Calls this year to raise the state and federal minimum wages from $7.25 to $10.10 brought the expected political responses from both sides of the aisle. Regrettably, neither side's response is clearly supported in reality. The final outcome will minimally impact employment and poverty. Politicians would more effectively spend their time passing legislation for making future adjustments to the minimum wage by regulation or by a commission.
Conservatives argue that raising the minimum wage will lead to lost jobs. This position overlooks key assumptions underlying the perfectly competitive market wage, which posits that both the potential employer and employee have power in a hiring transaction and assumes in particular that workers have perfect information about job offerings and prices and that labor is mobile. In reality, those in minimum wage jobs have limited information and find travel to be relatively expensive, so they are actually at a competitive disadvantage. Therefore, it is quite possible that minimum wage workers are being paid by companies below that competitive market wage. If this is the case, the boost in the minimum wage could have little or no impact on jobs.
If employers are paying less than the competitive market wage, tax payers are subsidizing private businesses through the earned income tax credit, a federal subsidy for low-wage workers. When costs of the tax credit are considered, the increased cost to companies may not be large.
The conservative response also ignores additional expenditures by those who earn wages at the higher minimum wage and the additional jobs that are created as a result. Since minimum wage employees live largely paycheck to paycheck, the minimum wage increase will rapidly flow into the economy through expenditures on goods and services. This secondary response is largely ignored in conservative discussions.
The liberal argument focuses on the impact of those newly created jobs and on the "injustice" of workers making less than a living wage. When the earned income tax credit is combined with wages, the impact on newly created jobs and on the level of living is likely to be relatively small. In turn, the "fairness" to those making less than a living wage will not be affected to any large extent. However, companies may benefit since research indicates that higher wages are likely to raise worker loyalty and lead to reductions in company costs for retention, recruitment and training at the low end of the pay scale.
The divergent political posturing is similar to the divergent views held by economists, who exhibit no consensus as to whether an increase will increase or decrease jobs. Whatever the impact, there is agreement that the change in jobs is not likely to be large in either direction. Only 2.8 percent of workers are paid the minimum wage. In addition, 21 states (and a number of municipalities) already have a minimum wage above the federal minimum wage.
There is growing evidence that a minimum wage that is a relatively small portion of the average hourly rate does little if any damage to the number of jobs. The current minimum wage is 36 percent of the average hourly wage in the private sector and is at the lower end of the range of the past 20 years. The current percentage is also low when compared to that in many developed countries. Going into the Reagan-Bush era, the minimum wage was 46 percent of the average hourly rate. Raising the federal minimum wage to $10.10 would make it approximately 50 percent of the average hourly wage.
Regardless of the political outcome, there is growing evidence that the current process for setting the minimum wage is inefficient. When one considers the legislative costs of the past 20 years and the general consensus of economists that the impact of raising the minimum wage will be minimal, it is time to move the setting of the minimum wage outside of the political arena to a commission (as is done in many countries) or indexing it to inflation. The minimum wage is already indexed to inflation in 11 states. If the 1963 minimum wage of $1.25 per hour was adjusted for inflation, the current rate would be approximately $9.60. The federal government has already seen the advantages of autonomous inflation adjustments, such as cost-of-living adjustments in Social Security. Such a move would be beneficial to employees and their employers. It would free the legislature to pursue issues which do not perpetually arise and free the public from this political posturing.
Frederick Derrick is professor of economics at The Sellinger School of Business and Management of Loyola University in Maryland. His email is FDerrick@loyola.edu.
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