Minimum Wage

Minimum wage laws set the minimum hourly wage a worker can be paid. A minimum wage of $7.25, for example, means a worker cannot legally contract with an employer to work for below $7.25 an hour.

The federal minimum wage sets the wage for the whole nation. In 2010, the minimum wage was $7.25. The federal minimum wage for tipped workers is lower than the standard minimum wage, on the assumption that these workers can meet or exceed the minimum wage through tips. On the other hand, many states have a minimum wage that is higher than that mandated at the federal level. Information on the current minimum wage, both federal and state, and who is covered by the law is available at the Bureau of Labor Statistics Web site (http://www.bls.gov/).

Approximately half of those earning the minimum wage (or less) are young workers (below age 25). Most are adults living alone (23 percent) or teenagers living with their parents (41 percent). About 15 percent are adults raising a family. Another way to look at the statistics is to consider that about 10 percent of teenagers earn the minimum wage (or less), and 2 percent of those above age 25 earn the minimum wage or less. Many studies show that increasing the minimum wage has little impact on the poor. One study, for example, found that, if the minimum wage were raised 30 percent, less than 2 percent of those living in poverty would have their wages directly increased (Wilson 2001).

Many economists oppose the minimum wage for two reasons. First, the minimum wage law, in effect, prohibits from working anyone who cannot produce enough value in his or her work to cover the minimum wage. That is, a minimum wage of $8 an hour does not help the person who can produce a value of only $6 an hour. In addition, it does not seem worthwhile to help 10 workers to earn $1 more an hour, for example, if another worker is forced out of a job paying $5 an hour. While there is controversy about whether a small increase in the minimum wage will reduce jobs, there is no doubt that a very high minimum wage will cause substantial job losses. It may be argued that a very high minimum wage is necessary to give workers a living wage, but this would be counterproductive if the worker cannot get hired at all. To a worker put out of a job, a hiring wage is better than a living wage.

The second reason many economists oppose the minimum wage is that there is a more efficient method of helping the working poor without jeopardizing their jobs—the earned income tax credit. If a person is poor, the earned income tax credit supplements his or her wage earnings. For example, a poor person earning $6 an hour might get another $3 an hour from the government. While the current earned income tax credit program it not that generous, it could be changed to be so and to significantly increase the incomes of the poor.

An earned income tax credit has several key advantages over the minimum wage. First, it only goes to the poor, while the minimum wage favors those whom employers want to retain (who are often the better-educated teenagers whose parents who are well-off ). Second, the minimum wage does impose a cost on society in the form of higher prices and lower profits. Because the poor are a small fraction of minimum-wage workers, and because the earned income tax credit only goes to the poor, for the same social cost, the earned income tax credit can give the poor a much higher wage than a minimum wage having the same social cost. Third, there is a social justice argument. The earned income credit is paid for by taxpayers, not employers. It can be argued that society (mainly taxpayers) benefits from making the poor better-off , so it is just that society—not employers—should pay the cost of making the poor better off . The earned income tax credit is more just than the minimum wage because it is paid for by society. There are some who feel that employers should do more for workers. But employers are doing something for workers—they are giving them a job. Blaming employers for not doing more is as unjust as saying the Salvation Army is responsible for poverty because it could do more.

The Minimum Wage and Employment

Does economic theory say that the minimum wage reduces employment? It does say that a large increase in the minimum wage would reduce employment. But what about a small increase similar in magnitude to past increases in the minimum wage? When labor markets are competitive, wages are bid up to the value of what workers produce. Thus, an increase in the minimum wage would push the wages of some workers above the value of what they are producing, and these workers would lose their jobs. On the other hand, when labor markets are not competitive, it is possible that a higher minimum wage would not reduce employment and, in some cases, would actually increase employment.

A minimum wage can increase employment if an employer is a monopsony. A monopsony is a situation where there is only one employer in a labor market. More generally, any employer who has to pay increasingly higher wages as he or she hires more workers (for example, paying $5 to hire the first worker and $6 for the second, and having to raise both of their wages to $7 to get a third) is a monopsony. Because a monopsony faces rising wage costs, the cost of each added worker includes the worker’s wage plus the dollar amount the employer has to pay in order to raise the wages of the other workers to the new wage. For example, suppose an employer employs 9 workers at $10 and must pay $11 to hire the 10th worker. The 10th worker costs $11 plus the $9 needed to raise the pay of the first 9 workers from $10 to $11. Thus, the 10th worker costs $20. If the worker produces a value of $15, the monopsony would not hire him or her. However, if there were a minimum wage of $11, the 10th worker would only cost $11 (since the wages of the first 9 workers do not have to be increased, as they are already at $11). In this case, the worker would be hired. A sufficiently high minimum wage (for example, $16) will cause this worker not to be hired and, if even higher, may cause others to lose their jobs. Over some range, a minimum wage causes a monopsony to hire more workers, but at some point, an even higher wage will cause jobs to be lost.

Research has found that restaurants have monopsony power over tipped workers. In the absence of a minimum wage, a restaurant hiring more tipped servers would find, at some point, that each tipped server earns less in tips per hour (as each will serve fewer patrons in an hour when more waiters are hired). As a result, the restaurant will have to raise the hourly cash wage to remain competitive with other employers. Therefore, a restaurant has monopsony power, and a minimum wage has the potential to increase employment of tipped servers. However, it was also found that when the minimum wage for tipped workers was increased too much, employment fell.

What do the data say about the effect of minimum wages on employment? Most studies of teenagers suggest that the minimum wage does reduce employment: every 10 percent increase in the minimum wage reduces teenage employment by 1 to 2 percent. The reason that most research on minimum wages involves teenagers is that they are the only group sizably affected by the minimum wage, which makes its effects more discernable. David Card and Alan Krueger have conducted considerable research that shows that minimum wages do not reduce employment. For example, they concluded that, when the minimum wage was increased in 1990 and 1991, states with a larger fraction of low-wage workers did not suffer a greater loss in jobs (Card and Krueger 1995). However, a study of the 1996–1997 increase in the federal minimum wage did show a greater job loss in jobs in states with larger proportions of low-wage workers (Wessels 2007). Thus, using their methodology, it appears that the minimum wage did reduce employment.

Another Card and Krueger study (1994) compared employment at fast-food restaurants in two adjoining towns—one in New Jersey, where the minimum wage was increased, and the other in Pennsylvania, where the minimum wage was not increased. They found no difference in before-and-after employment trends between the two towns and concluded the minimum wage had no effect.

Yet for the study’s results to be valid, both towns must have basically the same business conditions before and after the minimum wage increase. Otherwise, it is possible that the town with the minimum wage increase also had an improvement in business conditions (while the other town did not) that off set the negative effect of the minimum wage on employment. This is why nationwide studies usually are better sources of evidence; the year-to-year variations in local business conditions usually net out when averaged across the nation. The drawback to using nationwide studies is that the business cycle can be a potentially confounding factor. For example, the increase in the federal minimum wage in 1990 occurred during a recession, and it is possible that the negative effects of the minimum wage found then could have actually been caused by the business downturn. However, the minimum wage has been found to reduce employment in many business conditions.

Other Effects of the Minimum Wage

Minimum wages also have other effects. One major effect is that they raise the wages not only of minimum-wage workers but also of those earning more than the minimum wage. Studies have shown that a 10 percent increase in the minimum wage increases the average wage of all teenagers around 2 percent. This estimate is probably too low; most other studies have found a larger effect.

Another effect of the minimum wage is that it makes employers cut back on other amenities (by cutting fringe benefits, tightening work rules, and reducing on-the-job training). In this way, employers partially off set the effect of higher wages on their cost. The net effect for workers is that the minimum wage may not make them as well off as the increase in wages might indicate. One piece of evidence suggesting that this is the case is the fact that the past increases in the minimum wage have reduced (or had no effect on) the fraction of teenagers who want to work (as measured by their labor force participation rate). If the minimum wage increases the expected value of seeking and finding work, then it should increase the size of the labor force—but it does not.

A common error concerning the minimum wage is the belief that an increase in the minimum wage will be offset by workers becoming more productive and that, as a result, this will keep employment from decreasing. Various reasons have been given for the minimum wage increasing productivity, including the speculation that workers value their higher-paid jobs more or, alternatively, that employers try to offset the higher wage costs. If this were true, the minimum wage would reduce employment far more than it does. For example, suppose a minimum wage increases wages 10 percent and workers become 10 percent more productive. This will offset the effect of minimum wages on cost and leave the price of products unchanged. As goods cost the same amount, employers will produce and sell the same number of goods as before. But workers are 10 percent more productive, so employers would need 10 percent fewer workers to produce the same numbers of goods as before (indeed, that is what being more productive means). In this case, a 10 percent increase in the minimum wage would lead to a 10 percent decrease in employment. This is a far greater cut in employment than most studies find.

Conclusion

It can be argued that the poor would be better off if the political energy that goes into increasing the minimum wage were used instead to develop programs, such as the earned income tax credit, that truly help the poor. The minimum wage, according to much of the research in the field, reduces employment, but not sizably. More troubling, it does not increase the number of people who want to work, which suggests that it creates some offset such that workers on the whole are not better-off. Economists like to say that there is no such thing as a free lunch. The minimum wage is definitely not a free lunch. It may have benefits, but it also has significant costs.

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Bibliography:

  1. Andersson, Fredrik, Moving Up or Moving Down: Who Advances in the Low-Wage Market? New York: Russell Sage Foundation, 2005.
  2. Card, David, and Alan Krueger, “Minimum Wages and Employment: A Case Study of the Fast Food Industry in New Jersey and Pennsylvania.” American Economic Review 84 (1994): 772–793.
  3. Card, David, and Alan Krueger, Myth and Measurement: The New Economics of the Minimum Wage. Princeton, NJ: Princeton University Press, 1995.
  4. Ehrenreich, Barbara, Nickel and Dimed: On (Not) Getting By in America. New York: Henry Holt, 2002.
  5. Neumark, David, and William L. Wascher, Minimum Wages. Cambridge, MA: MIT Press, 2008.
  6. Pollin, Robert, Mark Brenner, Jeannette Wicks-Lim, and Stephanie Luce, A Measure of Fairness: The Economics of Living Wages and Minimum Wages in the United States. Ithaca, NY: ILR Press, 2008.
  7. Wessels, Walter, “Does the Minimum Wage Drive Teenagers Out of the Labor Market?” Journal of Labor Research 26 (2005): 169–176.
  8. Wessels, Walter, “A Reexamination of Card and Krueger’s State-Level Study of the Minimum Wage.” Journal of Labor Research 28, no. 1 (2007): 135–146.
  9. Wilson, D. Mark, “Who Is Paid the Minimum Wage and Who Would Be Affected by a $1.50 per Hour Increase?” June 28, 2001. http://www.heritage.org/research/reports/2001/06/who-is-paid-the-minimum-wage

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