Minimum Wage Hikes – or – What Econ 101 Didn’t Teach You

Your entry-level economics class taught you (or should have) that when the price of something goes up, less of it is consumed. This holds for cars, interest rates, widgets, and wages. So, during this week’s State of the Union address, when President Obama called for raising the federal minimum wage from its current level of $7.25 per hour to $9.00 per hour, and tagging the minimum wage to the cost of living, it drew a decent amount of criticism. The thinking against raising the minimum wage goes like this: if you raise the minimum wage, employers will be able to afford fewer workers; employment will go down; the economy is worse off. The counterargument is that with more money in their pockets, minimum-wage workers, will contribute more to the economy. However, with unemployment at 7.8%, nobody wants to be on the wrong side of the argument.

The problem is that basic economics seems to break down on this point. A recent paper from John Schmitt at the Center for Economic Policy Research surveys recent research on minimum wages and finds that there’s little effect on employment.

Before we look at that, though, let’s look at what this minimum-wage issue really looks like. The most recent data from the Bureau of Labor Statistics (2011) shows that about 59.1% of all wage and salary workers were paid hourly wages – that’s around 74 million Americans that earn their living by the hour. Of those hourly earners though, only about 1.7 million earned exactly the federal minimum wage, and 2.2 million earned less than the federal minimum. That’s a total of around 3.9 million people who are at or below the minimum wage; that’s around 5.2% of hourly workers and about 3.0% of all wage and salary workers.

Consider also that of those earning less than minimum wage, around half were working in restaurants and other food service establishments. So, a good chunk of those earning less than minimum wage are waiters and waitresses, positions that are typically paid less than minimum because their salaries are supplemented by tips and commissions. Tips and commissions aren’t counted in the BLS wage data, neither is overtime pay.

Also, some states have minimum-wage laws that are already above the federally mandated level. In fact, one state (Washington) already has a minimum wage above $9 per hour (they also don’t have state income tax), and Oregon is within a nickel of $9/hour. Lastly, ten states have tied minimum wages to some sort of cost of living index.

So, now back to the question…why doesn’t an increase in the minimum wage seem to affect employment? The most likely causes are

  • less employee turnover – higher-paid workers are more likely to stay in the job longer, reducing the costs of employers to find, hire, and train new workers. Paying workers more than the market wage is known as efficiency wages—Henry Ford did it; Costco does it.
  • cut wages on higher-paid workers – if you have to pay your minimum-wage workers more, you delay raises for your higher-paid or salaried employees.
  • pass the cost along – companies that hire a lot of minimum-wage workers are usually in a position to pass some of that cost along to their customers.

This isn’t to say that the viewpoint is unanimous. One study from the London School of Economics and the Central Bank of Turkey found a positive correlation between federal minimum wages and unemployment rates for states whose average wages were nearer to the federal minimum wage. Some sources link the 10% increase in minimum wage in 2009 with a decrease of around 600,000 in the number of jobs for teens. An assertion like that seems to ignore the historic recession that was raging at the time, which probably had more to do with the decrease than the minimum wage bump.

If there is indeed an economic impact, I suspect it’s somewhat muted. The negative effects, if any, on employment will show up more in states where the market wages are lower and in the service and hospitality sectors. Even if a higher minimum wage translated to fewer workers, hotels still have the same number of rooms and restaurants have the same number of tables. You may have worse service, but you’ll still be able to sit down and spend your money. The effect would definitely be more pronounced if the minimum wage were more prevalent in manufacturing – fewer people produce fewer goods.

If you’re interested, Brad Plumer at Wonkblog has a nice summary of the findings in Schmitt’s paper.

  • Kristen

    Great information!

    • Robin Anderson, Economist, Principal Global Investors

      Thanks for reading! And thanks for the comment!

  • Eric Hollister

    Robin, while on the topic of Minimum Wage, can you take a moment to address what happens to other people’s wages when the minimum wage goes up? Specifically, if the minimum wage go up by $1, how does that impact the wages of someone who makes $15.00 an hour. I’m sure it’s not a 1:1 relationship, but my first thought would be the person making $15.00 would feel the impact of higher costs, consequently, feeling like they received a cut in pay. What are your thoughts? Thanks, Eric

    • Robin Anderson, Economist, Principal Global Investors

      There are a few ways that raising in the minimum wage could affect somebody making a bit more than $7.25/hour, say $15:

      1—Employers would have to adjust their pay scales to move up those currently making $9 to $10 to $11, so that would mean somebody who makes $15/hour now may end up making a bit more depending on the pay scale adjustment. This is the White House’s view. They refer to the boost in wages for those making above the $7.25-$9 range a ‘ripple effect’.

      2—Employers decide to hold pay scales constant or reduce pay raises/bonuses for those making above $9 hour –‘wage compression’- as their labor costs increase. A recent academic study did find evidence of wage compression resulting from a minimum wage increase in Georgia and Alabama.

      3- Firms will pass on the cost of increased wages to the consumer. One literature review cited by Wonkblog found that a 10% increase in minimum wage led to 4% increase in prices (That is not a 1 to 1 relationship.)

  • Ben Miller-Coleman

    Hi Robin,

    Is there any research that details how many minimum wage employees also have to receive government assistance? And, how is unemployment in Washington and Oregon that have a high minimum wage?

    • Robin Anderson, Economist, Principal Global Investors

      Hi Ben! Thanks for reading and thanks for the questions! You bring up some interesting points, so I’m actually going to address these in my next couple of posts. Check back in for the answers!

  • Pingback: Minimum Wage Hikes Part II: Washington State Strikes Back | The Principal Blog

  • Pingback: Minimum Wage Hikes Part III: Minimum Wages and Federal Assistance | The Principal Blog

  • david ross

    Robin,
    I’m usually a little suspicious of these reports, especially when they come from an extreme left think tank like the Center for Economic Policy Research. I’m not disputing their assertions, but perhaps if you presented a counter argument from Cato or Brookings, we’d see a more balanced discussion. Thanks for starting the dialogue.

  • Chris Borey

    Interesting series of articles. Thanks for sharing this information. One observation.

    To your point on raising the minimum wage and likely causes, you listed “reducing employee turnover” as one possibility and followed that up with “Henry Ford did it” and “Costco does it”.

    I occurs to me that these two examples are at best self-refuting against the cause for raising the minimum wage, and at the least, questionable examples to use to support the much broader question of the affect on employment as it relates to all businesses that are subject to minimum wage standards. Here’s why:

    1) Ford and Costco are just two examples (there are numerous others too) showing that the market does recognize when higher wages are warranted. In the end, their higher wage offerings didn’t require gov’t action for it to occur.
    2) Ford paid his workers who were heads of households and in many cases, in their chosen career. It seems a bit disingenuous to me to try and draw a meaningful parallel between those jobs and many (granted, not all) minimum wage jobs that are filled often times by high school kids looking to work a few hours at a fast food joint to make some extra money.
    3) Finally, if/when the gov’t artificially equalize the playing field (i.e.…and thus Costco’s competitors end up being forced to pay same wages), they’ve in a sense cut down Costco’s competitive employment advantage and given their employees less reason to stay since the big box store down the street is now paying same/similar wages).

    Bottom-line: In seems to me, at least on this one point(given the two examples you cited), it supports the argument that a federal mandate is NOT required as the market will make adjustments and individual companies will be justly rewarded in doing so due to higher employee retention. In the very least, it seems to only support the correlation seen when specific individual companies voluntarily offer higher wages. This is a completely different question than the more broad/sweeping one. That is, “why doesn’t an increase in the minimum wage seem to affect employment?” Maybe it doesn’t, but in my opinion, neither the Ford or Costco examples would appear to be relevant in answering this question.