What You Need to Know About the Minimum Wage

[RS Davis]

[url=http://www.mises.org/fullstory.aspx?control=1603
]What You Need to Know About the Minimum Wage[/url]
By Shawn Ritenour
[Posted September 10, 2004]

Recently Tom Lehman lamented one of the frustrations free market economists often face when reading economic journalism: opposing bad policy for the wrong reasons.One of the earliest memories I have of feeling this pain was in college and reading that the first President Bush wanted a decrease in the capital gains tax because it would result in an increase in government tax revenues. Another cause for consternation is peddlers of bad policy leaning on conventional wisdom that, while generally believed, turns out to be false at every turn.

This is certainly the case regarding current debate over the minimum wage. John Kerry has called for an increase in the minimum wage to $7.00 an hour by 2005 and President Bush, in another display of perfecting the art of Republican me-too-ism, says he is willing to consider any increase that is "reasonable," whatever that means.

The general thesis that makes increasing the minimum wage attractive to the electorate, which makes it attractive to presidential candidates, can be summed up in two propositions: 1) Increasing the minimum wage lifts poor people out of poverty, while having no noticeable impact on unemployment, and 2) Raising the minimum wage is necessary now because so may minimum wage workers are the only means of financial support for their households. It turns out that every part of this thesis is founded on bad economic analysis, a disregard for economic facts, and misleading government pronouncements.

Helping the Poor

Wage interventionists claim that raising the minimum wage is necessary because of the plight of the poor. Well, when we consider whether raising the minimum wage helps the "poor," we should know something about who we mean by "poor." When we hear talk about how many poor people, and especially children, there are in the United States, it is natural to form mental images of people without adequate food, clothing, and shelter. People deprived of the very necessities of life.

Data from the most recent census, however, reveal that those who are officially classified as "poor" by the United States government possess a surprising amount of wealth.[2] The official "poor" are not that poor after all. For example, for those persons classified as "poor," 46% own their own home and 76% have air conditioning. More than 66% of the "poor" have more than two rooms of living space per person. In fact, the average "poor" United States citizen has more living space that the average citizen (not "poor" citizen) living in Austria, Belgium, France, Finland, Germany, Greece, Ireland, Italy, Portugal, Spain, and the United Kingdom; 97% of the official American "poor" own a color television and over half own more than one; 62% of the "poor" have either cable or satellite television. Far from being undernourished, the "poor" have a greater obesity problem than the rest of the population. The most common hardship that most poor people face is making late rent and utility payments.

The facts paint a picture very different from the images of squalor associated with the term "poverty." Much of this is due to a shift in the definition of poverty from one of absolute deprivation of the necessities of life to one of having relatively less than other people. As egalitarianism has gained a larger grip on the public intellect, policy entrepreneurs have become more and more inclined to accept the relativist definition.

Because in any free society there will always be people who earn more than others, there will always be the possibility of defining those on the low end of the income statistics as poor, thereby creating an instant constituency with which to exchange goodies for votes. In any event, whenever we hear claims that we must do this or that to help the poor, we need to remember that the number of people in this country that are actually deprived of food, clothing, and shelter are very, very few. Not exactly a reason over which to create or expand a government program.

The Minimum Wage and Breadwinners

One of the most successful rhetorical justifications given for raising the minimum wage is that there is no way for anyone to support a family while earning the minimum wage. It turns out that while it may be very hard to support a family earning the minimum wage, hardly any minimum wage recipients, in fact, are responsible for supporting a family. Data from the 1995 Current Population Survey reveals that of all workers who earned the minimum wage immediately preceding President Clinton's 1996 increase, 37.6% were teenagers living with their parents, 17.1% were single adults living alone, 21.5% were adults who were married to a spouse who also worked. Only 5.5% of all minimum wage workers were single parents, and only 7.8% were married and the sole wage earner for their household, which may or may not have included children.[3] The notion that a large percentage of wager earners are trying to support a family with children on the minimum wage is a myth.

Additionally, raising the minimum wage is not necessary for the official working poor to increase their income. Between 1998 and 2002 median wage growth for minimum wage employees was more than five times that for those earning above the minimum wage. Nearly two-thirds of all minimum wage employees who continue employment are earning more than the minimum wage within a year. More than 97% of all employees in the United States move beyond the minimum wage by age 30.[4] Those who do not progress to a wage above the minimum either lack the skills or motivations for them to be attractive hires at a higher rate of pay. The key to increasing one's income is not raising the minimum wage, but remaining employed. This is one reason why the minimum wage can actually be devastating to the working poor. The minimum wage tends to hurt the lowest skilled workers by making them less employable.

The Minimum Wage and Unemployment.

Within the past ten years it has become conventional wisdom among the left that we can get all of the benefits of raising the minimum wage "a reasonable amount" without increasing unemployment. This amounts, of course, to an assertion that we can easily put aside economic law. An increase in the minimum wage will not benefit all low income workers. It will help only some of them at the expense of others. Why is this so? Well, economic law tells us that if the price of any good increases, people will want to buy less. This is true for gasoline. It is true for apples. It is true for iPods. It is also true for labor services.

Even the "living wage" zealots at ACORN recognize this. In 1995 ACORN sued the state of California to get itself declared exempt from California labor law, so it would not have to pay the minimum wage to its own employees. In its brief submitted to the Court of Appeal, ACORN argued, "The more that ACORN must pay each individual outreach worker—either because of minimum wage or overtime requirements—the fewer outreach workers it will be able to hire."[5] As Bud Abbot says to Lou Costello in their "Who's on First?" routine, "Now that's the first thing you said right!" [/b]

[glow=red,2,300]Continued...[/glow]

[RS Davis]

[glow=red,2,300]Concluded.[/glow]

Employers cannot simply pay any old wage that makes workers happy. Businesses are constrained by the value that the workers add to the firm. If a worker's contribution to the firm is such that his output brings in revenue of $5 for every hour of his output, the business cannot afford to pay him any more than that and still break even. If he is forced to pay this employee $7 an hour, he is losing $2 an hour every hour that worker is employed. A minimum wage increase provides an incentive to hand him the pink slip.

That worker will soon be on his way out the door, most likely cursing his employer instead of the government mandated minimum wage. The direct result of a minimum wage above the market wage is mass unemployment for relatively less skilled workers. The number of workers who want to work increases, but the quantity of laborers that employers can afford to hire falls. The result is more people wanting to work at the minimum wage than can get hired. In other words, we get unemployment.

Employment losses due to minimum wage hikes are even more acute than most people realize, because of the number of taxes that firms must pay that are tied to employee compensation. In today's interventionist state, the wage rate is not the end of labor costs, but only the beginning. Government taxes such as Social Security, Medicare, and Unemployment taxes are all linked to wages paid. As monetary compensation to a worker increases, so does the amount that the firm has to pay in taxes. Consequently, as wages increase, the cost of hiring that worker increases by even more than the wage hike.

Currently the Social Security tax is 6.2% and the Medicare tax is 2.9%. The effective federal Unemployment tax rate is 0.8% while state Unemployment tax rates run from an average minimum of 0.5% to an average maximum of 7.32%. The average rate for new businesses is 2.7%. If Kerry and company were to get their way the minimum wage would increase by $1.85 to $7.00 an hour, the cost to a new business of hiring a lower skilled worker would increase by $2.08 an hour, not $1.85. The effective cost of hiring a minimum wage worker increases to $7.88 an hour. Suddenly this "modest" increase being bandied about seems about as modest as Madonna on her Truth or Dare Tour.

Businesses cannot simply absorb such losses painlessly. Some will be forced to lay off some of their lowest skilled workers. Others will be forced to slow their hiring to begin with. Those lower skilled workers who are laid off or never hired initially are hardly better off as a result of a minimum wage increase. They certainly are not lifted out of poverty.

One of the reasons that proponents of the minimum wage are able to pull the economic wool over the eyes of so may people is due to the selectivity of their use of unemployment statistics for fun and profit. As Tom Lehman pointed out is his piece, the main reason that there appears that the minimum wage has a relatively small effect on unemployment in general is that not every worker is affected by the minimum wage. The vast majority of workers earn market wages well above the minimum. If the minimum wage is raised to $7.00 an hour, this will have no direct effect on the employment situation of someone who already earns $15.00 an hour. It is only those workers whose market wage is below the minimum wage who are placed in employment jeopardy.

Because wages tend to track the value of the marginal product of labor, those most effected by changes in the minimum wage are lower skilled workers. In general they are young adults and teenagers. The minimum wage is one reason we see unemployment rates for teenagers much higher than that for the population as a whole. For example, based on analysis of the effects of the increases in the national minimum wage that took place in 1990 and 1991, economists Kenneth Burkhauser, Kenneth Couch, and David Wittenburg concluded that for every 10% increase in the minimum wage, employment for teenagers and young adults in general decreased by 2.5%.[6] The decrease for teenagers themselves was 5.7%. Those hurt the most by increases in the minimum wage are young adults without a high school degree and young black adults and teenagers. Another set of economists have estimated that the total effect of that same two increases were quite pronounced among effected workers.[7] They estimated that, following the increase from $3.35 to $3.80 in April 1990, employment for teenage males and females fell 1.5% and 2.5% respectively. When the minimum wage was again increased to $4.25 in April of 1991, employment for male and female teenagers again declined, this time by 3.1% and 5.2% respectively. Although an increase in the minimum wage may not have much impact on those workers whose market wages are above the minimum, those groups with the fewest job skills are effected. Only some minimum wage workers will remain employed and receive more wages at the expense of others who will be laid off or not hired to begin with.

Helping the Poor Revisited

Granted that the vast majority of those considered officially poor by our government live well above subsistence level, what impact does increasing the minimum wage have on these whose income is below the official poverty threshold? We have already seen that every effective minimum wage will lead to some amount of unemployment. It should surprise no one that helping usher the lowest skilled workers out of a job does not make them more wealthy. The effect is just the opposite of what apologists for the minimum wage assert. People who are poor because they have few employment options are not made better off by reducing what options they have. As you remove employment possibilities for those harmed the most by raises in the minimum wage, their incomes fall, and they will tend to become more poor, not less.

The bad news does not stop here, however. Those who are either laid-off or not hired to begin with are not shunned by employers because they are chock full of employable characteristics. They are left without work, precisely because they do not have the skills that allow them to contribute more to the firm and thereby earn a higher wage.

Not only does the minimum wage harm the poorest of the working poor immediately, but it also sets them on a lower income trajectory over their lifetime. Many of the skills making them attractive to employers in the future are those disciplines learned on the job. If the minimum wage is set above the market wage, it will take the lowest skilled workers longer to find employment initially. This does not help them in the least. They are hurt by the minimum wage and that hurt takes awhile to go away. Because it takes them longer for them to land their first job, they are delayed in developing the work ethic and job skills that make them more attractive to present and future employers. The poor get poorer, not because the minimum wage is too low, but because it is above their market wage.

A positive relationship between the minimum wage and poverty for effected workers is exactly what has occurred during American economic history over the last third of the 20th Century. Richard Vedder and Lowell Gallaway have conducted a massive empirical study of the relationship between the minimum wage and poverty from 1966 to 1998.[8] After much statistical analysis they conclude that the national minimum wage was ineffective in reducing overall poverty during this time period. They further found that for some effected subgroups, there was a positive relationship between minimum wage hikes and poverty.

Conventional Wisdom Is Foolishness

The bottom line is that everything we have heard from conventional wisdom regarding the minimum wage is false. The poor are not that destitute. The minimum wage does not generally lift people out of poverty, because it exacerbates unemployment for lower skilled workers. A very small portion of minimum wage workers are the sole income earner for their families, and the vast majority of those who work a minimum wage job will earn above the minimum wage provided they stay employed. Staying employed is the very thing that a minimum wage hike makes it harder to do. Raising the minimum wage in an effort to help those truly in poverty would be not the height of wisdom, but the depth of folly.


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Shawn Ritenour teaches economics at Grove City College.