Economics of the Minimum Wage

The last time legislation was enacted to raise the federal minimum wage was in 2007 when Congress passed the Fair Minimum Wage Act, gradually increasing the rate from $5.15 an hour to it's current level of $7.25, reached in 2009.

In the seven years since, that $7.25 has lost 8.1% of its purchasing power due to inflation. Congress considered legislation in 2014 to raise the minimum to $10.10 by 2020, though the measure was blocked by Republicans in the Senate. In response to Congressional inaction, a growing number of cities and states taken up this issue and passed laws to increase their minimum wage.  

This year citizens in four states – Arizona, Colorado, Maine, and Washington – approved ballot initiatives to raise the minimum wage to at least $12 an hour by 2020. In 2014, four other states – Alaska, Arkansas, Nebraska, and South Dakota – voted to do the same. In total, twenty-nine states have enacted measures elevating their minimum wage rates above the level set by Congress, and are joined in doing so by over 50 cities across the country. (A full list of minimum wage rates by state can be found here).

What Do We Know about the Economics of Minimum Wages?

Many economists have long opposed minimum wage laws. One study conducted by the Employment Policies Institute found that three-quarters of economists surveyed opposed raising the federal minimum wage.

The textbook analysis outlined in introductory economics courses is that minimum wage laws create price floors, reducing the number of jobs available for workers, as illustrated in graph below:

      Source: Edgewortheconomics.com

In this scenario, where the minimum wage is increased, the supply of people wanting work at the higher rate of pay is greater than the amount of jobs available, leading to higher unemployment.

Economists also argue that minimum wage laws create market distortions that negatively impact less educated and less skilled workers, who are often younger, work part time, and may not depend solely on their wages for support.

University of California, San Diego economist Jeffrey Clemons produced a study demonstrating that increases in the minimum wage over the course of the Great Recession reduced employment 5.6 percentage points for workers aged sixteen to thirty without a high school diploma. Clemons’ has argued elsewhere that the wage decline experienced in some sectors are a result of international trade and the increased automation of low skill jobs. As a result, he suggests that income subsidies and job training programs are better solutions to income inequality than minimum wage policies.

Other research paints a different picture entirely. A meta-study analyzing research carried out since the early 1990’s showed minimum wage laws to have little to no impact on the employment levels of low-wage earners.  

Many studies point to important tradeoffs that occur when minimum wages are elevated. The Congressional Budget Office issued a report predicting that an increase of the federal minimum wage to $10.10 would likely eliminate 500,000 jobs across the country, though 16.5 million low-wage workers would receive income gains significant enough to lift themselves out of poverty. Other research suggests that raising the federal minimum wage would lead to ‘ripple effects’, where workers earning slightly above the minimum wage would also see their incomes increase.

So What’s the Bottom Line?

Based on existing economic research, states that have recently enacted minimum wage increases may experience a reduction in employment, though it is difficult to predict how many jobs might be lost, or which business sectors will be most impacted. The costs of some products and services may also be passed along to consumers in the form of higher prices, though prior studies on this issue have shown the effect to be relatively small.

The gains that low wage workers experience in their incomes could have substantial offsetting benefits, however. Benefits to the larger economy could come from both the aforementioned ‘ripple effects’ as well as positive economic multipliers, whereby minimum wage earners have more discretionary income to spend in their local economies. Businesses may also experience lower turnover rates for employees that receive higher wages due to increases in the minimum wage.

The public is largely in support of raising the minimum wage. A 2014  Pew Research Center survey found that 73% of participants approved of raising the federal minimum wage to $10.10 an hour, while a Washington Post / ABC News poll indicated that half of those surveyed would be more likely to vote for congressional candidates who support raising the federal minimum wage. 

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