executive salary growth) actually came out of Dorgan’s own mouth. I also suggested that the fact that salary is determined by market forces and that minimum wage is not should have given Dorgan and other a clue to that solution.

Many people argue against the minimum wage by pointing to the fact that the vast majority of people making minimum wage are not trying to support families on that wage. I will not waste time making that argument. My main reason for that is that it is irrelevant. Having come to the conclusion that the market is the best determiner of wage (just as it is for salary), I do not want to employ an argument which still leaves open the possibility that Congress is a better determiner of an acceptable minimum wage than the market is.

My argument against congressional determination of a minimum wage is three-fold. First, as I’ve already pointed out, the market does a good job of setting executives’ salaries, as Dorgan himself recognizes; and this ought to be taken as evidence that the market can also set a minimum hourly wage. Second, such legislation actually puts out of work the very people Congress pretends to want to help. Third, the reason that, once Congress sets a minimum hourly wage, it doesn’t keep pace with executive salary is inflation, not corporate greed (or whatever other evil monster some prehensile politician wants to blame).


The first reason is that people who actually work for minimum wage (as well as, possibly, some who work for more than minimum wage) will work less; this means that, while their wage will increase, their actual income will decrease. Now, how can this be? Get your calculator handy: we have some math to do.Let’s imagine a business, any business. Let’s assume that in this business there are five controllable costs, v, w, x, y, and z. In our case, w represents labor, including executive salaries. (Non-controllable costs vary from business to business, so we won’t take them up here. If our make-believe business were a construction company lumber might be one of the other controllable costs.)

Let us say that, taking into account all other controllable costs, in order to be profitable our business cannot sustain labor costs in excess of 21 percent of adjusted gross sales. 5 percent of this is salaried management (who, by the way, may work up to 70 hours a week with no overtime). Our labor budget for hourly employees is then 16 percent. So, when we are planning our fiscal year we project our adjusted gross sales to be $32,000,000.00, giving us a labor cost (hourly wage employees) of not more than $5,120,000.00. To simplify things, let’s break this adjusted gross sales down to a weekly average (that is, divide it by 52): $615,384.62, giving us a weekly labor budget of $98,461.54.

To calculate the number of hours we need to schedule in order to reach this goal, we divide this figure by our average hourly wage. (We arrive at this average by totaling the hourly amounts each of our employees are paid and dividing this total by the number of employees.) Let's say that this average wage is $12.50. Dividing $98,461.54 by $12.50 we see that we can schedule no more than 7876.92 hours. If we schedule those hours and actually do at least $615,384.62 in adjusted gross sales, then we shall make our labor budget.Let us say, now, that an increase in the minimum wage increases our average hourly wage to the desired $7.25. This affects only any employees we have working for us who make the present minimum. Thus our average wage does not increase by the same amount as the minimum. But it does increase. In our case, it increases only to $12.76 per hour. That doesn’t look too bad, does it? Let’s see how bad it isn’t.

Using the same sales and labor budget figures, the number of hours we can schedule comes to 7716.92. This means that we shall have to decrease the number of hours that we schedule by 160.00 hours. 160.00. hours!!! When we divide that figure by 40 hours (i.e., the number of hours in a full-time workweek) we find that we have cut 4 full time employees.

We now have a question to ask ourselves, as good business managers. Are we going to let 4 full-time, experienced employees go? Not on your life. So where are we going to cut these hours? From those minimum wage workers, of course. Remember those poor people Congress was helping with that increase in the minimum wage? Many of them just lost their jobs. And guess what else? The amount of business our company is going to do didn’t decrease. So those employees who were not let go will now be working harder. And for a while they will be working harder with no immediate increase in their pay.

And don’t think those executives have it easy just because they didn’t lose their jobs. Or did they? Remember, we limited ourselves only to hourly employees because we are discussing the minimum hourly wage. But let’s assume all of them kept their jobs, along with all of the experienced hourly workers—all of whom are probably union. Those executives have to do the same amount of business minus 4 employees.

I know what you’re thinking. It’s only 4 employees, not very experienced at that. But remember, they were only less experienced; and that wasn’t going to be true very long. Also, the way that man-hours are calculated reveals just how valuable those less experienced employees may have become. 4 employees, working 8 hours per day each amounts to 32 man-hours of work per day, 160 man-hours of work per week, 640 hours per month, 8,320 hours of work per year, their skills and experience improving every day, every week. In their absence, that work will still need to be done.

I know what else you’re thinking. Why not just increase the labor budget and keep those 4 employees? That’s pretty easy to say. But recall that we are looking at only one of the many variables that affect the profitability of a business. If this were a construction company some of the other costs would include lumber, microlams, floor joists, sheet rock, nails (take a look around your house at all the stuff that was there before you moved your stuff in). How easy is it to control those costs? Do you know? Shouldn’t you know before you start screwing around with someone’s business? (Don’t forget that the suppliers of the materials I briefly listed also have their own costs—including labor—to meet.)

The only other way we can make our labor budget is to increase sales somehow, which we can do only by either increasing the number of people who choose to do business with us or by raising our prices just enough to cover the average wage increase we just experienced thanks to Congress. Of course, we'll have to raise our prices eventually; so will all of our competitors, who are having the same labor problems we are. It's just a matter of which of us will raise his prices first. Since none of us want to go first, all of us are going to cut hours from our minimum wage workers until one of us just has to start increasing prices.

This problem will affect anyone who has minimum wage employees; and as employers increase prices to offset the cost of the hike, the benefit will disappear. And when it does, there will be more demands to increase the minimum wage yet again...and again...and again; and so on. And when the wage is increased yet again employers will be faced with the problem the solution to which "caused" the need for the increase in the first place.So, the only way that Congress can make the minimum wage increase of any lasting value will be to forbid employers from cutting the number of hours worked. Not only that, but it occurs to me that Congress will also have to add a price freeze to the wage hike. In other words, businesses will be forbidden to raise prices (which will be defined as “gouging” in order to make people angry and support such a move). But of course, this price freeze won’t help with that other problem.

Let’s look at that problem.


Another problem with artificial increases in the minimum wage is inflation. In 1983 I bought a pickup truck for around $10,000. If I had bought that same, or a comparable auto, in 2000, then, utilizing Gross Domestic Product deflator method it would have cost me $15,375. Here's a funny thing: when I bought a new car in 2000 it cost right around $15,500! So the amount I was charged for my auto in 2000 was the same amount, adjusting for inflation, that I paid in 1983 for a comparable auto. Now let's look at the artificially (and arbitrarily) set (as opposed to market set) minimum wage. When I first started working, in 1982, the minimum wage was $3.35 per hour. It is now $5.15. Adjusting for inflation, using GDP deflator, that $3.35 would be the equivalent of $6.80 today. Clearly, this seems to bolster the argument for increasing the minimum wage. What it actually does is demonstrate the problem with setting the minimum wage by law: the law itself is not keeping up with inflation. To keep pace with inflation would require new minimum wage legislation every year or so. I think it’s easy to understand how automobile prices have managed to keep up with inflation, and how minimum wages will also if we let market forces set the wage. Unlike the minimum wage, automobile prices keep up with inflation because those prices are determined by the market, not by Congress; and the market is keeping up with inflation.Right now, the wage set by Congress is not keeping pace with inflation, because it’s locked in by law. So right now, that wage works well for employers. But we are being mentally lazy if we truly believe that a minimum wage can be effectively prescribed by law. When the minimum wage does go up, as it inevitably must (because Congress must repeatedly account for their screw-ups), that new wage will not keep up with inflation. It will be frozen in place while inflation increases.This, I think, explains much of the problem with executive salaries. The minimum wage is meant to be a wage paid to unskilled laborers. The unskilled have nothing to negotiate over. Executives are not unskilled. When companies are competing for executives whose skills they need, those applicants are able to negotiate better packages than the relatively unskilled. And, unlike hourly wage employees, whose wages are a function of the minimum wage, executive salaries, like auto prices, are likely keeping pace with inflation. As with auto prices, I find it easy to understand how executive salaries—without legislative interference—are able to keep up with inflation, but the minimum hourly wage can't. Hourly wages for skilled laborers are likely kept lower than they might otherwise be because they are all a function of the minimum wage; executive salaries, because they are unrelated to the minimum wage, are free to grow with inflation because these salaries are determined by the executive labor market. Clearly the market does a better job of determining salaries than Congress does of determining the minimum wage.There is another problem with the minimum wage. The last minimum wage increase (to $5.15) was in 1997, if memory serves. To keep up with inflation it should be about $6.07. But it isn't $6.07; it's still $5.15. Executives’ salaries are not now what they were in 1997. Now, let's say that Congress raises the minimum wage tomorrow to $7.25. That $7.25 will be ahead of inflation, which means that employers will be paying much more by far than even inflation requires. It raises the question: If, after the minimum wage increase to $7.25, employers will already be paying too much for their unskilled labor, why should they increase wages for their skilled labor?

But don’t worry. In a few more years, when that $7.25 has been deprived of all value due to inflation we’ll be at this again.


I have already mentioned—several times, in fact—that no legislation is required for executive salaries. Note also, that no legislation is required for professional athlete salaries. Clearly, the market does a decent job of setting the price when it comes to salary. Any yet, we are told that without a minimum wage legislated by Congress, people just won’t be able to live. Ostensibly, this is because businesses are greedy.

But if greed explains why wages will not be livable, it ought to explain why salaries are too low for executives to live on. That same greed which would purposely keep wage earners in poverty would surely do the same for executives, shouldn’t it? Of course, no one in Congress that I know of, is making the argument that executive salaries are too low for people to live on. Apparently, executives are doing well enough. One wonders how, with all that greed going around.

If employers were allowed to pay unskilled workers what those unskilled workers’ labor was worth to them (i.e., the employers) more of the employers’ labor budgets could be devoted to the pay of skilled workers, who because of their skills would be in as good a negotiating position as skilled executives.
Again, the question demands an answer from Congress: Why is it that executive salaries are so good that Congress sees no need to meddle with them?

This is the part where I go ad hominem. I think the reason Congress gets all on fire about the minimum wage is that there are more wage earners in the nation than there are executives. In a democratic republic when you’re a career politician you need a steady stream of votes. In order to get those votes, you need to appeal to a majority. And when that majority is wage earning, and relatively ignorant when it comes to economics, you can appeal for their votes on the basis of the amount of their employers’ money you are going to force those employers to part with, in taxes and wage increases. And it doesn’t even have to work; it just has to look good. The evil you may cause is irrelevant if your intentions are good, or at least you can say they’re good. Congress must keep doing this in order to have a steady stream of voters.

Whatever else these mercenary, vote-hunting politicians tell us, don’t let’s lose sight of two facts:

1. The Congress interferes with hourly wages by setting a minimum wage; and hourly wage employees are poorly paid, poorly fed, poorly sheltered, poorly clothed, poorly educated, underprivileged.

2. The Congress does not interfere with executive salaries—YET!!!—and executives are (relatively) well paid, well fed, well sheltered, well clothed, well educated, well heeled.

Employees whose incomes are set by the market are happy. Employees whose incomes are set by Congress are unhappy. The market compensates well and Congress doesn’t.

Minimum wage talk is a part of the whole politics of envy. It constitutes little more than a transfer of wealth. There is little difference between my putting a gun to you and telling you to give $7.25 to your neighbor and putting a gun to you to force you to give me $7.25 which I then give to your neighbor. In both cases, I have succeeded in robbing you of $7.25.


About Me

James Frank Solís
Former soldier (USA). Graduate-level educated. Married 26 years. Texas ex-patriate. Ruling elder in the Presbyterian Church in America.
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