Be careful what you wish for, workers-rights advocates pounding the table for national minimum wage hikes.
Government mandates of higher wages hurt profitability at large and small businesses alike, and economic analyses of the effects on workers show mixed results at best in cities that have implemented a $15 per hour minimum wage.
However, that doesn’t necessarily mean raising the minimum wage after years of stagnation would cripple the economy. Here’s how economists view the hot-button issue.
Why economists are skeptical of price regulations
A core tenet of economic theory is that markets are most efficient at equilibrium, which is where goods and services are naturally priced based on where supply and demand meet.
The graph above illustrates the effect wages have on the number of employees willing to work. Supply and demand lines are graphed based on a chart below that shows how many employees will work for a certain wage and how many workers employers will want to hire at that wage. For example, at a wage of $12 per hour, 900 employees will seek work while businesses will look to hire 700 workers.
The supply line of employees willing to work at each wage slopes upward to reflect that more employees will work as wages — shown vertically on the Y-axis — increase. The demand line for workers by companies is downward sloping since businesses will want to pay fewer workers when wages are expensive but will be glad to hire more workers as wages get cheaper.
The equilibrium wage of $10, shown at the light blue horizontal line, reflects the U.S. median wage of $10.22 per hour for low-wage workers, according to research from the Brookings Institution in 2019. Keep in mind that in this example, the steepness of the graphs isn’t to scale and the number of employees is made-up.
Employer surplus, shown in the shaded area in light green, shows the savings benefit businesses get by paying employees willing to work under the going rate, which is the equilibrium. The employee surplus in green above the equilibrium reflects the opposite, where workers benefit by receiving a wage above the equilibrium rate.
Simply put, economists frown on price controls like minimum wage because they reduce both employer and employee surplus and create deadweight loss— or market inefficiencies that cost society from an economic standpoint — shown in the graph in light pink. It’s an inevitable side effect of government interference in the free market.
The dark blue and red horizontal lines in the second graph show the current national minimum wage of $7.25 and the proposed $15 minimum wage, respectively. Employers, who would love to hire workers below those marks, could no longer do so and see their surplus disappear while employees willing to work for less than $15 or $7.25 couldn’t do so and see their employee surplus substantially shrink, as the laws artificially alter how much producers must pay for labor.
The light pink shade represents inefficiency under current minimum wage laws, and the dark pink shade presents the inefficiency that would be created under a $15 per hour minimum wage. The inefficiency stems from restrictions that limit connections between employers and employees that would ordinarily form in the free market at the equilibrium wage of $10.
As shown in the chart on the right, workers willing to work for under $15 per hour are unable to do so legally, even if they’re willing to. At a $15 wage, companies in this example will demand 550 workers, and 1,050 employees will seek work.
That creates a surplus of 500 workers that are now unemployed, given that there isn’t enough demand in the market for their labor. The 550 employed workers will become better off under a higher minimum wage, but there will be a higher unemployment rate in this example given the lower demand for workers at the artificially high wages.
Just as government controls via immigration quotas harm the efficiency of the free market by preventing talented immigrants from helping domestic companies, as a Madison Business Review analysis showed in October, laws mandating higher minimum wages make the free market less efficient, raise prices for goods and services that force consumers to pay more, and separate employers from employees willing to work for less.
Do immigrants help or hurt the economy, and will more immigrants boost gross domestic product or raise the unemployment rate? Read and decide before heading to the polls.
As a sidenote, it’s curious that those on the political left who tend to favor loosening immigration restrictions also argue for raising the national minimum wage from $7.25 per hour, given that the latter will cut margins and reduce the natural free-market economic benefits that come from higher immigration levels.
After all, employers forced by law to pay higher wages often cut back on hiring, as the graph would suggest. This can lead to surpluses of workers, meaning there are more workers supplied than there are demanded by businesses, which is a technical way of describing unemployment.
These examples illustrate the effect of government restrictions, including price controls, tariffs and quotas, which hurt competition and reduce free-market efficiency by restricting employees willing to work for under minimum wage from doing so.
Such a restriction clearly can be seen as beneficial for the workers they protect, but not in all cases. An article on price floors, surpluses and minimum wage in the Foundation for Economic Education, a libertarian economic think tank, noted that higher minimum wages can lead to hiring discrimination on non-economic grounds.
“With more young people applying for jobs than employers want to hire, and with no legal way of paying a lower wage, it costs nothing to exclude some applicants from consideration,” Dwight Lee, a research fellow at the Independent Institute, wrote. “If an employer has a choice between hiring the mayor’s son or a poor kid from the other side of the tracks who would be willing to work for less, the mayor’s son is almost sure to get the job.”
Libertarians argue that higher price floors not only create economic inefficiency but also hurt both young and low-skilled workers by making them far less attractive to hire. This will likely lead to corporate behemoths like McDonald’s replacing relatively expensive cashiers with kiosks in what Forbes noted is in response to rising minimum wages across the country.
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Minimum wage laws may not agree with pure economic theory and pure, free-market capitalists like Libertarians, but the basic concept has bipartisan support because of the protection they provide to workers by keeping corporations from wielding too much power over workers.
Whether or not minimum wage should be raised nationally is fiercely debated and less clear.
Minimum wage history, trends
National minimum wage has held constant at $7.25 per hour since July 2009, its longest time without an increase since its inception in 1938, though states are free to raise the price floor.
Advocates of a higher minimum wage are quick to note that while the nominal minimum wage value has risen steadily before stagnating in the 2010s, its purchasing power hasn’t kept pace with inflation and thus has decreased since 1968, according to Statista.
Indexing, or automatically linking the value of prices or wages to inflation, is a popular idea for ensuring the minimum wage doesn’t lose purchasing power over time. Fourteen states have introduced a minimum wage index, with the District of Columbia, Oregon and California expected to follow suit in the coming years, according to Raise the Minimum Wage.
Wage growth has been slow, uneven and unequal in the past four decades, according to the Economic Policy Institute (EPI), a left-leaning economic think tank, adding that consistent positive wage growth has occurred just 10 times in that span and wage inequality has widened.
Inflation, as measured by the Bureau of Labor Statistics’ consumer price index, has climbed 21.4% since 2009, meaning a wage of $7.25 in 2009 is worth $8.80 in 2020. The minimum wage mark of $1.60 in 1968 would translate to a minimum wage of $11.97.
A national minimum wage with $15 of purchasing power would be unprecedented, though such legislation had the support of two-thirds of Americans and was strongly favored by 41%, according to a Pew Research Center poll in 2019.
Does raising the minimum wage work?
A minimum wage hike may be right around the corner — especially if Democrats secure the Senate. President-Elect Joe Biden has embraced the idea of a $15 national minimum wage, following the footsteps of Sen. Bernie Sanders and the Democratic Party’s left wing.
"I do [support a $15 minimum wage], because I think one of the things we're going to have to do we're going to have to bail them out too — we should be bailing them out now, those small businesses," Biden said at the second presidential debate in October.
The Democratic-controlled House of Representatives approved a bill later dismissed by the Republican-controlled Senate that would hike minimum wage to $15 an hour by 2025, according to Business Insider. Such a move would greatly help workers hurt during the pandemic but would likely harm small businesses in the same spot.
Proponents of a higher minimum wage, like the EPI, point to the laws as a catalyst for stronger wage growth for low-end earners. The think tank found that states — plus Washington D.C. — with higher minimum wages saw average 10th-percentile wage growth at 4.1%, which outpaced the 0.9% mark in states with a $7.25 minimum wage.
However, that’s far from a bulletproof argument in favor of a national minimum wage increase. It doesn’t touch on wage growth at other percentiles or the unemployment rates and economic growth rates of those respective states. All it conclusively means is that wages grew modestly quicker for low-end earners in states with higher minimum wages.
Nonpartisan analysis by the Congressional Budget Office found a $15 minimum wage would boost earnings for over 27 million low-wage workers, lifting 1.3 million out of poverty, though 1.3 million jobs could be lost. Margins would also be far tighter for many businesses as their economic surplus shrinks, and conservatives fear that would put a damper on economic growth.
The pandemic crippled the U.S. economy and will do so through 2021, meaning it’s the wrong time to lower business income, job growth and economic growth by hiking minimum wage to $15 per hour, read a Bloomberg editorial by Michael Strain, the director of policy studies at the American Enterprise Institute, a right-leaning economic think tank.
But that doom-and-gloom rhetoric is purely political, Jeffrey Clemens, an economics professor at UC San Diego who’s published research for the AEI, said to Axios. Clemens’ research is used to argue against minimum wage increases, but — because no one can agree on anything — some think there’s evidence to contradict that higher paying wages hurt businesses at all.
What’s most likely is that whether a higher minimum wage’s impact is positive or negative depends on the state and region, an idea echoed by Diane Swonk, chief economist at international accounting firm Grant Thornton.
“The current minimum wage increases were successful because they were regionally based, and not national or one-size-fits-all,” Swonk said.
On that note, here’s a look at a major American city’s experiment with raising minimum wage.
Seattle case study
Seattle was one of the first major U.S. cities to pass a law raising its minimum wage to $15 by 2021 from $9 in 2014. Minimum wage was indexed with inflation each year and set to increase gradually.
As of January 2020, Seattle’s minimum wage is $16.39 per hour at companies with over 500 employees globally and $15.75 per hour in compensation at smaller businesses with no tips or healthcare benefits. However, businesses like restaurants can pay $13.50 per hour in wages so long as hourly compensation after tips and the cost of healthcare benefits is $15.75.
The move had mixed effects, as University of Washington researchers found in 2017 in the National Bureau of Economic Research. Total payroll was reduced after hours worked at low-wage jobs was sliced by 6-7% while hourly wages in such jobs were boosted by just 3%, according to Vox. That appears to show economic inefficiency and deadweight loss at its finest.
But the same researchers a year later discovered “significantly more rapid hourly wage growth” in take-home pay for workers at the low end of the wage scale. Those who worked more hours saw earnings rise while those who worked less saw level earnings thanks to higher wages. The researchers suspected a slowdown in hiring for low-wage jobs was behind the move.
That slowdown in hiring and the heightened possibility of shutting down and leaving the city were common warnings from the area’s business owners in 2015. And while some have, the number of jobs in Seattle-area restaurants and bars increased 16.2% from January 2015 to January 2020 — a healthy annualized growth rate of 3.3%, though it’s below the city’s population growth rate of 5.3% in that span, according to Macrotrends.
It’s worth noting that Seattle’s hot economy, home to corporate giants like Amazon and Boeing, is far more robust than nearly all other American cities, meaning a nationwide minimum wage increase could produce far more harmful effects than those in the Emerald City.
Will a higher minimum wage hurt the economy by lowering hiring?
In conclusion, higher minimum wages undoubtedly reduce efficiency by creating deadweight loss, but that isn’t the be-all and end-all to the argument. Minimum wage laws may have some negative side-effects, but they generally protect workers from being taken advantage of.
Most Americans appear to favor a $15 per hour minimum wage, as mentioned earlier, so it shouldn’t be controversial to say that minimum wage could use a boost after 12 years of stagnation and ever-declining purchasing power.
Higher minimum wages haven’t appeared to cripple growth as feared, but the key to political and economic success of a bill calling for a national minimum wage hike centers around the dollar number.
Mandating a $15 per hour minimum nationwide is likely far too steep and drastic, at least to gain bipartisan support. But an increase in the $10 to $12 neighborhood — with the latter approximating what 1968’s minimum wage purchasing power in 2020 would be — is less flashy but could very well be a solution to the apparent problem of stagnant wages.
James Faris is a senior media arts and design major. Contact James at firstname.lastname@example.org.