Maximum Wage

This week I received a call from a reader asking for our opinions on a minimum wage hike. Most of our readers know that I enjoy discussing topics with readers, engaging in constructive debate and answering any questions that they may have. We wanted to take this week to talk about how raising the minimum wage can have a negative impact on the US economy.

Many readers will remember that several weeks ago Massachusetts Senator Elizabeth Warren made the argument that since inflation has gone up and the dollar has lost some of its purchasing power over the last several decades the minimum wage should have increased as well, specifically calling for $22/hour minimum wage.

What Senator Warren does not realize is that the minimum wage has nothing to do with the cost of goods in the open market and has everything to do with the value of labor output.

For an easy example, we will look at McDonald’s and the price of a Big Mac hamburger sandwich. According to www.BigMacIndex.org (you truly can find anything on the internet), since 1986 the price of a Big Mac has gone from $1.60 to $4.20 today. In 1986 the minimum wage was $3.35/hour, thus Senator Warren believes that since the price of a Big Mac has increased by 2.62 times, then the minimum wage should have increased by at least the same amount.

What Senator Warren fails to realize is that one cannot look at 1986 dollars versus 2013 dollars and compare them apples to apples; we must look at real values which factor in inflation, as opposed to nominal values. When put in a constant level of 1996 dollars, the minimum wage in 1986 of $3.35/hour equaled $4.80 in 1996. The $7.25/hour 2012 minimum wage when adjusted for inflation to 1996 dollars was equal to $4.97. When raising minimum wage, ideally we want the nominal value to change as needed, while keeping the real value as constant as possible.

How do we determine the value of an employee’s output? Well, it is not as simple as the $4.20 per Big Mac times the number of Big Macs sold per hour. Using simple math, let’s assume a line cook at McDonald’s earns $7.35/hour and hourly overhead equals $50/hour. How many Big Macs whose raw materials cost $2.00 to make and sell for $4.20/burger must be sold in an hour to cover costs? Using these figures, that employee would have to sell 26 Big Macs in one hour just to cover costs.

Clearly McDonald’s sells other food items and covering their costs on simply one product does not make sense, but the principle stands true; an employee’s pay is not based on the costs of goods around them, it is based on the value of the output of their labor.

Peter Schiff of Euro Pacific Capital once wrote an article which we have referenced many times about Starkist Tuna in American Samoa. Congress said that since this was an American territory that the $7.25 minimum wage applied to Starkist’s operations in the Pacific. Samoan politicians begged for this not to happen, as they knew what would come. Starkist and Chicken of the Sea no longer had a competitive advantage to produce their canned tuna in American Samoa so they packed up and left, leaving all of the employees without a job.

Unfortunately, Utopia does not exist, and paying someone $22/hour for labor that is not worth that same value or more is not a sustainable system. We tell people all the time that if you want to do minimal work for high pay, you should have started a tech company in the 90’s. Minimum wage jobs should be treated as what they are, a stepping stone and a learning experience before moving on to bigger and better careers, not a long term employment solution that should earn exorbitant pay.

Ben Treece is a partner with Treece Investment Advisory Corp (www.TreeceInvestments.com) and licensed with FINRA (www.Finra.org) through Treece Financial Services Corp. The above information is the opinion of Ben Treece and should not be construed as investment advice or used without outside verification.
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