Why Raise The Wage?

Should the minimum wage be raised? That is the question that has been plaguing our political media for many years now. First and foremost, there is a debate over whether to raise it at all. If yes on that, the next logical debate is over to what level it should be set. $15? $12? $10.10? Something else? Let’s parse through why there is a minimum wage in the first place and how we can go about deciding the best answers to those critical questions.

Why have a minimum at all?

Labor economics theorizes that workers will supply their labor for a equilibrium price that intersects with the labor that is demanded by companies. This means that the free market will naturally decide on a wage that both the supply side (workers) and demand side (companies) desire. The theory is that if companies post job openings with too low of a wage, workers will simply supply less labor causing a shortage in the market. Therefore, there will be upward pressure on the wages to increase to the equilibrium point. The same follows in the opposite direction–that workers who demand too high of a wage will cause companies to not demand as much labor. Overall, this theory implies that a minimum wage is not necessary as both workers and companies have equal leverage power.

A critical flaw occurs when we apply the theory to reality. In reality, people need to work in order to make money. Therefore, their supply of labor is essentially inelastic to the wage that is offered by companies. Most of the time, people would much rather take a job with a low wage over having no employment at all. Some money is better than no money. Therefore, workers really do not have the aforementioned leverage power in the market. The power lies in the hands of the companies. As I argued in The American Dream: Reality or Just…A Dream?, companies wish to lower costs as much as possible, and labor is one of the greatest costs to a company. Therefore, companies naturally demand workers for the lowest wages possible. In reality then, the wages that are offered by companies may be relatively low while workers still accept them since they need to make at least some amount of money.

This market power of companies is exacerbated in a monopsonic market. Such is a market where there are just a few companies with a large workforce. An example of this is the fast food industry, where there are many people able to work in the industry, but there are only a few companies, such as McDonald’s, Burger King, and Subway. The first of those three has an especially large market share (1). With such great dominance over the industry, a company like McDonald’s can virtually set any wage it desires and workers will still take those jobs. McDonald’s faces little competition for those workers and, therefore, does not have to entice them with higher wages.

Facing this reality, we see that lower-than-desired wages will be offered to workers by companies, especially in monopsonic markets. Our next logical question to ponder then is: do workers deserve a higher wage than what the companies set due to their market power? Of course, we do not want such a high wage that is bankrupts companies, but there seems to be economic reasoning to raise the wage.

As I discussed in The American Dream: Reality or Just…A Dream?, consumer demand drives economic growth especially in times of recession. Because companies wish to keep costs as low as possible by having the bare minimum amount of employees needed for efficiency, the only way to encourage hiring is through empowering consumers. Then companies will be pressured to hire more workers in order to meet the increased demand and maintain efficiency. Additionally, most of the time wages will only feel upward pressure by the market when the economy is near full employment and companies do have to begin competing with one another over the few workers available. Thus, wages will not normally rise much on their own when an economy is in recession or on a moderate growth path. Therefore, we need to empower consumers with greater income in order to be able to pressure companies to hire more workers, which will then have upward pressure on wages.

We can begin this process by setting a minimum wage. Therefore, low- and middle-class workers would then have more money in their pockets to be able to spend on consumer goods like groceries, energy, and education. Additionally, those workers spend the greatest percentage of their income compared to the higher income classes. Therefore, any money put in those workers’ pockets will almost certainly reenter the economy immediately via consumption. This increased consumer demand should then have multiple positive effects on economic growth.

Now, if we have decided that setting some sort of minimum wage is reasonable, we need to determine the right wage that will effectively empower workers without harming companies’ abilities to invest and grow. In the United States, there is a federal minimum wage and also state-by-state minimum wages. Due to the supremacy clause of the Constitution, the states must abide by all federal laws, therefore, setting their own wage laws at no less than the federal wage level. The current federal minimum wage is $7.25 per hour. One way to begin determining to what level to set the wage, we can look at the past and see how much purchasing power the minimum wage has historically given workers. Adjusted to 2014 dollars in order to account for inflation, the minimum wage in 1938 was first set at $3.45 ($0.25 nominally). Since then, the real value and nominal value have changed often. The real value actually peaked in 1968 at $8.54 per hour and has not overcome that level ever since (2). Therefore, regardless of at which level we agree to set the new wage, we should tie the wage to grow according to inflation. Therefore, we would never have to debate raising the wage again once we agree what is the correct wage now.

Some argue, such as Senator Bernie Sanders, that we should raise the wage to what is known as a living wage. Such means that someone who is working 40 hours per week should not make such a low income that he or she is still in poverty. The current poverty rate for an individual is $11,770. However, if that person has two children, which is the average, then the federal poverty level is $20,090 (3). Do keep in mind that such a family may have a second parent, which would potentially add another income to the mix. If we just consider an individual person’s income with no children for now, he or she would work 40 hours per week at $7.25 per hour for 52 weeks of the year for a total of $15,080. If such workers have only themselves for whom to care, then they do already exceed the poverty line. However, if those workers are single mothers or single fathers of children, then they are considered in poverty. The data show that never-married workers are more commonly earning the minimum wage than married workers (4). Sadly many Americans do find themselves in this scenario. It is a common misconception that most wage workers are teenagers, yet that age group makes up only one fifth of all wage workers. Indeed, teenagers do make up almost 50% of all people who do earn the actual minimum or less, yet a minimum wage increase would affect many more wage workers than just those who make the minimum wage. This is due to the fact that workers under 25 years old make up only one fifth of workers who are paid hourly (4). Also, there is large economic consensus that empowering teenagers’ incomes is crucial to economic growth. This is due to the fact that they have little need save and can spend almost of the money they earn (5). Therefore, increasing the wage for teenagers should have a positive economic effect. People who currently make over $7.25 but under a potential new wage minimum wage would experience a raise. “In fact, 89 percent of those who would benefit from a federal minimum wage increase to $12 per hour are age 20 or older, and 56 percent are women” (6). Also, depending on the level to which the wage is set, the amount of workers affected varies.

Some people argue for a $10.10, $12, or $15 minimum wage, and since the economy is such a massive machine with countless variables, it may be impossible to pinpoint the perfect number for the wage. However, if we do raise the wage to $10.10, it could bring a single mother of two kids out of poverty by raising her income to $21,008 per year. That is an improvement, but when we think about how far $21,008 goes, it may seem insufficient. After paying for groceries, energy, clothing, and other necessities, it is difficult to imagine that such a person could have the money to afford an education to get ahead and move up the economic ladder. Additionally, people who are raised in a wealthier family are actually more likely to earn more as a result of a college degree (7).

Hershbein 21916001.png

Therefore, possibly even a higher wage is required. However, there is a purpose to having a federally-set minimum wage and also state-by-state minimums. This distinction is important as the cost of living truly does differ across the country. Because of this, some could argue that the federal minimum wage should be kept lower so that the states could then raise it if needed to adjust for differences in cost of living. However, this graphic shows just how high of a wage is needed in order to rent a two-bedroom apartment in the given state without spending more than 30% of one’s income (8).

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If we follow this logic in order to set a federal wage, Arkansas shows us that the federal minimum should be around $12 so that workers there could at least afford an apartment. Otherwise, it seems that many states should raise their wage to levels around or far more than $15 per hour. It seems that wages in Seattle, Los Angeles, and New York City especially should be set to around $20-$25 per hour.

Before we get ahead of ourselves, let’s remember that most wage hikes happen gradually in order to harm businesses as little as possible. Most states set the hike progression to $.25-$.75 per year. Therefore, by the time most states even reach their wage goal, inflation may have already increased the average price of expenses like rent. Therefore, we have to forecast into the future to ensure that workers will have enough money to survive and thrive. Also, if we do this correctly and according to the data, the economic impact should be positive.

“A number of researchers have found that modestly higher minimum wages can raise incomes for low-wage workers without reducing the number of jobs in an area.

Their evidence rests largely on comparisons between neighboring areas with different minimum wages. The seminal study in this vein examined fast-food restaurants on both sides of the Pennsylvania-New Jersey border before and after New Jersey raised its minimum wage in the early 1990s. It found no evidence that employment there fell as a result” (9).

Past wage hikes demonstrate that a minimum wage increase can indeed increase purchasing power to workers while not necessarily impacting job growth. The data on employment growth is somewhat unclear (10).

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6 out of the 11 past wage hikes have preceded employment growth while 5 of those 11 have  preceded mostly slight employment contraction. Therefore, a modest wage hike may not have an effect on job growth after all. Honestly, economics is far too complex with too many factors to be able to pinpoint a direct cause and effect at many times. Understanding the overall context of these time periods can help demonstrate what effect a wage hike could have had at those times. For example, two of the five times that jobs declined were during an economic recession. Nevertheless, if the data is unclear like this, then the case for a moderate wage increase seems to stand. It does not seem so dangerous to moderately increase the minimum wage and also tie it to inflation.

Now, the nonpartisan Congressional Budget Office has estimated that a wage increase could cause anywhere from a slight decrease in employment to one million jobs lost. However, this could depend on the new wage’s level and the graduated scale that the wage increase would follow. Furthermore, this may be a bit shortsighted as in the long term hopefully more money in consumers’ pockets will fuel consumer demand increasing revenues for businesses and pressuring them to hire more workers (11). There may be some lag time in between businesses raising wages and those same businesses feeling increased consumer demand.

Now, some may argue that raising the wage will simply cause inflation of prices. Businesses have to cover the cost of the wake hike, so naturally they will raise prices–so the logic goes. However, theory must be applied to reality and the effects a wage hike would bring. Worker productivity would increase due to increased worker satisfaction. This would increase speed and also customer service as workers enjoy working and feel it more worthwhile. Additionally, this would lower turnover rates of employees, which would lower training costs. Also, public perception of companies that treat their employees well may increase even if the wage hike would be due to a law. All of these factors could instead increase revenue eliminating the need for a price increase.

Now, the data can be split at times on whether inflation will be raised due to a wage hike. Economists know that GDP growth and inflation are tied in that as more goods are being produced due to increased demand, those goods will become more scarce causing inflation. The following is seen in this graph (12).

golddiag-2

As the economy grows, inflation naturally rises steadily. This occurs until there is a point of such rapid GDP growth that resources are much too scarce causing rapid inflation and an economic recession. So how does this tie into a minimum wage hike? The theory goes that increasing wages will increase purchasing power furthering consumer demand and fueling economic growth. As seen in the graph above, this will cause some inflation due to more scarce resources. However, that comes with an economic stimulus plan. An economy cannot grow without at least some inflation.

Now, what we want to know is whether past wage hikes have been eliminated by subsequent inflation. The data throughout the U.S.’s history show little to no direct relation between a minimum wage hike causing inflation. The graph below shows that as the wage increased, at most times inflation did not drastically increase (2). The argument is actually void due to the fact that the real wage already accounts for inflation. If all nominal wage increases caused equal inflation soon thereafter, the real wage would soon return to its original level, yet that is not what we see. Whenever the real minimum wage increased and stayed above its previous level, this means that it was beating out inflation. Furthermore, not having a minimum wage that increases yearly according to inflation means that it will undoubtedly be worth less in the following year as it cannot keep up with inflation.

FT_15.05.20_minWage_1938_2014

The important examples to look at are even when a nominal wage hike beat inflation, did companies raise prices so much to wipe out all purchasing power gains? For instance, in 1950 the minimum wage was raised so that it gained almost $3 in real dollars. Until the next time the wage was raised in the mid-50’s, the real value of the wage only decreased about $0.50-$0.75. If businesses raised prices equal to the wage hike, we would see an equal decline in the real wage’s value as the initial increase in the value. However, we do not see that. Workers still ended up with around $2.25-$2.50 more in purchasing power. The same occurred in the early 1990’s and the end of the first decade of the 2000’s.

The evidence to the contrary lies in the early 1970’s where a wage increase was essentially wiped out due to high inflation. However, knowing the context of the 1970’s and the oil crisis of the time shows that this occurrence was unrelated to the wage hike itself. The second contrary evidence lies in the early 2000’s; however, that loss in real wage value was probably caused by both the .com bubble and the extended period of time between raising the nominal minimum wage. Therefore, knowing the context of when the minimum wage did lose purchasing power shows that inflation has not been shown to follow nominal wage increases, and we know that some inflation should always be expected as such is natural in a growing economy especially when consumer demand is fueled by higher wages.

Therefore, there are smart methods to go about raising the minimum wage, and doing so will empower workers stimulating consumer demand and encouraging hiring, thus, stimulating the economy. Workers with more money in their pockets can then go on to afford education and other opportunities to move up the economic ladder and achieve the American Dream.cropped-new-logo.jpeg

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  1. http://www.wikinvest.com/stock/McDonald’s_Corporation_(NYSE:MCD)
  2. http://www.pewresearch.org/fact-tank/2015/07/23/5-facts-about-the-minimum-wage/
  3. https://aspe.hhs.gov/2015-poverty-guidelines
  4. http://www.bls.gov/opub/reports/cps/characteristics-of-minimum-wage-workers-2014.pdf
  5. http://www.nytimes.com/2003/12/01/news/economy-business-the-teenage-market-young-hip-and-looking-for-a-bargain.html
  6. http://www.dol.gov/featured/minimum-wage/mythbuster
  7. http://www.vox.com/2016/3/8/11178802/college-degree-income-discrimination
  8. http://nlihc.org/sites/default/files/oor/OOR_2015_FULL.pdf
  9. http://www.nytimes.com/2015/07/27/business/economy/scale-of-minimum-wage-rise-has-experts-guessing-at-effect.html?_r=0
  10. http://www.politifact.com/truth-o-meter/statements/2014/nov/06/ben-cardin/does-raising-minimum-wage-result-job-growth/
  11. https://www.cbo.gov/publication/44995
  12. http://macrobuddies.blogspot.com/2010/11/qe2-will-it-work.html
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