Tuesday, August 6, 2019

A hidden link between higher minimum wages and environmental destruction

The linkage between higher wages and increased consumption is well documented. That is the obvious link and I am NOT going to write about that today.

The linkage I will discuss occurs at the production level.

Wages, especially those of part-time workers with few benefits, are traditionally considered a 'variable' cost. That is, when demand drops the producer can send staff home and the producer no longer incurs the costs of those workers.

Enterprises that are labor intensive can be very responsive to changes in market demand, provided there are sufficient workers with the required skills. When demand goes up, more outlets or square-footage of factory can be rented and more workers hired. When demand goes down the workers are sent home and leases allowed to expire.

When the minimum wage specified by the government goes up, or when expensive benefits become mandatory, enterprises re-evaluate their operations. They look at every link in the value-chain and decide which operations can be automated and how many workers can be wrung from the employment rolls. The cost/benefit relationship changed due to the increased cost of labor but also because technology became less expensive since the last time the operation was rationalized.

Bear in mind that raising the minimum wage has a ripple effect. If you increase the wages of the production worker by 50% then there is pressure to raise the wages of the managers as well. Why take on the hassles of being a manager, for instance, if you can make as much money flipping burgers?

Most people visualize "automation" as $6 million dollar robotic work-cells. Automation can be much simpler than that. Consider that fork-trucks automated lifting and pulling in the 1920s and each truck eliminated twenty jobs called "shunters" from mines and factories. Also consider that drones or trolleys can eliminate the fork-truck driver.

Increasing automation, which enterprises MUST do if any of their competitors automate, shifts the cost structure from high-variable-cost/low-fixed-cost toward low-variable-cost/high-fixed-cost.

As a sidenote: The limitations of automation sometimes forces enterprises to reduce the number or complexity of products they offer to the public.

I already discussed how the first model HVC/LFC is very responsive to changes in demand. As you might guess, the second model LVC/HFC is extremely vulnerable to decreases in demand. The owners of the factory...and that might include insurance companies, mutual funds held in retirement accounts and traditional pensions...lose their shirts if the enterprise produces less than the planned volume and make money hand-over-fist if the volume is greater than forecast.

The rational thing for the business managers to do is to create demand.

Does the automation in the restaurant care if the outlet is open 24 hours a day? Not if the automation is well designed.

Another way to create more demand is to lower the price and send out blizzards of promotional materials and coupons.

Why not do this with the high-fixed-cost model? Because the margin between the incremental cost and transaction price is very narrow. In the high-fixed-cost model, the incremental cost of making one Extra SOOPer Sloppy Burger is primarily the cost of the ingredients and there is more room to "mark down" the transaction price.

If the nominal price of an Extra SOOPer Sloppy Burger is $3.50 then what are the odds of a customer buying two-for-$4 instead of one for $3.50?

The challenge to the managers of the enterprise are to prevent the two-for-$4 from cannibalizing the $3.50 sales and they can do that by putting time windows around the offer to shift demand to a period when they have fewer customers or they can link the better price to the purchase of another, high-profit item.

  • Increasing minimum wages eliminate jobs at all levels of the operation.
  • Increasing minimum wages drives more automation into operations.
  • Increasing minimum wages reduces the number of products or services offered to the public.
  • Increased minimum wages drive enterprises into 24/7 operations.
  • Increased minimum wages drives confusing incentive programs.
  • Increased minimum wages force enterprises increase sales volume, even if customers would not otherwise buy and consume those additional products. That is, increasing minimum wages create an incentive to consume more resources from the production side as well as the consumption side.

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