What’s at stake: In his State of the Union Address, US President Barack Obama resurrected a pledge to raise the minimum wage he had made during the 2008 campaign. In an effort to fight inequality, alleviate poverty and make work more attractive President Obama proposed proposed a $9 federal minimum wage, indexed to inflation. This has generated a lot of writings in the blogosphere, with the main issues revolving around the classic questions of the employment effect of the minimum wage as well as its efficacy as a means of redistribution.
A historical perspective on the minimum wage
Arindrajit Dube (whose paper was quoted in Obama’s SoU) writes that in 1968 the minimum wage was around 50 percent of the average production-worker wage. If that were true today, that minimum wage would be around $10 an hour. So from that perspective, raising it to $9 is well within, indeed under, the historical norm. Another way to think about this is looking at other countries. There are many countries in the developed world that have a minimum wage that is as, or even more, generous than 50 percent of average wages. Another way to think about this is to consider what the purchasing power of the minimum wage. The 1968 minimum wage, adjusted for inflation, today would be somewhere between $9.25 and $10.50 depending on what CPI index you use. Again what the Obama administration is proposing is safely below this. Dube also notes that 9 states already have an indexed cost-of-living increase for the minimum wage.
In a 2012 column, The Economist reports that New Zealand pioneered the first national pay floor in 1894. America’s federal minimum wage dates from 1938.
The macroeconomic argument for a minimum wage
Jared Bernstein writes that the share of workers picked up in the “sweep,” i.e., the area between the current and the proposed new minimum wage has, historically, been less than 10% of the workforce.
Christina Romer writes that if an increase in the minimum wage successfully redistributed some income to the poor, it could increase overall consumer spending — which could stimulate employment and output growth. But the effects would probably be small. The president’s proposal would raise annual income by $3,500 for a full-time minimum-wage worker. A recent analysis found that 13 million workers earn less than $9 an hour. If they were all working full time at the current minimum — and a majority are not — the income increase from the higher minimum wage would be only about $50 billion. Even assuming that all of that higher income was redistributed from the wealthiest families, the difference in spending behavior between low-income and high-income consumers is likely to translate into only about an additional $10 billion to $20 billion in consumer purchases. That’s not much in a $15 trillion economy.
Complicated employment effects
Edward Glaesner writes that Alan Krueger, now chairman of the Council of Economic Advisers, and David Card, of the University of California at Berkeley, are responsible for the research that reopened the debate on the efficiency costs of the minimum wage. They compared fast-food workers in New Jersey and Pennsylvania and found little decline in employment after New Jersey raised its minimum wage in 1992. Their 1997 book brings together five years of their serious scholarship, which suggests that at low levels an increase in minimum wage does little to discourage employment. For a useful presentation of the most recent evidence that generalize the Krueger-Card methodology, you can read this interview with Arindrajit Dube.
Gary Becker sends us to a recent paper by Neumark, Salas and Wascher (2013) supports the allegation that a higher minimum wage had negative employment impact on vulnerable groups like teenagers. Studies by French economists Guy Laroque and Bernard Salanie also support the view that minimum wages reduces the employment of women and young people. Stephen Gordon that the US evidence of harmless employment effects is not confirmed when looking at Canadian data, which offers more province (State)-level variation. He cites a 2005 study by Morley Gunderson that reviews evidence supporting above-consensus employment elasticities with regard to minimum wages, suggesting a 10% increase in the minimum wage would lead to a 3-6% reduction in employment of teens.
Imperfect competition and the minimum wage
Christina Romer writes that one argument for a minimum wage is that there sometimes isn’t enough competition among employers. In our nation’s history, there have been company towns where one employer truly dominated the local economy. As a result, that employer could affect the going wage for the entire area. In such a situation, a minimum wage can not only make workers better off but can also lead to more efficient levels of production and employment. But I suspect that few people, including economists, find this argument compelling today. Company towns are largely a thing of the past in this country; even Wal-Mart Stores, the nation’s largest employer, faces substantial competition for workers in most places. And many employers paying the minimum wage are small businesses that clearly face strong competition for workers.
Daniel Kuehn argues that if employment relationships create rents, these must be divided between employer and employee by means of a bargaining solution. If workers are in a weak bargaining position, a minimum wage can support their position in the struggle for rent capture.
The EITC as a substitute or complement to the minimum wage
Christina Romer writes that we could do so much better if we were willing to spend some money. If a higher minimum wage were the only anti-poverty initiative available, I would support it. It helps some low-income workers, and the costs in terms of employment and inefficiency are likely small. A more generous earned-income tax credit would provide more support for the working poor and would be pro-business at the same time. And pre-kindergarten education, which the president proposes to make universal, has been shown in rigorous studies to strengthen families and reduce poverty and crime. Greg Mankiw agrees with her analysis.
Arindrajit Dube writes that research by Berkeley economist Jesse Rothstein shows that roughly 27 cents on the dollar from the EITC is passed on to employers. So there's some leakage there. And for some people, the presence of EITC acts as a multiplier for a hike in the minimum wage. So as a result, when thinking in terms of efficacy, these two policies may complement each other. They may go together. David Lee and Emmanuel Saez have also theorized that, when employers capture part of an EITC, a minimum wage is a good compliment.
Paul Krugman writes that the complementarity of the two measures is actually Econ 101, but done right: given a second-best world in which you use imperfect tools to help deserving workers, two tools together can produce a better outcome than either one on its own.
Jared Bernstein writes that those who solely depend on the redistribution through the tax and transfer code are implicitly calling for Congress to ratchet up these measures year after year. That’s not going to happen, so every few years we need to raise the wage floor so as to be certain that low-wage workers get a slightly larger share of the pre-tax growth they’re helping to create (and if we index the wage floor, as the President proposes, we won’t have to keep revisiting it). Mark Thoma makes a similar point and fears that opponents of the minimum wage on the right will team up with well-meaning Democrats to say yes, we agree, the EITC is much, much better way to help the poor and use it as an excuse to block minimum wage legislation. Then, when it comes time to fund the EITC, we'll here that it's a good idea, but with the budget the way it is, we just can't afford it right now.