Google search the topic “minimum wage.” I can guarantee that you will get a new article every day. This is a topic under constant scrutiny and controversy, but we will rise above petty politics to a higher sphere of inquiry. Won’t we?
Note a conversation I overheard the other day between two of my friends to whom I will refer as Betty Business and Lydia Labor.
Betty: “Wages should be set by free markets. Besides, if we increase the minimum wage, unemployment will rise, forcing lower income families out of work.”
Lydia: “Increasing the minimum wage is the right thing to do. It will give a badly needed boost to hard working lower income families.”
Betty: “Raising the minimum wage will not help low income families. Businesses will simply mark up prices which will fuel inflation. The higher wage will be used up by higher prices.”
Lydia: “You are forgetting that higher wages put more money into the pockets of people who must spend all they have to survive. Their extra spending will help stimulate the economy and provide more jobs.”
Betty: “Small businesses will be decimated by the president’s proposed minimum wage hike. If we want to help those below the poverty line, there are far more efficient ways to do so.”
Lydia: “Paying higher wages will actually benefit businesses through lower turnover rates and reduced absenteeism. That sounds efficient to me.”
This about summarizes what we hear and read in the media. So what is real? Does economics as a science (as opposed to a political tool) shed some light on these issues? A fair amount.
Is raising the minimum wage “the right thing to do?” Economists do not generally deal with right and wrong. We are above such things, or below. Yes, probably below.
As for the public, according to the most recent poll I could find (Pew) published a couple of weeks ago, 73 percent of Americans favored raising the minimum wage. In fact, half of all adults said that they would be more likely to vote for a candidate who favored increasing the minimum wage, with 19 percent stating the opposite. Apparently the public seems to think that raising the minimum wage is the right thing to do.
Should wages be set by free markets? There is a difference between free markets and competitive markets. This is an important distinction to make throughout the economy and not just with regard to the minimum wage debate. Employers do have a degree, and in some cases a great degree, of monopsony power over employment.
This means that in a “free” market, wages are generally set below a “competitive” market rate. Many economic studies have confirmed this.
Will a 10 or 20 percent increase in the minimum wage create unemployment? No. When wage rates move up from a free market level to a competitive market level, employment will not fall off. This assertion is supported by a large body of empirical work. The one exception to this is youth employment. A smarter approach to the minimum wage includes varying wages according to age.
Will raising the minimum wage cause sufficient inflation, so as to cancel out the gains received by low income earners? Businesses do pass on some or all of the increase in the minimum wage to customers. The spillover effect on inflation is very small relative to the increase in the minimum wage. One of the most widely referenced academic papers on the subject was produced by Sara Lemos at the Institute for the Study of Labor in Bonn, Germany. She performed an extensive literature review, which concluded that an increase in the minimum wage by 10 percent raises prices by, at most, 0.4 percent.
This may, however, understate the price effect on low wage earners. Businesses which use a large portion of minimum wage labor for their products will raise prices by more than businesses who pay Goldman Sachs type wages.
Low income earners generally devote more of their spending on products provided by other low income workers. Thus, the effect of a 10 percent increase in the minimum wage on them is likely to be more than the 0.4 percent move we have observed, over many decades, for the economy as a whole. However, it will not be even remotely large enough to negate all or even a significant portion of the gains from the increased wages.
Will raising the minimum wage reduce poverty? Yes.
A recent literature review by Arindrajit Dube, at UMass Amherst, found that nearly all minimum wage research studies over a long period of time indicate that there is a statistically significant negative correlation between the minimum wage and the poverty rate. The conclusion indicated that the elasticity of minimum wage to the poverty rate is -.36. Translated into English, this is to say, if the minimum wage is raised by 10 percent, the poverty rate will drop by 3.6 percent over time.
Are there more efficient ways to aid the poor? Economists generally feel that there are more efficient ways to reduce poverty.
The Earned Income Tax Credit is more efficient according to standard economic theory. In practice, this may be more problematic. It is difficult to pass increases in EITC through Congress.
Further, EITC feels like a handout when a higher minimum wage feels like something earned and deserved. Maybe we economists need to change the way we look at efficiency?
How about the effect on small businesses? Small business owners are concerned about labor costs. They are even more concerned about sales. If the minimum wage is increased, costs must be passed on to consumers. There is a concern that this will lower sales. These are real concerns. They have been real concerns every time the minimum wage has been raised, since 1938. Somehow, it never seems to materialize. Why not?
Small business’ survival does not require attracting labor at below-competitive-market rates. Small and large businesses survive because they offer a product or service which people want to buy. It has always been true. It will continue to be true.
Finally, will raising the minimum wage actually help businesses through lower turnover and reduced absenteeism? This is repeated by proponents time and time again.
Higher wages are empirically associated with lower turnover and absenteeism. However, there is an economic disconnect going on here. Businesses set wages to maximize profits. Therefore, they must be aware of the relationship between wages and turnover and have set wages accordingly.
It is tough for me, as an economist, to argue that businesses have chosen a wage rate, which is below what is actually best for them. That is a bridge too far.
So how do we come out? You decide, but do take note of Australia. They currently have lower unemployment than we. Their inflation is also well contained. Their current full time minimum wage is 16.37 AUD (just under $15 U.S.) per hour or 622.20 AUD ($566 U.S.) per week. It seems to work quite well. Australia also has much lower income inequality than the US. Can we learn from another former British colony?
One other paper which some readers might find of interest comes from Berkeley’s Center for Labor Research and Education entitled “Living Wage Policies and Big-Box Retail.” It is an enjoyable and enlightening read.
(Marcus Hutchins, MA, M. Phil, Economics, Columbia University, NYC, is a former economist, treasury bond arbitrage trader and hedge fund manager. He retired to Southport in 1997 where he resides with his wife Andrea and his youngest daughter Abbey. He welcomes feedback at coastaleconomist@me.com.)
