Small business and labor cost

One of the biggest misconceptions in our society today is that minimum wage will fix the problems that surround income inequality and that it will also allow people to not live in poverty.  There are a number of reasons why this is not the case but for the purpose of this article I will focus on the effects of labor costs and small businesses. 

73% of all new jobs that were created in 2018 were by small businesses in the US.  Many, if not the majority of small businesses are creating jobs that are entry level low to medium wage jobs and many that require less skilled labor.  The simplest example of this is a new local restaurant that opens up in a community might create anywhere from 5 to 15 jobs.  Many of those jobs will be positions such as server, cook, and host.  Like any business a new business will be excited to get going and will want to establish a great reputation which means hiring good, trusted workers that will help build a great product from the start. 

How does free market labor work?

In a competitive environment where businesses are trying to hire the best workers they compete on wages (how much they pay someone).  Here is a quick example of how this works:

Restaurant A: Has been around for several years and pays their employees $10 an hour (arbitrary number used in this example).

Restaurant B: Planning to open up in 3 months.  Looking to hire new employees and wants the best.  Offers to pay $11 per hour.

Employee A: Works at Restaurant A but is interested in a new opportunity, something different, maybe more growth opportunity.  They are enticed by the higher pay as well at Restaurant B.

Restaurant B: As Employee A leaves for Restaurant B.  Restaurant A now gets wind that Restaurant B is paying employees more per hour.  Restaurant A realizes that to compete and get the best labor they eventually will need to raise their wages.

Restaurant C: Now a new restaurant comes along months/years* later and again drives up the wage price and thus labor and wages are able to move freely with the market.

*It's important to note this exercise does not happen overnight.  It's a result of increased competition and employees seeking out new opportunities and higher wages in a competitive environment.

How wages and the labor market work today?

In today's society the cost of labor is set by our national policy.  This established cost of labor is the "minimum wage" and in economic terms is called a "price floor".  Price floors tell someone how little they have to pay for something and in this case, labor.  Much of the uproar that we see in society about income inequality is misleading because society is advocating for continuing to raise the minimum wage. What is not understood though is that policy can only react every so often and cannot keep up with the market.  What happens instead is the following:

  1. Price floor signals to businesses what they have to minimally pay.

  2. In the short term wages will likely rise for individuals but less labor will be demanded by businesses as the extra cost for some businesses will be tough to sustain

  3. In the long term businesses will search for solutions to reduce labor and even automate (look around your local Walmart/Target stores at the self-checkout lanes).

  4. Most importantly - until the next policy is put in place which may or may not take years businesses now know how little they have to pay someone and are therefore not required to focus on the competitive market. This helps explain how inflation rises (due to increased cost of goods) and wages will stagnate.

In a booming economic system the minimum wage will not be a concern, but this might only apply to a few areas and does not apply to small communities.  The single biggest misunderstanding about how this works as well is that the focus of raising the minimum wage always centers around the biggest companies with the most employees. However, the biggest companies with the most employees are typically the most profitable companies and are already paying employees above these levels and/or can easily sustain a policy change such as this.  It's the small businesses that suffer the most when these policies are put in place and is a key driver in further widening the gap between the most powerful people/businesses and the upstarts in our economy.