The Sin Of Minimum Wage Is…

Poverty? Inequality? Business Failure? An Economist Explains

Don’t tell anyone, but I fancy myself an amateur economics geek. Not that I could ever be a real economist; I’m certain that I’d flunk statistics, and my eyes glaze over at hardcore graphs and deep-dive numbers. Let’s just say I’m fascinating with the idea of economics, how currency and governmental structure collide with human nature and hard numbers, how the discipline’s theories of monetary policy, supply and demand and productivity become very palpable, very quickly, when they translate into whether people can feed themselves and their families, find a job or have dignity and stability in the early and latter stages of life.

Since human societies grew beyond scattered tribes, then established barter systems, then created money to represent the mutually accepted value of good and services, they have fought wars over who gets what, and what it’s worth. A whole lot of the Bible deals with how those ancient societies were built around property, hard-and-fast caste hierarchies (including centuries of slavery), and, in the New Testament, what belongs to God or Caesar. Time and again, Yahweh steps in to bring down kings and elevate what Jesus, in Matthew 25, called “the least of these.”

Which brings up today’s ongoing political and economic debate about the federal minimum wage, which has remained at $7.25 per hour for over a decade – equivalent to $8.75 today when adjusted for inflation.

The news came today that an apparently all-powerful entity otherwise known as Senate parliamentarian shot down the Democratic Party’s attempt to raise the minimum wage to $15 per hour incrementally over the next four years as part of its leviathan-sized pandemic relief budget reconciliation bill. That development disappointed a lot of people, me included; when fully implemented, the increase would have lifted many millions out of poverty. Virtually nobody debates the fact that no one can live securely at eight bucks an hour, especially if they’re feeding an extra mouth or two while trying to make rent, keep insurance current, plus fill prescriptions and the gas tank, too.

So, something’s gotta give, and in may states, it has. Nevada’s minimum wage is $8, increasing to $8.75 on July 1. California’s is $14 for business with more than 26 employees, $13 for those with fewer than 26. In fact, fully half the states raised their minimum wages in 2021, 19 of the remaining 25 are stuck on the federal minimum, with two states, Wyoming and Georgia, bottomed out at $5.25 (though businesses subject to the Fair Labor Standards Act – which ones aren’t? – are held to the federal minimum).

To be fair, according to a good friend of mine who’s a published and respected economics professor, fewer than two million workers were “paid at or below the federal minimum wage in 2019, and about half them were under 25 years of age.” Still, an across-the-board raise to $15 would “affect about 50 million workers, about a third of the U.S. workforce” – even though, when figuring in inflation, that fifteen bucks will be worth only $13.60 in 2025.

That sounds like a pretty solid nod to Jesus’, and society’s, economic “least.” A good thing, certainly. But, of course, it’s not that simple, starting with how “productivity” is defined, and how the cost of living varies greatly across this vast land.

I’ll let my friend take over from here, and step in to ask questions along the way. I truly appreciate his offer to share his analysis.

In the face of inflation, what should the minimum wage be?

If the minimum wage had kept up with inflation and worker productivity, it would be significantly higher. How much higher, however, depends on your measure of productivity. The most commonly reported measure is called labor productivity, essentially total output produced in the economy per hour worked. A better but less commonly used measure is total factor productivity, which accounts for capital investment and other factors. Using the former measure, the $1.60 minimum wage in 1969 would be equivalent to $19 now. Using the latter measure, it would be equivalent to $15.50.

What about the consensus among many business owners that this increase would force them to reduce payroll?

Simple supply and demand would suggest that an increase in minimum wage would increase the unemployment rate for those earning it, and so policymakers are trading off the benefit to those receiving higher wages from those receiving no wages at all. How many jobs would be lost would depend on what economists call the elasticity of labor demand.

Elasticity estimates average around -0.1 in the short run and -0.3 in the long run, so if these numbers hold then this wage increase could reduce minimum wage jobs by 6% in the short run and 17% in the long run, once employers have had the chance to find alternatives. For workers earning between the new and old minimum wages, the effects would tend to be smaller.

Unsurprisingly, some economists disagree, in part because markets are not quite so simple. Supply and demand models of the labor market assume that any employer who offered a penny less than the going wage would lose all their employees. Since this is clearly not true, simple math shows that employers who can pay less will benefit by doing so, and so probably already are. Economists call this monopsony power, and where it exists increasing the wage (at least a little) could theoretically increase employment, not decrease it [italics mine].

Economists turn to the data for answers, but it can be tricky to untangle cause and effect. Most studies have found resulting small decreases in low-wage jobs, some have found increases, and many have found no significant effect at all. We do know that in the aggregate there is no historical correlation at all between changes in the minimum wage and the unemployment rate.

However, the proposed $15 wage is a bigger increase than we have seen before, even with a gradual phase-in. It’s important to admit that we don’t really know what the nationwide effects will be.

But that $15 goes further in some places than others …

The effects of the increase are likely to be greater in regions where average wages and the cost of living are low. There is a big difference between the wages of a childcare worker in Pueblo, Colorado versus one in Decatur, Alabama, and there is a big difference between the cost of living in the New York metropolitan area versus 500 miles away in Beckley, West Virginia.  Many states and cities with higher costs of living have already implemented their own minimum wages in the last decade, due largely to the federal government’s inaction. A better federal proposal might consider those regional distinctions, but that does not seem to be on the table.

On balance, a raise would help more than hinder, right?

There will certainly be winners and losers. Low-wage workers who are paid more will win, and the Congressional Budget Office (CBO) estimates that a million fewer people will be in poverty. Owners of firms who depend on low-wage workers will make lower profits, and some may even go out of business. Firms that sell products to low-wage workers will be winners, and some firms may even benefit from having more motivated workers. Taxpayers are likely to benefit because they won’t have to subsidize as many workers with food stamps and other support programs.

What about the idea that prices will go up to cover the jolt to employers’ bottom line?

Perhaps for some things, but not across the board. Fast food may become a little more expensive, along with the cost of hiring a maid. But for most goods and services, low-wage labor is only a small part of the total cost, and big firms which have raised their own minimum wages have not significantly raised their prices. Other prices change too as things shift around. Economists think price inflation is generally a monetary phenomenon, mostly driven by the interaction between banks’ willingness to lend and individuals’ willingness to keep money in a checking account instead of spending it.

Finally, what are your thoughts on how the minimum wage debate figures into the ongoing trend toward greater income inequality?

Over the last forty years the US has become one of the most unequal developed economies in the world. The income share of the poorest 40% of households fell from 14.3% in 1979 to 11.4% in 2019, while the income share of the top 5% rose from 16.9% to 23.0%. In spite of the potential downside effects on employment, the CBO estimates that the proposal before Congress would increase income for the bottom half, and thus lead to a reduction in inequality for the first time in decades.

Sounds like it could, and should, be a political winner.

Harry Truman famously asked for a one-handed economist, since he found it annoying to be told that virtually every policy he proposed had both costs and benefits. Perhaps the implementation of a higher minimum wage could be improved to minimize the costs and maximize the benefits, but on the whole a change of this magnitude could lead to a significant improvement in the well-being of our lowest-paid workers.