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Minimum Wage Hike Unlikely To Help The Poor, But It Can Help You (Background)

"It seems clear to me that we need a guaranteed minimum income to address the structural unemployment and falling demand automation is already causing, which may get exponentially worse in the next two decades." Rev. Joe Zarro, a commenter on this article.

This comment stood out to me for two reasons. First, the comment seemed directly related to another instablog. I was preparing to publish in regards to value. The second reason the comment stood out was that it was a perfect illustration that most people are learning the wrong lessons from technological innovations. With all due respect to Mr. Zarro and those who think like him, he could not be more wrong. "Guaranteed" minimum income will not address falling demand [for labor] due to automation...it will prompt it. Fortunately, this provides investment opportunities for those willing to exploit them.

Bottom Line Up Front

Let me first admit that the premise is contentious and difficult to prove. Even as we speak, policy makers, under the guise of "helping" lower class employees are pushing both a raise in federal unemployment wages, as well as many significant wage raises in various states. It is far out of the scope of this article to discuss whether these proposals are ultimately good for society, and frankly, there are too many issues to address to be able to do so intelligently. I will limit my scope to the idea that substantial raises in minimum wage should spur innovations in automation, which, of course, would benefit companies marketing automation solutions, and, in the long run, lead to greater profitability in those companies who heavily employ minimum wage employees. Unfortunately, this will come at the price of fewer employees needed in minimum wage positions, at least positions that currently exist.

Current Situation

I thought a summary of the current situation might be helpful. As I'm writing this, President Obama is proposing raising federal minimum wage to $9.00 an hour from its current place at $7.25. Adjusted for inflation, this would be a somewhat below its peak in 1968 (roughly 16% lower). However, this rate would be in line with most of the other rates of the 1960s and 1970s, and well above what was paid in the past 3 decades. Progressive states such as California and Washington state have proposed raising minimum wage to anywhere from $10.00-$15.00. The higher proposed figures far outpace any minimum wage rate mandated in U.S. history. Perhaps a graph might by illustrative at this point:

(click to enlarge)

I built the graph from data provided by infoplease.com here.

The graph is somewhat biased towards expectation of higher wages. There was a minimum wage prior to 1955, with origins dating back to 1933 (the wage successfully surviving the courts in 1938). Buying power was significantly lower than any point depicted on the graph (about $2.81 in 1996 dollars) and did not rise significantly until the mid 50's.

Gather 'Round the Good Stuff

Let's get back to the point. Will a guaranteed minimum income address structural unemployment due to innovation as Mr. Zarro insists? History seems to have a different story.

(click to enlarge)

While one can't necessarily draw the conclusion that higher minimum wage laws prompted innovation in automation, we can conclude that higher wages (much higher than now) did NOT result in a reduction of automation (which should be intuitive). In fact, the years, and decades following record highs in minimum wage led to huge drops in minimum and low wage jobs for bank tellers, low wage factory workers, and gas station attendants, amongst others. Perhaps, as some insist, higher minimum wages filtered through the economy, creating more jobs at higher levels allowing upward mobility. But, a quick look at U.S. unemployment rate history shows us that the highest rates of unemployment followed the highest minimum wage rates.

(click to enlarge)

(Graph provided on about.com us politics here)

Only the most simplistic amongst us would claim that high minimum wages caused follow-on high unemployment. Still, it's interesting to note that unemployment, whether correlated or not, was highest in the decades (and just after the decades) when minimum wages were the highest on record, and unemployment dropped coinciding with a drop in minimum wage real purchasing power.

To be fair, most proponents aren't claiming that minimum wage hikes will cut unemployment. The ultimate stated goal is to reduce income inequality (and thereby, wealth inequality). Fortunately, we have estimates of that as well provided by business insider.com here.

(click to enlarge)

Hmm… it seems like the giant minimum wage hikes in the late 50's and early 60's had little if any impact on the growth of wage disparity.

As investors, we need often need to make predictions of complex situations by using empirical evidence when possible, and theory when necessary. Let's see what the empirical evidence presented today says:

  1. Minimum wage raises in the 50's and 60's may or may not have spurred existing innovations in automation by making them more cost efficient alternatives to maintaining low skilled employees
  2. Minimum wage raises in the 50's and 60's did not seem to affect unemployment in a positive way
  3. Minimum wage raises in the 50's and 60's did not meet their stated goals: reducing the growing income inequality gap.

Yes, the charts I presented offer a pretty simplistic view. At this point, examining the opinions of scholars, and economists is our next best step. Unfortunately, the issue is so politicized that we are unlikely to find consensus amongst either parties. For instance, a Cato Institute article presents several peer reviewed studies showing an increase in unemployment following minimum wage increases along with a few that contradict the findings. The Economist presents findings that show no increase in unemployment. Yet their analysis is still not counter to my central thesis:

"…suggests that the minimum wage does not primarily boost pay by reallocating the surplus generated by a hire. Instead, employees seem to respond by working harder while employers invest in training and other workplace productivity boosters. That's a lovely thing to have happen, but also reason for caution. Technological progress seems to be boosting opportunities for automation all the time, and at some point firms will cross the threshold beyond which it makes sense to replace labour with capital rather than invest in more productive labour. Amazon's fulfillment centres generate tens of thousands of jobs, many at or near minimum wage. Maybe a higher minimum wage will lead to better pay without much of an employment effect. Or maybe Amazon will accelerate the deployment of warehouse robots. Maybe a higher minimum wage will boost pay at fast-food restaurants. Or maybe it will lead the restaurants to get serious about automation." (http://www.economist.com/blogs/freeexchange/2013/12/minimum-wages)

Ok. Here's the problem as I see it. Proponents of raising minimum wage, and the populace in general, see it as a clear cut decision. People in those jobs are suffering. Company profits are at an all time high. Mandating a boost in wages seem like an easy and effective way to "level the playing field". But if you truly care about reducing poverty, or reducing the income disparity, than you should care about results. And those who propose to take out of one group's pocket, should declare their intent, and show some kind of historical proof that that intent can be met. Voters should demand accountability for policies passed.

As investors we need to determine how policies like those described above will impact us. In addition, we need to determine whether such policies open up any particular opportunities for us. This argument was supposed to be part of a larger discussion focusing on avoiding macro predictions and looking at opportunities increased spending in automation would have. However, laying what I felt was the necessary framework (the material above), also bathed in contentious political material. If you found this article and found it interesting. I'd like to invite you to view my article on the subject matter here (coming soon).

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.