Wednesday, January 10, 2007

The Small Business Fallacy

Hopefully, by the end of the day, Congress will approve a raise in the minimum wage from $5.15 to $7.25. Unfortunately, the NYTs is reporting the wage hike may have to be linked to tax cuts for small business because raising the minimum wage will lead to their ruin. Thankfully, WaPo's Steven Pearlstein cuts through the bullshit -- whether it's from free-market fundamentalists or politicos too close to their local small business community. Much of his broadside is against Senator Max Baucus (D-MT), chairman of the Senate Finance Committee, but Pearlstein does a good job of shooting down the scare tactics ideologues generally use while arguing against any wage increase (unless it's for Corporate America).
We will hear all the sob stories about how struggling small businesses with thin margins will be forced to cut back on hiring, pull back on expansion plans and, in some instances, close their doors. Moreover, this won't be a tragedy just for small-business owners and employees but for the economy as a whole, since everybody knows that small business creates virtually all new jobs. Only another round of tax breaks can keep the great American jobs machine humming.

And here's the thing: Most of it is nonsense.

To begin, both economic theory and history suggest that small business will, in time, pass on its increased costs to its consumers. Small businesses that pay low wages tend to compete with other small businesses that pay low wages, so they will all face the same cost pressures and respond in similar fashion. The worst that can be said is that a higher minimum wage will add, very modestly, to overall inflation.

There is also general agreement among economists that a higher minimum wage, at the levels we are talking about, will have a minimal impact on adult employment. Slightly higher prices might reduce, slightly, the demand for Wendy's hamburgers, cheap hotel rooms and dog-walking services. But largely offsetting those effects will be the increased demand for goods and services by tens of millions of Americans who will finally be getting a raise. A higher minimum wage doesn't lower economic activity so much as rearrange it slightly.
But Pearlstein also forgets another benefit of a minimum wage hike: the multiplier effect. This means as the wage increase hits the market, other workers higher up on the wage scale will receive raises as well. And while business owners bemoan this, it's good for overall economic activity. Workers will take the extra cash in their paychecks and return it immediately back into the economy, thereby increasing economic activity and expanding the marketplace.

If raising the minimum wage would kill the economy, do you think over 650 of the country's leading economists would advocate it?

So when you hear all the fearmongering surrounding the minimum wage hike, remember to check who funds that thinktank or who gave that politician the campaign contributions needed to get elected.

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