Minimum Wage Policy In The US
November 16, 2015
Recent raises in municipal and stage minimum wages in Seattle, Los Angeles, San Francisco, New York City and elsewhere have brought minimum wage policy into the forefront of current economic policy debates. Ever since the minimum wage was first introduced during the New Deal in 1934, supporters have argued that such policies enable low-wage workers to earn “living wages” that allow them to achieve basic economic security themselves and their families, as well as promoting equity by redistributing income away from allegedly excessive corporate profits towards labor. Critics, by contrast, contend that they reduce labor market flexibility, leading to increased unemployment and a forcing-out of small businesses from markets. Academic economics and policy studies have not been immune to this debate, with the consequence that political activists on each side tend to cite those economists and policy writers who reinforce their own views.
Minimum wage policy has important implications for fiscal policy at all levels. Crucially, their effect on employment, wages, and consequently, welfare dependence rates has a significant effect on government spending on “welfare spending”, broadly defined as both direct monetary and other payments as well as more indirect spending, such as insurance subsidies to low income-earners in the Affordable Care Act. Welfare spending is a complex mix of federal (e.g. TANF), federal/state (e.g. Medicaid, unemployment compensation), and other spending sources. If a hike in the minimum wage allows greater numbers of low-wage workers to earn a sufficient income to eliminate or mitigate welfare dependence, the policy will tend to reduce public welfare spending; but if it leads to greater unemployment and increases aggregate welfare dependence, the policy will tend to increase it. The positive question, “Just what effects we can expect from minimum wage hikes on labor markets?”, is therefore essential to understanding the fiscal consequences of minimum wage policy.
Theory and Evidence
Minimum Wages and Unemployment
The standard argument presented in Econ001 points out that, all else equal, any price floor tends to lead to a surplus of supply over demand. In modern society labor is a commodity, so this applies to labor markets as well. A minimum wage which is below the equilibrium price of labor (or, more specifically, of markets for labor in those low-wage sectors which minimum wages tend to effect) would be superfluous; a minimum wage above the equilibrium price creates a situation where more people want to work but there are fewer jobs available. Therefore, critics say, it’s better to let the market decide prices for labor, and if wages are too low for certain workers to sustain themselves, the government should step in to provide welfare assistance (derided by minimum-wage supporters as “subsidies” to low-wage companies) in order to preserve labor market flexibility.
(Image: The effect of a wage floor in a simple labor supply and demand model. Source: Wikimedia Commons)
This argument was widely accepted in the economics profession until the 1990s, when Card and Kreuger made their landmark empirical studies comparing unemployment and other factors across state borders where one had raised their minimum wage and the other had not. The idea was that the geographic proximity would control for extraneous factors associated with variation across states. The studies did not show increases in unemployment correlated with hikes in statewide minimum wages. On the other hand, food-stamp usage did appear to show a negative correlation with minimum wage hikes. This led to a period of intense debate and reassessment in labor economics, and numerous conflicting empirical studies were published supporting and failing to support a correlation between minimum-wage hikes and unemployment. According to Professor Arindrajit Dube, the proportion of economists who would predict job losses from minimum wage hikes has declined from 90% in 1978 to 34% today.
(Image: Study comparing 288 pairs of contiguous U.S. counties with minimum wage differentials from 1990 to 2006. Based on this, researchers found “no adverse employment effects” from a minimum wage increase. Source: Public Domain License – Wikimedia Commons. Study Source: Dube, Andrajit; Lester, T. William; Reich, Michael; Minimum Wage Effects Across State Borders: Estimates Using Contiguous Counties, Working Paper Series, Institute for Research on Labor and Employment, 30 November 2010.)
So the empirical record is still some conflicted; but since the theory seems so clear, why might the effect of minimum wages on employment be so ambiguous in the first place? One factor to consider right off the bat is that firms may respond to minimum wage hikes, not by laying off workers but simply by hiring fewer new workers, so that the effects are not seen so immediately.
Another has to do with the price elasticity of demand for labor. This is the “slope” of the demand curve in the market for labor. A highly elastic demand for labor indicates that firms’ demand for labor in a particular market is highly sensitive to changes in price, while an inelastic demand means that their demand for labor is relatively constant despite changes in price. Price elasticity of labor may be thought of as a measure of the “bargaining power” of labor; if it is more difficult to replace workers with technology or do without them otherwise, the demand for labor will be more inelastic, and workers can extract a greater surplus from wage hikes with relatively few losses in total employment.
Minimum-wage workers are highly concentrated in the retail and service industries, especially restaurants. Firms in these industries need real human workers to perform “affective labor” and are highly location-specific; a department mall, unlike a factory, can’t just decide to up and move to somewhere else where labor is cheaper. This might be reason to think the demand for labor in these markets is relatively inelastic, providing a rationale for minimum wage hikes to reduce working poverty. On the other hand, many food retailers and “fast food” restaurants like McDonalds are moving to adopt technological substitutes for human cashiers, which would make the demand for labor more elastic and make minimum wage hikes less effective.
Finally, some supporters of minimum wage hikes have cited Keynesian arguments around aggregate demand: workers consume more of their overall income than the wealthy, so redistribution of income to workers would tend to drive aggregate demand for goods, in turn providing more opportunities for employment. The empirical record is dubious here; Card & Kreuger’s studies found neither a positive or negative on employment from minimum wage hikes.
What level of government?
The federal minimum wage has not been raised since 2009, when it was set at $7.25. However, many municipalities and states have begun raising minimum wages on their own. Examples include Seattle and San Francisco, which are raising their minimum wages to $15 over the course of a few years. What are the advantages and disadvantages of implementing minimum wage hikes at different levels of government?
One rationale for implementing minimum wage hikes locally is that municipalities tend to vary considerably in their costs of living. Housing prices are magnitudes greater in New York City than in a midwestern small town. Setting minimum wages at the municipal level allows greater flexibility to set “living wages” at the rate that it is appropriate for the cost of living in that locality.
On the other hand, setting minimum wages locally also runs the risk of creating a “race to the bottom” where firms move to municipalities with cheaper labor, putting pressure on cities to compete to have the lowest labor costs. It is much less expensive for a firm to move to another municipality or state within the US than to move abroad. However, if minimum wage jobs are concentrated in location-specific sectors such as retail, the risk of a race to the bottom might be markedly less pronounced.
When considering whether or not to raise the minimum wage in order to address poverty, we should consider it not just against the status quo, but against the best possible alternative. What alternatives exist to minimum wage hikes as a strategy to address the needs of the working poor?
One alternative already mentioned is to provide public welfare assistance to low-wage workers to supplement their incomes as employees. The rationale for such a policy is that it preserves labor market flexibility by spreading the costs of providing livable incomes to all across the taxpaying public at large. However, such welfare policies are not without their own effects on labor markets: public welfare to the employed puts downward pressure on wages, as people are willing to work for lower wages once they have the alternative source of income.
Another alternative involves relying on collective bargaining to set livable wages, without direct policy intervention except insofar as is necessary to secure collective bargaining rights. With strong unions, so the argument goes, wages are “co-determined” by workers and employers at individual firms to reach a living level, without need for a mandated minimum wage. This is a common feature of labor systems in social-democratic policy regimes in Europe, such as in Germany and the Scandinavian countires. These countries either do not have minimum wages or only recently adopted them, instead relying primarily on strong unions to set living wages.
The rationale for collective bargaining as an alternative to minimum wage hikes is that it is more flexible to differences across labor markets and that unions have an incentive not to demand wages that are too high at the risk of bankrupting their employers. On the other hand, the outcome of collective bargaining is highly contingent on bargaining power; union density in the United States is very weak right now (6.7% in private sector and 35% in the public sector) so union bargaining power might not be strong enough by itself. Also, the sectors in which minimum-wage jobs are concentrated (retail and service) are not sectors that the union movement has traditionally focused on. At any rate, the efforts of SEIU and Fight for $15 to organize workers in these traditionally un-organized sectors to collectively bargain for higher minimum wages at the firm level is highly significant and worth further observation and study.
While most policymakers agree that working poverty is a serious issue that needs to be addressed, they disagree about the effectiveness of minimum wage policy to fill this need. Supporters argue that they are the most direct way to enforce livable wages, decrease reliance on food-stamps and other public subsidies, and to redistribute income from capital to labor. They argue that minimum-wage sector jobs are relatively resilient to changes in price due to peculiar features of those sectors and that increased worker incomes drive aggregate demand. Critics argue that minimum wage policies reduce labor market flexibility, reduce employment and growth over the long run, and increase reliance on unemployment insurance and other transfers to the unemployed. The empirical evidence does not conclusively support either a positive or negative on employment due to minimum wage hikes, at least not across state lines.
There is also significant debate about whether welfare and collective bargaining policies should be substitutes or supplements to minimum wages as strategies to address working poverty. Welfare to poor working households provides a basic income level while preserving labor market flexibility, but subsidies lower wages, as well as introducing moral concerns about “dependence” on government. Collective bargaining has proven to be both flexible and effective at raising and keeping wages at a livable level in sectors with strong unionization, but the sectors in which minimum-wage workers are concentrated have traditionally been weakly unionized. Novels forms of labor organizing, such as Fight for 15, may signify a new approach to strengthening collective bargaining in low-wage sectors. Notably, this form of organizing has already shown success at major firms such as Walmart and McDonalds.
When thinking about minimum wages, policymakers should bear in mind the positive side (effects on employment) as well as the normative side (distribution, self-reliance, etc.) of the matter. Policymakers should also consider the pros and cons of minimum wage hikes at the local, state, and national levels, and should compare proposals for minimum wage hikes with alternative strategies such as transfer payments and collective bargaining.
Additional Blog Posts
Student Blog Disclaimer
The views expressed on the Student Blog are the author’s opinions and don’t necessarily represent the Penn Wharton Public Policy Initiative’s strategies, recommendations, or opinions.