Minimum Wage Hikes (Repost)

On the occasion of the scheduled fast food-workers strike today (Thursday, December 5), I thought I’d dip into the vault and repost something from earlier this year on a proposal to hike the federal minimum wage. Workers in around 100 U.S. cities are striking on demands that their wages be moved from the current federal minimum of $7.25 per hour to $15 per hour – that’s well ahead of what President Obama suggested in a State of the Union address back in February. What we look at in this post is why basic economics breaks down when talking about increasing the cost of labor. While you’re looking, you might want to check out a couple other posts I did on minimum wages: one on Washington state (who’s minimum wage is above the federal one) and one on the relationship between minimum wage and federal assistance.

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.

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