The Minimum Wage Paradox
- the haptic investor
- 2. Aug. 2024
- 6 Min. Lesezeit
Why I Consider the Minimum Wage Discussion from an Entrepreneurial Perspective in the Current Economic Environment to be Nonsensical and Even Harmful.
After a conversation today with a befriended family of owners of one of Germany's largest bakery chains, where real political and economic issues repeatedly dominated the conversation, I decided today to address a particularly popular topic: the minimum wage.
I have firsthand experience with both perspectives, that of the employee and that of the employer, and therefore have empathy and sympathy for the arguments of both sides. However, today I want to focus exclusively on the entrepreneurial perspective. This perspective is often criticized by politicians and others, often without these critics ever having taken on significant entrepreneurial risk or having earned the wages of their employees in the free market.
The fact that I cannot currently report too much positive about the German economy and the location of Germany has nothing to do with Germany-bashing, but rather results from my personal experiences as an entrepreneur and my heavily entrepreneurially shaped environment in this country.
In Germany, a country with a stagnant or shrinking economy, the debate about raising the minimum wage is once again at the center of political discussions. From my perspective, however, such a discussion is currently entirely inappropriate.
The demand for an increase in the minimum wage is often based on the argument that employees must earn a living wage. While this may seem morally and socially just, from the perspective of many entrepreneurs, it is economically not feasible, without drastic cuts elsewhere, particularly in an economy already confronted with challenges such as stagnant growth or even economic shrinkage.
In today's post, I want to illustrate, using concrete examples, why I consider the discussion in the current economic environment to be foolish, short-sighted, and inappropriate.
One crucial point that is often overlooked is the impact of a minimum wage increase on a company's operating costs. Particularly small and medium-sized enterprises, which often do not have large financial reserves, are heavily affected by such an increase. A minimum wage increase inevitably means an increase in labor costs, forcing companies to choose between raising their prices, laying off employees, reducing their profit margins, or reducing their reserves. This can be illustrated wonderfully.
Let's take the following completely simplified example (without the figures necessarily corresponding to the real distribution) and assume that the minimum wage increase leads to a total wage cost increase of 10%:
The labor costs of a small bakery account for 30% of the total costs. So, out of €100 in costs, €30 is solely the labor cost block. In this block, let's say we're talking about a 10% increase. So, it becomes 33% labor costs. In total, that's 3% more costs.
Doesn't sound like much to you?
The Expert Council advising the German government has so far projected a growth of 0.7% for the German economy in 2024. That's even generous. Other estimates are as low as 0.2%. So, let's assume a marginally weak bakery grows parallel to the German economy at 0.7%. Even then, there remains a shortfall of 2.3% to offset the increased labor costs of a total of 3%.
This now presents the bakery with a fateful decision.
Option a) Generate revenue growth
Option b) Cut costs
Considering again the current economic climate in Germany. Which scenario is more realistic? Naturally, option b). Generating revenue growth is particularly impossible for immobile, location-bound businesses. Prices can only be raised to a certain extent depending on elasticity without losing customers. This means that only the option of cutting costs remains. But where can costs be cut?
Layoffs
Layoffs can indeed reduce labor costs, but they would only make sense if productivity, i.e., economic output, remains identical despite fewer employees.
Product Assortment Adjustment
Certainly, changes could be made to the assortment to remove cost-intensive products with lower margins. However, whether medium-sized companies can accurately predict the effects of contribution margins or cross-selling effects and thus anticipate how the new assortment will affect purchasing behavior and thus economic success, I consider at least questionable.
For example, coffee is a high-margin product. However, if the bakery now removes the low-margin chocolate croissant from the assortment, it may be that customers no longer come to the bakery because they came for the combination of croissant and coffee, not for a single product. Tough luck.
Reserves
Certainly, the bakery could consider forming lower reserves. However, this will backfire, especially when unforeseen, uninsurable (additional) costs arise or special situations such as a pandemic occur and external financial aid does not arrive quickly enough. Thus, reducing reserves almost inevitably leads to a threat to business stability.
However, according to the German Minister of Economics, this situation is not too tragic. Even if the company loses customers and the reserves are depleted. Because according to Habeck, these companies do not go bankrupt; they just stop producing (September 6, 2022, Habeck on Maischberger). No, this is unfortunately not a joke.
Loss of Profits
The option of accepting profit losses is out of the question for almost every company. This is only logical because primary production costs (such as through suppliers, energy, etc.) are increasing rapidly, so there is a lot to be managed on this front as well. In addition, capital costs and thus investment costs are increasing, increasing economic risk. Thus, this risk must also be offset by a fair profit. Furthermore, it is difficult to grow with lower profits.
The Myth
It is often claimed that minimum wage increases lead to increased consumption. However, this calculation does not hold up if the productivity of the company does not increase.
A simple example: The employer pays his employee €5 more per hour. However, the company stagnates and does not generate more sales or profit than usual. The €5 that the employee can spend more, the employer cannot spend anymore. Consumption gain - based on the same consumption behavior - = 0%.
A brief thought in conclusion:
Companies may tend to increasingly rely on automation and technology to compensate for rising labor costs. This could lead to a decline in job opportunities for low-skilled workers, especially in industries such as retail, gastronomy, and agriculture. Another important aspect is the regional diversity of the economic situation. While regions with a flourishing economy and a high standard of living may be able to easily cope with a minimum wage increase, regions with a weaker economy and lower living costs could feel more severe effects. Furthermore, industry-specific competitive situations (such as oligopolies) are overlooked.
A uniform minimum wage increase often does not take into account regional differences and can therefore lead to disproportionately heavy burdens in some areas.
I would find it more interesting to talk about alternative approaches to improving the income situation of employees, such as tax exemption for overtime from the 40th hour or tax exemption for performance-related special payments. So, you see, the discussion material doesn't run out for us.
That's it for this week.
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