There has been much discussion about raising the minimum wage, with proponents claiming it will improve the lives of the working poor and reduce “inequality” and opponents claiming it will reduce employment, making the poor worse off.
Classical economic theory claims that raising the minimum wage (or instituting it where there is none) will lower employment.
Closer examination suggests that a higher minimum wage will lead to increased inflation, some job losses, increased economic growth and reduced inequality.
“The standard model of competitive labor markets predicts that a higher minimum wage will lead to job loss among low-skilled workers. The simplest scenario considers a competitive labor market for a single type of labor. A “binding” minimum wage that is set higher than the competitive equilibrium wage reduces employment for two reasons. First, employers will substitute away from the low-skilled labor that is now more expensive towards other inputs, such as equipment or other capital. Second, the higher wage and new input mix implies higher prices, in turn reducing product and labor demand.” (http://www.frbsf.org/economic-research/publications/economic-letter/2015/december/effects-of-minimum-wage-on-employment/ )
Consider the archetypal low-wage earner, Jim, the hamburger-flipper. He makes the legal minimum of $10/hr (all numbers are fictitious, for illustrative purposes only). If the minimum wage is raised to $15/hr, his pay in increased by 50%. The obvious way to accommodate this by the owner of the burger joint is to increase prices. Opponents of higher minimum wages claim that John’s pay goes up but so do prices, so he is no better off than before. This is not true if we look at the components in the price of a hamburger and the effect of a higher minimum wage on each:
- Hamburger-flipper 50% higher
- Cleaners, dish-washers etc 50% higher
- Rent none
- Electricity, utiliies none
- Municipal taxes none
- Beef none (commodity pricing)
- Wheat (for bun) none (commodity pricing)
- Lettuce, tomatoes, onions none (commodity pricing)
- Transportation – truck none (steel, other materials, skilled labour)
- Transportation – fuel none (commodity pricing)
- Transportation – driver some
- Owner’s profit $0.10/burger (??)
To maintain his profit, the owner needs to increase prices by much less than 50%, say 15%.
Thus Jim makes 50% more, but prices of burgers rise by 15%, so he can afford more burgers.
As a result sales go up. Say the burger joint sold 10,000 burgers a month, giving the owner $1000 of profit. If the sales go up by 10%, i.e. he sells 11,000 burgers a month his profit will go up. However, most of the costs have already been covered by the first 10,000 burgers, so the profit on the extra 1000 may be $0.50 each. The net profit therefore goes from $1000 to $1500 per month. Truly a win-win situation.
Of course, raising the minimum wage will have a knock-on effect on other wages – someone who was earning $11/hr will want $16/hr etc. This will lead to general inflation. However, currently inflation is extremely low and economists are concerned that it is too low for a healthy economy. Thus the inflation generated by a higher minimum wage will be welcome.
Right-wing critics say “if $15/hr is good, why not $100/hr?” The answer is that there is a limit. This limit is dictated by the earnings of skilled workers, mainly in the manufacturing sector. Their wages are limited by global competition, so will not be affected by an increased minimum wage.
The effect on employment is a worry. Many studies have been carried out with differing results (see (http://www.frbsf.org/economic-research/publications/economic-letter/2015/december/effects-of-minimum-wage-on-employment/ for a comprehensive review. Overall, the conclusion is that there probably is a reduction in employment, but it is small. The real threat to employment is rising automation of many menial tasks.
The effect on the overall economy is probably beneficial. As shown in the case of Jim, the hamburger-flipper, he is better off and the profits of the owner are increased. In the US, studies have shown that a $1 increase in spending on food stamps increase GDP by $1.84 (USDA) and $1.73 (Moody’s). In contrast, a $1 cut in taxes increases GDP by less than $1 (presumably because it affects the well-off more, who save/invest the extra cash).
The overall conclusion is that an increase in the minimum wage can have a beneficial effect on boosting the economy and improving the lives of the working poor.