THE BLOG
12/06/2013 05:10 pm ET Updated Feb 05, 2014

Employers vs. Free Markets: Why the U.S. Needs a Minimum Wage Hike

In a capitalist system, the government should not intervene in free market dynamics, but what if those free market principles fail? On the heels of Black Friday's Walmart worker strikes and historic levels of nationwide protests, it is worth examining if wages for low income workers really conform to free market principles, and if the minimum wage should be raised.

The essence of free markets is competition and this applies equally to wages as to prices. The wage level for any job is determined by what employers are willing to pay for that job. In theory the system is fair, because the broader market and competition can keep individual companies honest, but in practice, a handful of major players set the wage level for smaller competitors as well.

The reason, simply, is pricing power. When Walmart, for example, decides to pay its workers a dollar per hour less so that it can reduce prices, small retailers who are already struggling to compete with the economies of scale that big firms enjoy have no choice but to reduce their own prices - and therefore their workers' pay, to maintain their margins. The free market then is no longer 'free' since a handful of powerful players set both prices and wages that smaller competitors have no choice but to adopt.

Similarly, if a smaller retailer wanted to maintain its existing wage levels, it could do so only by reducing its workforce or replacing its inventory with cheaper quality goods in order to match Walmart's lowered prices, but that can harm the retailer's relationship with its customers and its sales, and so it will opt for reducing wages instead. In fact, there cannot be a free market for wages when a handful of top players exercise a virtual monopoly over a sector and therefore are the market.

There are, of course, outliers such as Costco, Zappos, Amazon, Trader Joe's, H&M and others who set a higher bar for paying workers, but such companies are the exception. In industries such as retail and fast food the problem of low wages is systemic. Front line fast food workers, for instance, make on average $8.69 an hour, while retail workers make $10.09 an hour, which is still 10% below the level required to rise above the federal poverty line. While Walmart claims that its average wage is $12.78 an hour, 30 percent of the retailer's workforce is designated as part time and another 10 percent as temps, who are typically paid less, denied benefits and excluded from the calculation of the average.

From the public's standpoint too, low wages carry a heavy cost. According to a recent study conducted by the Labor Center at UC Berkeley, fast food workers alone receive nearly $7 billion in public assistance through Medicaid, the Children's Health Insurance Program, food stamps and Earned Income Tax Credits. This dependence of low wage earners on the nation due to a lack of sufficient income puts further stress on the so-called free market and pushes us away from economic rationality.

Barring a wholesale migration of companies such as Walmart to higher wages voluntarily, the only solution seems to be a mandatory increase in the minimum wage. The common argument against this is that an increase in wages will force employers to hire fewer people, but there is no definitive data to support that thesis, and the more likely outcome would be a modest increase in prices. In the case of Walmart, calculations show that having to pay its workers a living wage would require the retailer to raise its prices by only one percent (if it passes 100 percent of the wage increase to its shoppers), which will hardly dent the consumers' -- and therefore the company's -- bottom line. More importantly, a wage and price increase by Walmart would require a corresponding move by its competitors to attract workers and maintain margins, leading to a "lifting of all boats" (the positive flip side of a monopolistic market).

The debate over whether to raise the minimum wage and by how much is highly political and will continue far beyond this holiday season, but the town of SeaTac in Washington state recently voted to pass a $15 minimum wage, and with the possibility of other places following eventually, it would make sense for the business community to adapt its own thinking on the subject, recognize how the status quo on wages violates the very dynamic that it needs to prosper, and prepare to do better on that front.

SANJAY SANGHOEE is a political and business commentator. He has worked at leading investment banks Lazard Freres and Dresdner, as well as at multi-billion dollar hedge fund Ramius. His opinion pieces have appeared in TIME, Bloomberg Businessweek, FORTUNE, and Christian Science Monitor, and he has appeared on CNBC's 'Closing Bell', TheStreet.com, and HuffPost Live on business topics. He is also the author of two thriller novels.

For more information, please visit www.sanghoee.com