As we launch into 2015, there’s something other than an 18,000 Dow to celebrate. Thanks to increases in state minimum wage levels, nearly 4 million hardworking Americans in 21 states are getting a raise this year, according to the Economic Policy Institute — from 15 cents an hour in Washington state to $1.25 in South Dakota. The leadership of the Republican Congress and its allies in the business community continue demonizing these initiatives as job-killing government price controls. Most of the rest of us see something simpler: economic justice.
The intellectual case against the minimum wage can be boiled down to the seemingly noncontroversial observation, backed by every introductory economics textbook, that whenever you raise the price of something, people will buy less of it. That iron law of the “downward sloping demand curve” applies as much to labor as it does to caviar and beer. Yet, if it’s so obvious, why do countless studies show that the impact on low-wage employment ranges from zero to small? And why did 47 percent of economists tell University of Chicago pollsters that the distortionary effects of a proposed $9-an-hour federal minimum wage are outweighed by its benefits to low-wage workers? (And another 32 percent said they weren’t sure.)
According to standard economic theory, when government artificially raises the wage of low-skilled workers above the value of what they produce, business owners will tend to replace them over time with a combination of technology and higher-skilled workers. Others may raise prices to cover their increased labor costs, which by the logic of the downward sloping demand curve will reduce sales and, with it, employment. Either way, the minimum wage is doomed to hurt the very workers it is meant to help.
But what if labor and products and capital markets are not as perfectly competitive as this theory assumes? What if wages within a firm don’t precisely reflect each worker’s marginal productivity but are influenced by social and psychological considerations? And what if the real effect of the minimum wage is to redistribute modest amounts of income from business owners, higher-paid employees and consumers to those low-wage workers it was meant to help?
In the real world, the way companies respond to an increase in the minimum wage is not unlike the way they respond to an equivalent increase in the cost of rent, energy, raw materials or taxes. Owners try to pass the cost on but may be forced to swallow some of it themselves. How it sorts out depends on how price-competitive and profitable and price-sensitive the industry is and the state of the economy, and the answer may be different in the short term than the long.
At fast-food restaurants, for example, there’s some evidence that much of any minimum wage increase is passed on to consumers. Minimum wage workers at such restaurants account for about 20 percent of total expenses, so a 25 percent increase in the minimum wage to $9 could result in a 5 percent increase in prices. That’s about 30 cents on a $5.70 Big Mac meal, which could very well result in a small drop in demand.
But remember that those who don’t buy Big Macs will have to buy more Kraft macaroni and cheese, as an example, which will increase employment at Kraft. Even more important, because of the minimum wage increase, the Congressional Budget Office estimated that 11.8 million workers would get a pay raise, which some of them would surely spend on Big Macs and other goods and services produced by low-wage workers. Add all of these employment responses together, and any negative impact on jobs from a $9 minimum wage is likely to be so small as to get lost in the statistical noise.
(Note: There are other proposals to increase the federal minimum wage to anywhere from $10.10 to $15. The economics of those proposals, to say nothing of the politics, would be considerably less favorable.)
Then again, maybe the full wage increased won’t be passed on in higher prices. Maybe the owner of the firm could offset the pay raise for low-skilled workers by reducing pay increases for supervisors and managers and other higher-paid workers.
Fifty years ago, the wage gap between skilled and unskilled workers was much narrower than it is today because the social norm favored more-equal pay. The minimum wage is one way that society expresses and adjusts such norms, and polls indicate a majority of Americans believe a bit more “wage compression” is a good idea now.
It is also possible that a higher minimum wage will lead to lower business profits. Call me a cynic, but I doubt the long-standing and virulent opposition to the minimum wage by owners of fast-food restaurants and retailers stems from their abiding concern for the job security of low-skilled workers. It’s a good guess the reason they have set up a permanent lobby to oppose the minimum wage is that it lowers their profits, through squeezed profit margins or reduced sales. We need not shed any tears for the Wal-Mart billionaires or the private-equity sultans who own Burger King. But given the slim profits for small retailers and fast-food franchisees, there’s a legitimate concern.
I’m fairly confident, however, that a more thorough analysis would show that business owners would share the pain of a higher minimum wage with their landlords and their franchisers, as well as with the tax man. Or they might respond to the challenge of lower profits by coming up with new ways to reduce costs (simplify the menu, let customers pour their own coffee).
While I wouldn’t want to push this point too far, those higher wages could pay for themselves in part by enhancing worker loyalty and productivity. After all, if pay increases are an effective incentive for bonus-laden CEOs, there’s no reason it won’t work for front-line employees, too.
Indeed, even if a $9 minimum wage winds up reducing employment by 100,000 low-skilled workers, as the CBO estimates, that hardly settles the issue. Given the high turnover in minimum-wage jobs, the odds are those unlucky 100,000 will not be unemployed for long. And when they do find a job, those working full time will enjoy an increase of pretax income of up to $3,500 a year, along with the 11.7 million other low-wage workers who did not suffer any job loss at all. On balance, that looks like a pretty good deal for low-income workers.
But our economic analysis of the minimum wage should not end there. One of the things we know about economies is that those characterized by high levels of trust, collaboration and mutual concern — what economists call social capital — tend to generate higher incomes and growth rates. Moreover, the people who live in those places are happier and express more satisfaction with their lives, which at the end of the day is what we ought to care about. We also know that social capital is enhanced when there is a widespread belief that the distribution of income and opportunity is fair.
In the end, that may be the most important rationale for raising the federal minimum wage. Fairness matters. Decades of stagnant incomes and rising inequality have so torn the social fabric that we can see its impact in higher costs for business and government, diminished engagement of workers and a dysfunctional political process. A reasonable increase in the minimum wage would be a small step in restoring social capital.
That’s not to say that a minimum wage increase is a free lunch, as some advocates would have you believe. It is, however, an economically benign way for a country whose economy is growing and whose stock market is soaring to redistribute income from households with above-average incomes to a struggling working class.