I have been thinking a lot lately about the economic impact of the changing minimum wage. There has been all sorts of activity here, from public firms like McDonalds and Wal-Mart raising minimums and changing their policies to lots of experimentation taking place amongst various cities and states.
The modern history of the minimum wage debate traces its roots back to a now famous 1993 paper by Alan Krueger and David Sands. The title is Minimum Wages and Employment: A Case Study of the Fast Food Industry in New Jersey and Pennsylvania (NBER Working Paper No. 4509), and the paper is widely regarded as the seminal study on minimum wage impact on employment and the local economy.
In 1992, New Jersey’s minimum wage had increased from $4.25 to $5.05 per hour; Card and Krueger looked at the impact of the law by surveying 410 fast food restaurants near the border between New Jersey (where min wage rose) and Pennsylvania (where it did not), before and after the rise in the wages.
The conclusion was surprising to what the dominant economic theory at the time predicted should have happened: That raising the cost of labor would reduce job growth. Yet the opposite happened, and job growth was much stronger on the side of the border where the minimum wage increased. Lots of subsequent studies confirmed this conclusion, and (for the most part) it has stood the test of time and numerous other challenges.
The key takeaway is that modest increases in minimum wages do not hurt employment, and tend to increase economic activity.
Why was the theory wrong? It was too narrow, focusing only on the relationship between employers and employees. It completely ignored the local macro impact (can I use that phrase?) of what happens to the regional economy when the lowest paid employees earn more, and their employers earn that much less profit.
My own explanation is simple: Raising the minimum wage works as a wealth transfer, from shareholders and franchisees, to minimum wage workers. (We shall for now, set aside the other wealth transfer from taxpayers, to both employers/employees).
We know that when lower income employees get more income – especially those receiving minimum wage – they will spend all of it; that marginal increase in consumer spending is stimulative to the local economy.
Contrast that with when wealthier people get more income: they tend to spend little of it, but mostly, they save and invest it. The immediate impact on the local economy is muted, if felt at all. There are (arguably) long term effects of this additional savings and investing. However, these do not show up any time soon in local GDP.
In the case of a a single fast food franchisee, it’s the difference of a few 100,000 dollars per year. Not enough to buy into a new franchise (thereby creating jobs) but enough passing through the hands of employees to very much impact local retailers.
Hence, an increase in minimum wage shifts money from savers to consumers.
Note that I am not make any moral or ethical judgments about this; I am merely observing what happens, and why. And one cannot help but note that the simple supply and demand calculation that forecast falling employment was too simple.
Economists on the right do not love this data. It justifies something that they philosophically disagree with – using the power of government to force an outcome that is decidedly not one the free-market would have made on its own.
At least, not right away. As we have seen in companies like Wal-Mart and McDonalds, an improving economy makes very low wage workers harder to find and hire. The invisible hand of the market eventually moves wages up in response to the limited supply of labor during periods of full employment, but it is a slow process. This cycle, especially slow.
The Federal Minimum wage is now $7.25, and has been since 2009. It has not kept up with inflation, meaning low wage workers are falling behind a rising cost of living. Suffice it to say that minimum wage workers are definitely not getting ahead in this economy. It can be shown to be either bad or worse, the exact amount by which it has fallen depends upon which data period we cherry pick. (Note: the cause income inequality is the rapid rise at the top of the income scale, not a low minimum wage).
We have a real life experiment* going on now, with 14 cities and a number of states raising minimum wages in 2015; another dozen cities raised the base wage in 2014. We will learn soon enough of the Krueger/Card analysis is still valid.
How McDonald’s and Wal-Mart Became Welfare Queens (Nov 13, 2013)
The Minimum Wage and McDonald’s Welfare (Dec 17, 2013)
Always Low Wages? Wal-Mart’s Other Choices (Dec 18, 2013)
Wal-Mart’s Minimum Wage Breakdown (Feb 23, 2015)
Ending the Minimum-Wage Subsidy (May 20, 2015)
* 2015 increases were Emeryville, CA $15.00 (by 2018) Los Angeles, CA $15.00 (by 2020) Portland, ME $10.68 (by 2017) Kansas City, MO $13.00 (by 2020)** Birmingham, AL $10.10 (by 2017) St. Louis, MO $11.00 (by 2018)** Palo Alto, CA $11.00 (by 2016) Johnson County, IA $10.10 (by 2017) Los Angeles County, CA $15.00 (by 2020-21) Mountain View, CA $15.00 (by 2018) Sacramento, CA $12.50 (by 2020) Lexington, KY $10.10 (by 2018) Tacoma, WA $12.00 (by 2018) Bangor, ME $9.75 (by 2019)
2014 increases were Las Cruces, NM $10.10 (by 2019) Santa Fe County, NM $10.84 Mountain View, CA $10.30 Sunnyvale, CA $10.30 San Diego, CA $11.50 (by 2017)* Oakland, CA $12.25 Berkeley, CA $12.53 (by 2016) Richmond, CA $13.00 (by 2018) Louisville, KY $9.00 (by 2017) Chicago, IL $13.00 (by 2019) San Francisco, CA $15.00 (by 2018) Seattle, WA $15.00 (by 2018-21)