Could hiking the minimum wage boost the economy?

March 7, 2013

One of the arguments for raising the minimum wage is that it might provide a bit of stimulus for the economy. After all, the theory goes, low-income workers are far more likely to spend their extra earnings than people further up the income ladder.


What a surprise, this makes a difference. (Scott Eells -- Bloomberg)

But does this actually happen? In a recent essay at VoxEU, Daniel Aaronson and Eric French of the Chicago Federal Reserve Bank discuss past research on this very question. Their conclusion: Minimum-wage workers do end up spending more in response to a hike. But there are also reasons to be skeptical that raising the minimum wage would provide much of a stimulus.

In one recent paper, Aaronson and French estimated that adult workers at the very bottom spend an extra $700 per quarter, on average, in response to a $1-per-hour hike in the minimum wage. For the most part, workers who receive a raise appear to take on more debt in the short term to buy durable goods like cars and trucks. (They have to pay that debt off later, but in the short term, that's a stimulus.)

So does that bode well for President Obama's proposal to raise the federal minimum wage from $7.25 per hour to $9 per hour? After all, his proposed raise would affect about 13.4 million Americans by the end of 2015. That should translate into tens of billions of dollars in stimulus, no?

Well, not so fast, write Aaronson and French. While the theory is plausible, they note, the overall stimulative effects are still unclear.

That's because a minimum-wage hike mainly boosts consumer spending in the short term by spurring low-wage workers to borrow more. At least, that's been true in the past. But it might be less true today. Since 2008, banks have tightened their lending standards for low-income Americans and it's become harder to borrow money. What's more, Aaronson and French's research only looked at minimum-wage adults. About 23 percent of current minimum-wage workers are teenagers — it's not clear that they'd also start borrowing money to buy cars and trucks at the same rate.

Another key point: A lot depends on how employers react to a minimum-wage hike. They could start hiring fewer low-wage workers or laying people off. Or they might raise prices. Or they might respond by making their employees work harder. Economists disagree on how, exactly, companies respond to a minimum-wage hike, but if unemployment among low-wage workers does go up, that would blunt the stimulus effects.

"For these reasons," Aaronson and French write, "we should be somewhat suspicious of claims that the minimum wage will significantly boost the economy." Though they do agree that "putting money into the hands of consumers, especially low-income consumers, leads to predictable increases in spending."

Now, extra stimulus is hardly the only argument for raising the minimum wage. There are all sorts of other things to consider, from alleviating poverty to basic economic fairness. But seeing as how the country is still mired in a subpar recovery that can use all the help it can get, the stimulus question is worth exploring.

Further reading:

-- Economists disagree on whether the minimum wage kills jobs. Why?

-- Four things to know about Obama's minimum wage increase.

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Ezra Klein | March 7, 2013