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The Minimum Wage and Economic Growth

By       Message Seymour Patterson     Permalink
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As of January 1, 2015, twenty-nine states have committed to increase the minimum wage above the federal minimum of $7.25 per hour. This action will benefit 3.1 million workers, but not all equally, since the increase will run the gamut from a few pennies to $1.25 an hour. Some businesses such as Wal-Mart have decided to raise their minimum wages, too. But this decision did not necessarily emerge from the goodness of their heart. Rather, a series of worker protests for higher compensation drove that decision according to a piece in CNN Money.

The minimum wage demographic has changed: Low-wage workers are no longer mainly poor teens earning pocket money and work experience. This change supports the case for raising the minimum wage since such action will give $1.6 billion to low-income workers who are likely to spend it. The case against it: unemployment will rise. (see: NY Times)

President Obama's effort to raise the federal minimum wage to $10.10 is likely to be frustrated with the Republican takeover of Congress, despite the popularity of the idea in the country for a higher minimum wage. The opposition in Congress has construed the November 4, 2014 midterm results as some sort of mandate--after all, voters were aware of the Republican position on the minimum wage. Republicans view a minimum wage increase as posing an upside risk to economic growth and employment. Ironically, voters were also aware of the president's desire to raise the minimum wage when they resoundingly reelected him to a second term. He views raising the minimum wage as having a positive effect on economic growth--by infusing more spending--without adversely impacting the downward trend in the unemployment numbers.

Who is right Congress or the president? Paradoxically, both might be right. Raising the minimum wage can cause some unemployment as firms make adjustments for the expected higher labor costs. Firms might substitute capital (machines, robotics, etc) for labor to reduce costs. However, the increase in income due to the higher minimum wage conceivably can have a dual effect: (1) a minimal reduction in the inequality gap plaguing the country, and (2) greater spending in the economy. Sales and employment increase, mitigating some of the uptick in unemployment initially induced by the higher minimum wage.

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Let us do a simple explorative exercise to determine who is right Congress or the president. The current federal minimum wage is $7.25 an hour. The president's proposal would raise it to $10.10 an hour, benefiting 3.1 million workers who earn the federal minimum wage or less. The next step is to assess the relationship between the cost of an item and the item's availability. Our intuition, indeed, our day-to-day experience informs us that when the price of something increases, on average, we reduce our consumption of it, meaning we are price sensitive! Recently, the astonishing fall in the price of gasoline has presented an empirical analysis. As gas consumers, drivers were delighted by the lower prices, and they bought more gas. The lower gas prices left buyers with more disposable income to spend on other goods during the holiday season, inasmuch as it was possible to fill up for less money.

The numerical link between wages and employment is a measure of the sensitivity of changes in employment to changes in the minimum wage. More specifically, the measure of sensitivity is a percentage change in employment due to a percentage change in wages. For instance, the Congressional Budget Office estimates that the full implementation of the $10.10 increase in the minimum wage would reduce employment by 500,000 or 0.3 percent. Next, the percentage change in the minimum wage from $7.25 to $10.10 is 39.3 percent. Now, the measure of sensitivity is the ratio of the percentage change in employment due to the percentage change in the minimum wage, namely (-0.3/39.3)=-0.0076, which suggests that employment changes are insensitive to minimum-wage changes. Thus, a forty-percent rise in the minimum wage would cause a three-tenth of percent fall in the employment rate. This, of course, is a naive arithmetic exercise against raising the minimum wage, implying that the government should not raise the minimum wage. While there is a kernel of mathematic truth in that position, it obscures the indirect positive effects of higher wages on business profitability whose maintenance sometimes requires hiring more people.

We are prone to make hyperbolic predictions--such as the apocalyptic implication of the reelection of our president--on the decimation of jobs. None of this has panned out: The stock market has been breaking records and more people have health insurance. Further, the unemployment rate is now 5.5 percent. Oddly, though, Senator McConnell suggested that Republicans should take credit for the growing economy. (See: Washington Post) I am always disappointed with criticisms of good news, which the opposing side sullies when they greet lower unemployment numbers with claims of 'cooking the books'. We are better than this. We ought to celebrate good news. This is true too about news on raising the minimum wage--where this had been done Armageddon had not ensued.

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Higher wages, of course, crimp profits by putting upward pressures on overall business costs: so does union-negotiated benefits, retirement, and business-sponsored health insurance for their employees. This does not cause profits shy away from worker-friendly businesses, like Qualcomm, Whole Food Market, and Google. Raising the minimum wage might both increase income and the level of employment. From society's standpoint that would be a good thing.

A multi-tier wage system has a redeeming outcome. Let us consider two wage levels cohabiting a market, one low, namely $7.25 (federal minimum wage) and the other $10.40 (US average hourly wage). We deduce that the average of the two is $8.23. This will have a depressing effect on wages since employers who can pay $10.40 would be happy to pay only $8.23 and those who can only afford $7.25 will see a migration of workers away from their businesses. These two effects could automatically lead to a higher minimum wage.

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Seymour Patterson received a Ph.D. in economics from the University of Oklahoma in 1980. He has taught courses and done research in international economics and economic development. He has been the recipient of two Fulbright awards--the first in (more...)
 

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