The Minimum Wage Muddle

Fast food workers on strike in Richmond, VA. Image: Bernard Pollack

In today's world of rising inequality and decreasing social mobility, there are few economic issues as contentious as that of the minimum wage. There have long been loud voices arguing on either side; interestingly, both those who are for and against an increase maintain that they hold the best interests of the poor.

Recently the tide has favoured those advocating for a higher minimum wage. This is particularly true in the United States, which has a lower minimum wage than most developed countries. Those who support a higher minimum wage assert that it is an effective way to improve the plight of the growing ranks of the working poor, people who often work multiple jobs but remain beneath the poverty line. Many demand that a 'living wage'—a wage high enough to maintain a normal standard of living—be instituted. They say that a living wage is the only way to ensure wellbeing for workers in a labor market where many struggle to find higher paying jobs.

On the other side of the debate, there are some businesspeople, such as Burger King co-owner David Sutz, who argue that lifting the minimum wage could have calamitous consequences for the economy. They're concerned that it will squeeze small businesses and put large numbers of people out of work. Such fears are probably exaggerated. In the US, the minimum wage is set at $7.25, or 37% of the median wage. There is some evidence to suggest that beneath a certain threshold, commonly said to be 50% of the median wage, increasing the minimum wage does not significantly impact employment rates.

Further, opposition to a higher minimum wage is waning, even among those who many warn will bear the brunt of it. Recent surveys have found that over six in ten small business owners actually support a rise, and a similar number believe that greater minimum pay would be beneficial to the economy.

A number of politicians, delighted to have found a policy which neither alienates most businesses nor requires raising taxes, have gladly thrown their weight behind revising minimum wage legislation.

However, the living wage often cited by activists is $15 an hour, 77% of the median wage in America. Supporters claim that the impact upon businesses' costs will be offset by higher employee productivity and reduced turnover. To a certain extent, these are logical arguments. Yet, it is unlikely that the effect of such a high minimum wage will be counteracted by slight increases in the amount workers value their jobs.

Those who champion the $15 minimum wage certainly have the best interests of workers in mind, but their reasoning is dubious and ignores some fundamental economic concepts. A minimum wage essentially acts as a 'price floor,' the lowest price a producer—in this case a worker—can receive for supplying a particular good or service. When a minimum wage is set in the labor market, there is a greater supply of workers than their is demand. Thus, unemployment occurs.

This argument maintains that although a higher hourly rate may improve the welfare of some workers, many others will find themselves out of a job. In Milton Friedman's words, the minimum wage is a requirement that 'employers must discriminate against people who have low skills,' because the least able workers—often those that need the job most—will be the first to go. Importantly, these workers may become stuck in the rut of long-term unemployment, unable to find a foothold in the job market.

Additionally, there are very real concerns that a heightened minimum wage could accelerate the shift toward automation, particularly in the fast food industry. This would eventually put far more people out of work. Although some may be able to find employment in other industries, it is highly likely that many jobs will be lost permanently.

In the heated debate between those who clamour for a 'living wage' and those who warn of mass unemployment, the underlying issue is sometimes lost. There is as yet no definitive conclusion regarding the effect of a higher minimum wage; however, proponents of a higher minimum wage ultimately strive to relieve workers from the burden of poverty. Therefore, the question that should be is asked is not whether a raise in the minimum wage is in itself 'good,' but rather if it is the most efficient way to reduce poverty. The answer to that question is perhaps no.

At some point, someone must pay for the minimum wage. If companies don't absorb the costs and become less profitable, they will pass those costs onto their consumers. Naturally, these higher prices will disproportionately fall on those in the lower and middle classes, for whom the price increases will constitute a relatively larger share of income. The nonpartisan Congressional Budget Office estimates that only one-fifth of the monetary benefit of a higher minimum wage goes to those beneath the poverty line.

One of the most promising alternatives to an increased minimum wage is raising the earned income tax credit (EITC). These tax credits act as income top-ups for the working poor, and are currently capped at $6,000 per family per year. Adjusting the current limit on the tax credits would result in the same direct benefits as raising the minimum wage, without the adverse effects on employment.

No sane person would declare that income inequality and poverty are not among today's most pressing problems. It is also true that a greater minimum wage would, in some countries, do more good than harm. However, it would be unwise to proceed to ever higher rates with so much fervour without considering valid alternatives and the potential economic ramifications. A higher minimum wage sounds great, but reality is far more complex.