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The Minimum Wage

The minimum wage has always been the cause of much debate and controversy in economic and political circles. Recently, there was much debate over the United State’s proposal to increase the minimum wage to $15 an hour. While proponents of the minimum wage argued that it was essential to ensure a living wage for workers, opponents argued that it would push workers into unemployment and put a greater strain on businesses. These arguments were exacerbated by the context of Covid-19, where workers and small businesses alike were struggling financially.

Two of our writers take on this issue and debate the effects of the minimum wage on the employed vs. the unemployed, on issues of equality, and the greater economy. Elisabeth Hoole argues for the minimum wage, while Rado Baarda argues against the minimum wage. 


Impact on the Employed vs. Unemployed:

Rado:

The recent proposal to increase the minimum wage ought not to be implemented. While being labeled as ‘for the poor and those in need,’ this program will almost certainly create an outcome that is exactly the opposite of what is intended. Those who believe that increasing the minimum wage to $15 per hour would be helping the poor are incorrect. What you are actually doing is pricing those individuals out of the labor market. People who do not have the requisite skills to justify that wage will be unemployed. As we know from basic market equilibrium theory, when the government sets a minimum price for any good—including labor—this results in a distortion of the market. The demand for a service such as labor will drop while its supply will increase. This means that the number of employees that will be hired will drop in those sectors that are affected by this policy. To dismiss this, you would have to argue that the demand for labor is incredibly inelastic. This is incredibly difficult to do if you’re accounting for the substitutability of these jobs. It is, however, exactly these jobs that will be affected by the proposal since it would hurt those sectors where employers could easily substitute workers with machines. The consensus of studies on the elasticities for employment was found to be between -0.1 to -0.3, which means that a 10% rise in minimum wage would lead to a 1-3% drop in employment.

So, what is the consensus finding on the effect of the minimum wage? All economists agree that businesses will change due to the higher labor costs post minimum wage implementation. The main finding in economic theory is that when the minimum wage increases, unemployment increases also. The higher this minimum is set relative to the competitive market wage level, the higher the job loss. While the implementation of this program is said to be in the interest of the poor, in reality, those who benefit are those who are currently working either just below, at, or just above the new mandatory minimum. The burden falls disproportionately on those individuals who are least skilled and most disadvantaged. This includes the disabled, the young, and immigrants. Why is this the case? Well, in a competitive labor market, employers bid for the productivity of workers which results in the wage distribution. If a mandatory minimum wage is imposed by the government that lies above the market wage rate, employment will be reduced. This exact effect has been studied many times; 85% of the most credible studies showed negative employment effects caused by the implementation of a minimum wage. Those studies that provided any convincing evidence to the contrary often assumed monopsony’s in their model to explain these effects, but this is most likely not applicable in any real-world situation of this kind. The most famous of these studies—executed by Card and Krueger—compared New Jersey’s increase in minimum wage to $5.05 and compared the effects to Pennsylvania where the minimum wage remained at $4.25. This study found a small positive but non-significant effect on employment. However, this study left out various many important variables and later replicating studies have found negative results.

The U.S. Congressional Budget Office estimated the budgetary effects of raising the minimum wage to $15/hour by 2026. The increased minimum wage would have several effects on employment. First, the higher wages would increase the cost of production for employers. This would be passed on to consumers in the form of higher prices, which, in the long run, would lead to a decrease in demand. This decrease in demand would, as a result, decrease employers’ need for production and reduce employment. Second, when the cost of employing low-wage workers goes up, the relative cost of employing higher wage and more experienced workers—or investing in machines—goes down. This would thus lead to a shift of low-skilled jobs towards substitutes. Based on their estimates, the proposed level of the minimum wage would cut back a total of 1.4 to 2.7 million jobs. Most of these workers are too low-skilled to find a new job, and about half will drop out of the labor force completely.


Elisabeth:

The above argument that the minimum wage would lead to increased unemployment is not only out of touch with reality but has been disputed by numerous empirical studies and economists. The idea that a minimum wage would increase unemployment is based on a very simplistic labour demand-supply model taught in every first-year economics course, and so it is understandable that economists against the minimum wage are prone to hold onto this model, despite its unrealism. Professor James Kwak refers to this problem as ‘economism’ – “the misleading application of basic lessons from Economics 101 to real-world problems”. In reality, also according to Kwak, if labor costs go up due to the minimum wage, companies are unlikely to let go of workers immediately. Small businesses often do not have the flexibility to fire workers since they are unable to maintain their already low level of operations with fewer workers. Similarly, large monopoly businesses often manipulate their labor demand to lower wages, which no longer becomes viable when a minimum wage is imposed, thus often increasing employment levels. Additionally, if labour costs do increase, firms are more likely to pass them on to consumers through higher prices, rather than fire workers and lose potential output. However, since minimum wages are often implemented in stages, and so aren’t a dramatic increase in labour costs, any rise in prices is often insignificant and therefore unlikely to seriously affect demand, future output, and employment levels.

This intuitive idea that a minimum wage does not necessarily increase unemployment is reflected in data. Multiple studies have found that the link between the minimum wage and higher unemployment is statistically insignificant, while others have even found that a minimum wage increase has increased employment levels. For example, a meta-study of 64 minimum wage studies found that the most precise estimates were clustered around near-zero unemployment effects. However, even given this, it is often unproductive to harp on empirical studies because both economists and research reports are extremely divided in their findings of the link between the minimum wage and unemployment. Proponents of the minimum wage believe that opponents use outdated models that overestimate the effects on unemployment, while opponents believe the opposite. To ensure that we are not stuck in this unproductive cycle of pointing statistic-filled ‘fingers’, the rest of my analysis will use unemployment figures created and supported by opponents of the minimum wage.


Using speculative data provided by The U.S. Congressional Budget Office (CBO), an increase in the minimum wage to $15 an hour in the U.S. would lead to the loss of around 1.4 million jobs and would lift nearly 1 million people out of poverty, and improve the standard of living of nearly 27 million workers. Despite the fact that many economists are doubtful of these figures, and believe that the true number of jobs lost would be around 500,000, even these potentially overestimated figures do not provide a clear picture of whether the minimum wage would hurt more than those it would benefit. When faced with this data dilemma, even when using data provided by opponents of the minimum wage, it is important to look at the goal of the policy. A minimum wage policy aims to protect workers, especially those from the lower-income classes, and ensure that they are paid a living wage and are not driven into poverty by exploitative firms. In this goal, the minimum wage is undoubtedly successful as it is predicted to lift millions of workers out of poverty. Therefore, while using the minimum wage to protect workers, the government can use other measures to reduce any potential adverse effects on unemployment levels. For example, the government could invest in the education and training of workers, to reduce structural unemployment, coordinate the matching of workers with firms to reduce frictional unemployment, or use indirect policy measures such as expansionary fiscal and monetary policy to increase aggregate demand and thus drive down unemployment levels.

At the end of the day, all policy measures have adverse side effects, which is why governments often use multiple policy measures to minimize any costs to the economy. The minimum wage should mainly be evaluated in its ability to improve the lives and standard of living of workers, while simultaneously using other measures to reduce any potential adverse effects (which are minimal at best).


The importance of equality

Elisabeth:

Moving past a purely economic debate, the minimum wage debate concerns issues of equality and principles. The minimum wage would push for equality in multiple dimensions.


The minimum wage is, on principle, against class inequalities. Even by simple implementation, it signals that the government prioritizes the needs and protection of the working class, and signals that each worker deserves a humane wage. More practically, a minimum wage would reduce income inequality as it essentially redistributes money from owners of capital (business owners) to the lower-income working class. It is essential that the government commits itself to protect the working class since those whose wages fall below the minimum wage are often low-skilled workers who cannot demand higher wages without the risk of losing their jobs. Instead, when there is a nation or state-wide minimum wage, it is harder for firms to take it out on individual workers. This redistribution of income is also imperative because the obscene amount of profits made by large firms, such as Walmart and Amazon, are made through the exploitation of already vulnerable workers. For example, Jeff Bezos, the owner of Amazon, became richer during the Covid-19 pandemic, while his workers were suffering from inhumane wages, worsened by the impact of Covid-19. These immoral income gaps must be closed using tools such as the minimum wage. Further, the state should ensure that workers are able to live above the poverty line at a minimum.

The second dimension of equality is that of race. It is well known that America has a racial wealth and income gap, especially between white and Black workers, which has only been growing in recent years. The minimum wage would succeed in reducing this racial income gap. Research from the previous rise in the minimum wage in the U.S, shows that it led to a significant decrease in income inequality between Black and white Americans, accounting for around 20% of the total reduction in the income gap. While the racial wealth gap exists due to systemic racism and therefore requires systemic reform to sustainably reduce, the minimum wage would be an effective measure in the short-term, along with long-term reforms, to bring about more economic racial equity.

The final dimension of equality is that of gender. Research shows that a minimum wage would reduce the gender wage gap – which currently stands at 82 cents for every dollar earned by a man, and is much lower for women of color. This ongoing gender (and racial) pay gap is due to occupational segregation. Women and people of colour have been historically locked out of high-paying jobs due to institutional and societal sexism and racism. As a result, women and people of color are overrepresented in low-wage occupations which would mainly be affected by a minimum wage rise. This is why, according to the Economic Policy Institute, 59% of the workers who would benefit from a minimum wage increase in the U.S. are women, and 31% are African American, and 26% are Latinos. By instituting (or lifting) a minimum wage, the government would be increasing the wages of women (and people of colour) and therefore reduce the gender and racial pay gap.


Rado:

Who are the people that would be affected by the proposal? While advocates believe that these laws would help boost incomes of full-time adult workers in low-income families who are supporting children, evidence from the CATO institute suggests that this is not the case. Most of the workers that earn the minimum wage are young, part-time workers from middle-class households. According to the Bureau of labor statistics, in 2010, approximately 1.8 million employees earned the minimum wage of $7.25. Roughly half of them are young adults under 24, 62.2% of which live in families whose income is two times or more than the poverty level—the average annual income in these families is 70,600. Only 4.7% matches the description of full-time working adults raising a family.

Let’s also not forget about the welfare programs that are in existence to help those groups that are in need. The major benefit programs are the supplemental nutrition assistance program, Medicaid, housing subsidization, and welfare. If you want to argue that each of these programs brings inefficiencies of their own and are very restrictive to the individual, I agree. I would love to see these programs reformed. However, in this instance, it would have to be encouraging people to work and not restrict the available employment opportunities. It is a production that gives people happiness; if you have a job that you believe is meaningful to someone, that will make you happy. If, on the other hand, we take these people’s jobs away and tell them that they are not needed since they pay too little relative to what a well-meaning group believes is the minimum any job worthwhile ought to pay, we will have an enormous mental health and drug crisis on our hands as can be seen by what is happening in, for example, Appalachia or inner cities.


A rise in minimum wage increases the demand for workers with greater skills because it reduces competition from low-skilled workers. Within the American economy, low wages are usually paid to entry-level workers, with research finding that 2/3 of these workers move above that wage level within one year. While low paying, these jobs are incredibly important for young workers since they allow them to establish a track record and learn skills. As Milton Friedman noted, “the minimum wage law is most properly described as a law saying employers must discriminate against people who have low skills.” That is because it would be illegal to employ anyone whose skills are valuable to an employer at a lower wage. If he employs the worker at a wage above his value, the employer is engaging in a form of charity, and most employers cannot afford this.


Unlike the utopic effects described by my co-author, reality will look very different. Research from the Employment Policies Institute showed that instead of aiding minorities, the minimum wage would negatively affect them. The study, conducted by Dr. Neumark from the University of California at Irvine, found that for every 10% increase in the minimum wage, minority employment decreased by approximately 3.9%. This effect is even more devastating for teenagers; minority teenage unemployment increased a drastic 6.6% with African American unemployment even rising by 8.4%. Although my opponent rightly pointed out that minorities would make up a large share of the people who could benefit from an increased minimum wage, we need to keep in mind that these benefits are only received if one is allowed to keep their job.

Besides the above described direct effects of the minimum wage, studies have found that there is also a wide range of indirect effects that can be disastrous for the affected communities. For instance, it would lead to increased duration of unemployment for low-skilled workers. Employers would also cut back on worker training. My colleague might argue that this could be solved by offering reeducation programs. However, studies have already found that a higher minimum wage even leads to reduced school attendance in communities that are most at risk. Due to higher unemployment and reduced school attendance, economists have even found that the minimum wage increases, rather than decreases, crime rates. They found that a 10% increase in minimum wage between 1998 and 2016 led to nearly 80,000 additional property crimes committed by 16-24 year olds.


Although my opponent was quick to point to large corporations, stating that a minimum wage would lead to a redistribution of wealth from the owners to the workers, it would not be the case. Currently, the owners of large corporations are, together with trade unions some of the fiercest advocates for the minimum wage increase. While this might appear odd at first, it is understandable when you look at their underlying motives. These large corporations currently have to compete with many small businesses who would not be able to afford the increased labor costs. The increased minimum wage would lead to the destruction of exactly those small stores that form the path into the middle class for millions of individuals. Large corporations would benefit massively from this; they would increase their market power and with it, their price setting power. A quick google search can show that companies such as Amazon and Starbucks have raised or will raise their minimum wage to $15 per hour.


Effect on the general economy

Rado:

The net effect of higher minimum wages on GDP is an empirical question that depends on how the minimum wage was to affect the demand for low skilled workers, low skilled workers’ wages, the availability of substitutes for goods produced by minimum wage workers, workers’ effort, job training, and educational attainment. Research on the minimum wage increases and GDP is not conclusive either way. The enacted federal minimum wage was correlated with declines in GDP during the early 1990s and mid-2000s, while it was correlated with a rise in GDP during the late 1990s and early 2000s. During both these periods, the real value of the minimum wage had declined. The later studies found a positive but insignificant result on the effect of the minimum wage on GDP.

There is also a different effect of the minimum wage increase on the productivity per sector. Minimum wage increases reduce the productivity in industries that employ a relatively larger share of low-skilled workers relative to those that employ a larger share of high-skilled workers. The estimated result of a 10% increase in the minimum wage is associated with a 1-2% decline in GDP generated by low-skilled workers. And this relative effect on the lower-skilled productivity is larger during periods of moderate growth than during a recession.

The increased minimum wage will also lead to inflation due to two issues. The first is cost-push inflation. This arises due to the increase in prices of raw materials and labor for producers. This is due to the fact that producers will pass part of these costs on to consumers in the form of higher prices. The second is demand-pull inflation. This is because those people who earn less also have a higher propensity to consume. This will increase the demand for certain goods, which will lead to an increase in prices. If it is correct that the minimum wage does not help those who it sets out to help, then low-skill employees will face higher costs of living while not benefitting from the higher minimum wage; not only will their unemployment rise, so too will their costs. Hence, those who are most in need of help will also be the ones that will be hurt the most.


Elisabeth:

Possibly the second biggest argument used by opponents of the minimum wage is that it would reduce the profits of businesses. These opponents would have you think that it is a clear walk from a minimum wage being implemented, to reduced profits and failures of small businesses. However, this is far from reality (yet again).

Before addressing the plight of small businesses, it is essential to distinguish between the effects on small businesses and large businesses. Increased labour costs for large companies and subsequent reductions in profit would only be a result of the dampening of their exploitative powers and therefore is not cause for concern since their enormous profit levels can more than absorb any potential rise in costs.

However, one of the greatest reasons that profits of small businesses will not necessarily reduce is because of the efficiency wage theory, which is supported by most economists. According to this theory, worker productivity tends to increase when wages increase for various reasons, including greater ability to buy nutritious food and become more physically fit, increased loyalty towards the firm etc. Following this more realistic theory, an increase in the minimum wage would reduce marginal labour costs rather than increase them due to greater labour productivity that would offset the rise in wages. This idea is reflected in research – in a survey in the U.S. after the last increase in the minimum wage, 57% of small business owners said they could absorb increased costs, and it would have no effect on their business. Data also shows that the number of small businesses grew at a larger rate in states with higher minimum wages, and minimum wages often have a statistical correlation with business successes.

Even given this data, the government could use other measures in conjunction with the minimum wage to lower the pressure on small businesses. For example, it could subsidize small businesses, offer tax cuts, or the minimum wage can be implemented in stages so that firms have time to respond and adjust profit margins efficiently (which is what is often done in reality).


Furthermore, a positive effect on the economy that a minimum wage would have is that those with increased wages would spend more. It is well known that those from lower-income classes have a higher marginal propensity to consume (meaning they consume a higher percentage of additional income), since saving is a luxury. At the same time, the reduction in income of owners of capital and the middle class will have an insignificant impact on aggregate demand since they have a lower marginal propensity to consume. Therefore, when these workers’ incomes increase, they are likely to spend much of it in the economy, which in turn increases aggregate demand, which causes a multiplier effect and leads to economic growth. This solves the potential side effects of the minimum wage that was mentioned by my opponent. Namely, higher aggregate demand would increase the profits of small businesses and would lead to higher levels of employment as more output is created in the economy. If this does lead to higher inflation, as my opponent also pointed out, it is not in itself a valid argument against the minimum wage, but rather a very natural and often-realized side effect of economic growth. Economists have grappled with this trade-off for years and have various ways of reducing the impact of growth on inflation. The minimum wage could then not only improve the welfare of low-skilled, low-income workers, but of everyone in the economy as a whole.


Conclusion:

As with most debates, there is no clear answer as to which side is most correct, especially given the often-conflicting empirical data on the impact of the minimum wage. As a result, the implementation (or disregard) of minimum wages are often motivated by politics, and not economic reasoning. However, this debate should have ideally shed some light on the complex nature of the issue. As with most policy issues, there are many effects – both direct and indirect–that one needs to take into account. The issues that will shape the times we live in are of great importance. No matter what view you have on this particular topic, being exposed to the ideas of the other side has hopefully enticed you to think more deeply about the issue. As long as we recognise that there are people on both sides with good intentions, there is a way towards crafting effective policies.

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