Raising the Floor

President Obama, in his State of the Union speech, made two proposals that will reduce inequality, and that have strong research support—raising the minimum wage and universal pre-school. The main difference is that raising the minimum wage is a short-term, direct solution to inequality. It proposes to help the working poor by ensuring that they make more money. Universal preschool, which I'll discuss in a future post, is about making kids more socially mobile 20 years from now. Not surprisingly, more things can go wrong with that plan.

The current federal minimum wage is $7.25 per hour, which is $15,080 per year—well below the federal poverty level for a family of three, and well below the minimum wage in most industrialized countries. The value of the minimum wage in this country peaked in 1968 at $10.56 per hour in inflation adjusted dollars. But worker productivity has risen sharply since 1968. If the minimum wage had kept pace with productivity growth, it would be $16.50 per hour. Obama proposes to raise it gradually to $9 (24%) by 2015—hardly a radical proposal—and index it to the rate of inflation thereafter, so that it increases with the cost of living without requiring action by Congress. For comparison, the top 1% increased their real income (adjusted for inflation) by 281% between 1979 and 2007. Although every income group lost money during the Great Recession, during the economic recovery (2009-2011), income increased by 11.2% for the top 1%, but declined by -.4% for the bottom 99%.

In a 2012 survey, raising the minimum wage to $10 in 2014 and indexing it to inflation thereafter was favored by 73% of Americans, with 20% opposed and 7% undecided. Support is strongest among Democrats and those who would be helped most by the proposal—women, minorities and young adults.

Unfortunately, there is an incorrect argument about the effect of raising the minimum wage that appeals to the conventional wisdom. It states that raising the minimum wage causes employers to hire fewer workers or lay off existing workers. House Speaker John Boehner reacted to the President's proposal by saying, “When you raise the price of employment, guess what? You get less of it.” Fortunately, this is an empirical question, and Boehner is wrong.

The fact that the minimum wage has stagnated since 1968, while bad for the country, has been a boon to research on its effects. Some states and cities have raised the minimum wage above the federal level. This variability makes it possible study whether raising the minimum wage depresses employment. The modern history of this research begins with a before-after comparison group design by Card and Kreuger. New Jersey increased its minimum wage in 1992 while Pennsylvania did not. The authors did a telephone survey of employment in fast food restaurants in counties along the NJ-PA border. (Restaurants were chosen because they are the business that experiences the greatest increase in cost when the minimum wage goes up.) They found no evidence that NJ's minimum wage reduced employment relative to PA.

Of course, this could be an atypical case. But Dube, Lester and Reich published a study in 2010 comparing restaurant employment in 318 state borderline pairs of counties in which the minimum wage differed, essentially replicating the Card and Kreuger study over a much larger sample of times and locations. They found no employment effects. In recent years, there have been two meta-analyses of minimum wage studies, one of which summarizes 1492 separate tests of the minimum wage hypothesis. They find no significant overall effect on employment among low income workers, teenage workers, or anyone else. (By the way, 80% of minimum wage workers are adults.)

These studies are now well accepted by economists, but they raise the question of why the conventional wisdom is wrong about the effects of raising the minimum wage. The most likely reason is that, for most owners, the cost of increasing the minimum wage is small relative to other costs affecting their business. Schmitt has suggested 11 “adjustment channels” that might explain the lack of a minimum wage effect. Here are the four that he feels have the greatest research support.

• Increasing the minimum wage reduces turnover, an important cost savings for employers.
• Workers who are paid more increase their productivity, either on their own, since the job is more important to them, or in response to employer demand.
• The cost is passed on to consumers in the form of increased prices. Does this cause inflation? Yes, but not very much. One study found that a 31% increase in the minimum wage increased restaurant prices between 1% and 2%, at worst increasing the cost of a $10 meal to $10.20.
• In the long run, employers compensate by reducing wages paid to higher wage workers. This results in “wage compression,” or less wage inequality within the organization.

Of course, Boehner's comments suggest that the President's plan is dead on arrival in Congress. But let's imagine we lived in a country where some wage relief for the working poor were possible. If the minimum wage is to be indexed to inflation, it is important that it start from a baseline that is high enough to be fair to low income workers. The data in the second paragraph suggest that $9 is too low. Wicks-Lim has suggested that businesses could easily adjust to a 70% rise in the minimum wage to $12.30 per hour. Raising the minimum wage could be seen as a form of reparation for the harms caused to low wage workers by the successful class warfare waged by the rich for the past 30 years.