The efficacy of increasing US Minimum Wage
Authors: Joel Tan, Ivan Chin
Region Head: Ace Chua
Editor: Akshat Daga
Illustration by Sonja Lam
In 2019, The Raise the Wage Act was passed in congress to gradually raise the federal minimum wage to $15 an hour by 2024. While the Act was effectively passed to protect low wage workers, close to half of the house was against it, citing concerns that such a move will eviscerate jobs. This article looks into the US minimum wage model and analyses the effectiveness of increasing federal minimum wage.
In the United States, different states set their own minimum wages independent of the federal government. When the state and federal minimum wage differ, the higher wage prevails. As of January 2018, there were 29 states with higher minimum wages than the federal minimum of $7.25 per hour. However, not every low wage worker is covered by the minimum wage. Some categories of workers receive lower hourly rates than the federal minimum wage. They include student-learners, youths in their first 90 days of employment, disabled workers and seasonal workers. To boost wages for about 17 million low wage workers, The Raise the Wage Act 2019 was passed to increase minimum wage to $15 per hour by 2024 in spite of Republicans’ fears that it may eviscerate close to a median of 1.3 million jobs (Lea, 2019).
Effectiveness of increasing US minimum wage
The minimum wage increases wage earnings for low wage workers and acts as a form of income redistribution to reduce inequality. A 10% increase in the minimum wage increases the income of workers in the bottom income bracket which subsequently reduces nonelderly poverty rate by about 5% (Dube, 2018). Higher income may also stimulate aggregate demand. Low-wage workers who receive minimum wage have higher marginal propensity to consume than high wage workers. Therefore, to the extent that minimum wage increases raise the income of low wage workers, a minimum wage increase could have a stimulus-kind effect on the economy, given that they increase non-discretionary consumption.
Next, increasing minimum wage may spur labour productivity – both at the enterprise level and at the aggregate level. According to the efficiency wage theory, low wage workers are more motivated to work harder with an increase in wages (Akerlof, 1984). With higher wages, they will tend to stay longer gaining more valuable experiences. In California, reduced turnover for restaurant workers is attributed to the effect of the minimum wage, which reduces wage competition between low-paying enterprises. When employers can better retain their workforce, workers can learn on the job and be trained to become more productive over time (Dube, Lester and Reich, 2012).
According to Neoclassical Economics, increasing minimum wages reduces employment. Firstly, increasing minimum wages may force firms to raise the prices of goods and services, leading to a scale effect where consumers and international buyers cut back on their demand. Secondly, an increase in minimum wage raises labour cost and lower firms’ profit margins, which incentivise firms to substitute low-paid workers with increased automation. If these effects are large, aggregate employment levels of low-wage workers may decline. According to CBO’s median estimate, raising the wage to $15 can increase unemployment by 1.3 million in an average week in 2025 (Lea, 2019).
There is also likely to be a “cross-industry” effect which may widen income inequality. Employment is more likely to fall in labour-industries where there is a greater proportion of low-wage and low skilled workers relative to other higher-skilled industries as the increase in minimum wage only increases the labour cost for low skilled workers. Thus, industries with higher wage workers who are not affected by the minimum wage are unlikely to be affected, potentially worsening the inequality.
To combat poverty, targeted tax credit may be a better approach than increasing minimum wage. The minimum wage is a relatively blunt anti-poverty policy as it may raise wages for people not in poverty such as suburban teenagers who live in middle- or high-income households as compared to tax credits which target and provide financial incentives directly to low-income households.
Taking a leaf from France’s minimum wage model
Over the last three decades France has adopted the “salaire minimum de croissance” (SMIC, minimum wage policy) to eliminate low pay, and it was effective: the low-wage share has dropped to just 10 percent.
Fig.1 Minimum wage hourly rates
According to Fig.1, the purchasing power of the U.S. federal minimum wage has decreased by almost 28% between 1967 and 2016, whereas the French minimum wage has increased by 266% over the same period. In 2016, the purchasing power of the SMIC hourly rate (in 2015 US$ PPPs) was 55% higher than the US federal minimum. By automatically indexing the level of minimum wage to inflation and growth, France managed to ensure low-wage workers are able to meet the living wage, which is the income necessary to meet their basic needs. Perhaps, the US should also index minimum wage level to inflation instead of leaving up to Congress to decide on the minimum wage level who, in turn, have stagnated the minimum wage since 2009 at $7.25 per hour.
To maximise the benefits of increasing minimum wage and minimise the ills of it, the government should employ a suite of policies. While increasing minimum wage benefits low-wage workers significantly, the government has to be careful not to set an exorbitant minimum wage which has the potential of distorting market efficiency and creating a productivity-wage mismatch. Instead, the government should set a reasonable minimum wage level relative to the living wage and complement it with other policies like targeted tax credits to improve the standard of living for low-wage workers while minimising the aggregate unemployment effects. References
1.Lea, B. (2019, July 08). $15 minimum wage would boost some workers' pay, eliminate others' jobs: CBO. Retrieved October 23, 2020, from https://www.foxbusiness.com/economy/15-minimum-wage-worker-pay-jobs
2.Lea, B. (2019, July 10). Republicans slam Democrats' $15 minimum wage bill: It would 'eviscerate' US jobs. Retrieved October 23, 2020, from https://www.foxbusiness.com/economy/republicans-slam-democrats-minimum-wage-bill
3.Dube, A. (2018, April 10). Minimum wages and the distribution of family incomes in the United States. Retrieved October 23, 2020, from https://equitablegrowth.org/minimum-wages-and-the-distribution-of-family-incomes-in-the-us/
4.George A. Akerlof. (1984). Gift Exchange and Efficiency-Wage Theory: Four Views. The American Economic Review, 74(2), 79–83.
5.Dube, A., Lester, T., & Reich, M. (2016). Minimum Wage Shocks, Employment Flows, and Labor Market Frictions. Journal of Labor Economics, 34(3), 663–704. https://doi.org/10.1086/685449
6.Living Wage calculator. (n.d.). Retrieved October 23, 2020, from https://livingwage.mit.edu/articles/61-new-living-wage-data-for-now-available-on-the-tool