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Making the Economic Case for More Than the Minimum Wage

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Jody Sullivan -- BW

This is Jody Sullivan, 44, from Rosendale, N.Y. She earns $8 an hour as a cashier at a discount store. (Justin Maxon/Businessweek)

In his January 2014 State of the Union address, President Obama called for a new federal minimum wage of $10.10 an hour. The year before, in the same speech, he proposed a $9 minimum wage. Obama didn’t provide an economic rationale for the increase so much as a marketing one, ad-libbing: “It’s easy to remember: 10-10!” If instant recall is the primary goal, why not $10.04, in a salute to Smokey and the Bandit? Or $10.66, the year of the Norman conquest of England? Or better still, $10.99 after the IRS form?

Obama isn’t the only party guilty of loose thinking about the minimum wage. His bid to raise the floor from the current $7.25, set in 2009, has reheated a simplistic, dumb-as-rocks debate that’s dragged on for decades. Fiscal conservatives and the libertarian wing of the Republican Party reflexively view any increase in the minimum wage as a job killer. Labor unions and liberal Democrats cavalierly suggest that, oh … doubling it! sounds about right to them.
Raising the minimum wage is certain to be a wedge issue for Democrats in the midterm elections because it’s the rare redistributive measure that enjoys broad popular support. A Washington Post-ABC News poll in December found that two-thirds of Americans support a minimum wage increase. But to opponents, it smacks of Big Government heavy-handedness. That explains why politicians on both sides are loudly reminding their constituents of their ideologies. The back and forth, however, fails to address the real issues: What’s the right minimum wage? And what’s the fairest way for the world’s largest economy—historically a beacon of social mobility—to arrive at it?

The first question is a bit easier to answer. The original minimum wage, 25¢ an hour, was born in 1938 under similar conditions of economic hardship and class resentment. Labor Secretary Frances Perkins and President Franklin Roosevelt had fought for it for five years. The night before signing the Fair Labor Standards Act, in a radio fireside chat, Roosevelt said, “Do not let any calamity-howling executive with an income of $1,000 a day … tell you … that a wage of $11 a week is going to have a disastrous effect on all American industry.”

Free-market conservatives argued during the Depression, and do now, that it’s wrong in principle for government to interfere in work contracts between consenting adults. Even if you don’t embrace laissez-faire libertarianism, they make a more pragmatic case: The minimum wage is counterproductive. It steals jobs from the most vulnerable people—those who could get hired at $5 an hour, say, but not at $7.25 or $10.10.

Generations of students, steeped in neoclassical economics, were taught that setting the price of labor above its equilibrium level causes supply to exceed demand and leads to more unemployment. It makes sense. But as physicist Doyne Farmer once wrote, “If one were to go through any standard introductory economics textbook, and color every statement pink with weak empirical confirmation, most of the book would be pink.”

The argument that a wage floor kills jobs has been weakened by careful research over the past 20 years, beginning with a seminal 1994 study by David Card of the University of California at Berkeley and Alan Krueger of Princeton. The duo compared employment in fast-food restaurants in New Jersey, which had just enacted a minimum wage hike, with fast-food restaurants across the border in Pennsylvania, which had kept its rate the same. The result: no reduction in New Jersey’s employment rolls.

The Card-Krueger study touched off an econometric arms race as labor economists on opposite sides of the argument topped one another with increasingly sophisticated analyses. The net result has been to soften the economics profession’s traditional skepticism about minimum wages. If there are negative effects on total employment, the most recent studies show, they appear to be small. Higher wages reduce turnover by increasing job satisfaction, so at any given moment there are fewer unfilled openings. Within reasonable ranges of a minimum wage, the churn-reducing effect seems to offset whatever staff reductions occur because of higher labor costs. Also, some businesses manage to pass along the costs to customers without harming sales.

So where to set the wage floor? Whether he arrived there by logic, intuition, or dumb luck, there’s a defensible case that the sweet spot is in the neighborhood of Obama’s suggested $10.10 an hour. The Initiative on Global Markets at the University of Chicago Booth School of Business found in a survey last year of leading economists that 47 percent felt the good effects of a $9 minimum wage—the figure on the table at the time—would outweigh any bad ones. Only 11 percent disagreed. Last month seven Nobel prize-winning economists and four former presidents of the American Economic Association, along with more than 600 other economists, signed a letter to Congress urging passage of the $10.10 floor. “At a time when persistent high unemployment is putting enormous downward pressure on wages,” the letter said, “such a minimum-wage increase would provide a much-needed boost to the earnings of low-wage workers.”
It’s an ambitious target, $10.10: Correctly adjusting for inflation using the Bureau of Labor Statistics’ best historical data series, it would be the highest minimum wage ever—more potent in buying power than the $1.60 mandated wage in 1968, when middle-class jobs were plentiful, factories hummed, and labor unions ruled. It’s just more than half of the $19.55 median wage for full-time workers, which would put the U.S. minimum-to-median ratio back in sync with that of other rich, industrialized countries.
Bumping up the base over two years, as suggested by the Obama-endorsed bill by Representative George Miller (D-Calif.) and Senator Tom Harkin (D-Iowa), would directly affect 17 million workers and indirectly benefit an additional 11 million near-minimum workers who’d probably be given raises to preserve pay ladders, estimates the Economic Policy Institute, which favors the increase. Those 28 million workers make up a fifth of the labor force, and an almost 40 percent raise would meaningfully relieve their economic anxiety. (On Feb. 12, Obama signed an executive order raising the floor for federal contractor workers to $10.10 starting next year.)

Even people who earn multiples of $7.25 can relate. Adjusted for inflation, Americans’ real incomes have fallen 8 percent since the start of 2000, according to a December calculation by Sentier Research of the seasonally adjusted median household income. Research by University of Ottawa economist Miles Corak shows that, among wealthy nations, the U.S. has the third-lowest social mobility, besting only Italy and the U.K. In late January, the Pew Research Center reported that almost as many Americans now identify themselves as lower class or lower-middle class (40 percent) as say they are middle class (44 percent).

Still, even if the minimum wage detractors overstate their case, they’re right to warn that raising it too much can cause more harm than good. Few American economists have signed on to fast-food workers’ drive for $15, which kicked off with a series of strikes last year. Paul Osterman, a Massachusetts Institute of Technology labor economist who signed the January letter to Congress endorsing $10.10, says, “To jump from $7.25 to $15 would be a long haul. That would in my view be a shock to the system.” Because a $15 minimum wage is outside the realm of experience in the U.S. economy, Osterman says, “anyone who talks about its effect is kind of making things up.”

Even if a higher minimum doesn’t have much effect on total employment, it can realign winners and losers in ways that are important yet sometimes hard to detect. Economists call this labor-labor substitution: Employers forced to pay a higher minimum wage react by substituting marginal workers with higher-skilled or better-motivated ones who are attracted by the better compensation. It may be as subtle as one teenager knocking aside another or one low-income woman displacing another. The job loser suffers even when government bean counters don’t show any employment change by demographic group.

Economist David Fairris of the University of California at Riverside did one of the few studies of this phenomenon, exploiting data gathered to assess a living wage initiative for city-service contractors in Los Angeles. He found that workers who were hired after the wage hike were much more qualified (as measured by the pay at their previous jobs) than the incumbents and those who left. Says Fairris: “One hypothesis is that employers upgraded the quality of the labor force.”

In a tacit acknowledgment that a too-high minimum wage can harm vulnerable groups, Congress has allowed American Samoa, a U.S. territory in the South Pacific, to have a range of occupational wage floors starting at just $4.18 an hour for garment workers. Puerto Rico, which also has low labor productivity and suffered an unemployment rate of 15.4 percent in December, has no such exemption. Justin Vélez-Hagan, executive director of the National Puerto Rican Chamber of Commerce, says he was planning to open several nursing-home franchises but gave up because the proposed $10.10 minimum wage, coupled with the island’s severe recession, “is going to kill our business plan.” In 2012, the Federal Reserve Bank of New York warned about the detachment of young and unskilled Puerto Ricans from the labor force and suggested a subminimum wage for people younger than 25. Nothing has come of the idea.

But just as war is too important to be left to the generals, the minimum wage is too important to be left to the Ph.D.s. Many people view the wage floor as a statement about the worthiness of work itself—a sense that Obama got at in 2013 when he said no one working full-time in the wealthiest nation on earth should have to live in poverty. The declaration rings true to a lot of people, even if a grumpy economist would say, “Well, that all depends on the marginal product of labor.”

During a taping of The Daily Show With Jon Stewart in January, audience members reacted with disbelief when libertarian economist, commentator, and investment adviser Peter Schiff said the intellectually disabled would have an easier time finding jobs if they were allowed to work for $2 an hour. “You’re worth what you’re worth,” he said. Stewart’s viewers might have been more horrified to learn that the U.S. Department of Labor essentially agrees with Schiff. It allows work centers called sheltered workshops that employ disabled people at below the minimum wage. In 2001, when the minimum wage was $5.15 an hour, almost a quarter of employees in sheltered workshops were earning less than $1 an hour, according to a survey by what was then known as the General Accounting Office. (The program continues, but more recent wage figures aren’t available.)

For those who view wages as a proxy for the dignity of human labor, it’s hard to justify anyone getting paid less than the minimum. The Association of People Supporting Employment First says even the severely disabled merit the federal minimum; employers just need to be creative about matching their abilities to the tasks. “A subminimum just perpetuates the soft bigotry of low expectations,” says Laura Owens, the group’s executive director.

This line of thinking can be used to justify some pretty high minimum wages. If relieving economic stress is the objective, then even $10.10 really doesn’t cut it. In December 2013, San Francisco Mayor Ed Lee called for a ballot initiative to raise the city’s minimum, already the highest among major cities at $10.74 an hour, and said $15 was “worth evaluating.” While the National Restaurant Association inveighs against higher minimums, the local Golden Gate Restaurant Association has cautiously embraced some kind of hike: “We live in a place where there’s some level of acceptance that we should take care of others,” says Executive Director Gwyneth Borden.

In certain circles even $15 is considered miserly. Amy Glasmeier, an MIT regional planning professor, has created a “living wage” calculator that among other things figures in the rent on an apartment at the (relatively high) 40th percentile of local market costs. It puts the living wage for a single parent with two children in San Francisco at $29.66 an hour.

Maricela Flores, a Mexican immigrant, earns $8 an hour washing floors and cleaning bathrooms at a department store in Shakopee, Minn. She says she has to choose sometimes between meat and fruit when shopping for herself and the four of her children who share her trailer home. According to MIT’s calculator, the living wage for a single parent with three children in Shakopee is $33.28 an hour. For Flores, that’s a fantasy.

You see the problem. Social justice demands a minimum wage of more than $20 an hour. Economics won’t allow for one much higher than $10. The way out of the dilemma is to acknowledge that the minimum wage is being called on to do more than it reasonably can. A minimum-wage job shouldn’t be any family’s primary means of support, yet in many cases it is: In 2012, 76 percent of workers earning $7.25 an hour or less were aged 20 or older.

It’s better to regard the minimum wage as one part of the safety net. Raising it reduces the amount of money taxpayers have to spend for government aid. A 2013 Congressional Budget Office study found that the federal government gives about $8,800 per household in annual assistance to the lowest fifth of households by income but only about $4,000 to the next fifth (households averaging $35,500 in market income, which is $17 an hour full-time). The earned income tax credit—supplementary income for low-paid workers—is a conservative favorite, but it inadvertently subsidizes employers by allowing them to reduce how much they need to pay to attract workers. The minimum wage prevents those employers from reducing too much.

There are two ways the minimum wage could fade in importance in coming years. The good way is if strong economic growth generates more demand for workers of all kinds and if education and training lift the skills of the lowest paid so that employers get into a bidding war for their services, making the wage floor largely irrelevant. That should be everyone’s objective.

The bad way to irrelevance is the exact opposite: If the demand for workers slumps and a growing segment of the population lacks the skills that employers need, it will be impossible to prop all of them up with a minimum wage. That seems to be the direction we’re heading. Oren Cass, who was the domestic policy director for Mitt Romney’s presidential campaign, observed in the National Review last October that high school-educated males earned more than double the poverty line for a family of four in 1970 but only 30 percent more than the poverty line now.

Weak productivity at the bottom of the wage ladder, if it happens, can’t be decreed away. Either Congress will set the minimum wage too high and cause massive unemployment, or it will set it realistically low, which will keep people employed but leave them short of subsistence. Either way, in this dark scenario, the government will have to come to the rescue of the disadvantaged. The safety net will become the de facto minimum wage.

The stakes are mind-blowing, but the process of setting the federal minimum wage in the U.S. is and has always been ad hoc and political. In contrast, countries from Mongolia to Botswana have formal processes, generally involving consultation with business and labor groups, for deciding the national minimum wage. “You need some statistics and some data to have an evidence-based approach,” says Patrick Belser, senior economist at the International Labor Organization in Geneva. When Britain instituted a minimum wage in 1998, it created a nine-member independent body called the Low Pay Commission that advises the government each February on what the wage floor should be. It issues serious reports with titles like National Minimum Wage: The Nature, Evolution and Distribution of Non-Compliance. Washington has nothing of the kind.