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Making Low Wage Work Pay
Why Minimum and Living Wages May Make Economic Sense
Yourtown, USA. Whether it has stately tree-lined boulevards, vegan cafes and smoke-free bars, or the hustle and bustle of a large metropolis, they are omnipresent. Whether it’s your morning cappuccino and croissant, your clean streets and sidewalks, or your “fill ‘er up with regular and check the oil,” they are there. Minimum wage workers play a ubiquitous role in America’s increasingly service-oriented economy. This increasing significance of minimum wage jobs has fueled a sharp debate over the pros and cons of minimum and living-wage legislation during the last decade. Proponents appeal for economic justice for the working poor. Opponents, meanwhile, claim that minimum and living wages do not deliver justice at all. They argue that such requirements hurt both small businesses and the poor, since employers, faced with higher costs, are forced to lay off low-skilled workers.
Although several proposals for increasing the federal minimum wage have been put forth in recent years, these proposals have received relatively little political or media attention. Most recently, presidential candidate Richard Gephardt’s goal of enacting a “global minimum wage” was characterized in a February 23rd Washington Post article as “hardly a grabber in these times.” Congressional inactivity has led to wage legislation at the state and local levels—currently, twelve states have minimum wages higher than the U.S. mandate of $5.15 per hour and more than 90 local governments have enacted living wage ordinances. Living wage laws typically set a minimum hourly wage that must be paid by companies that do business with or receive subsidies from the local government. One exception, however, is Santa Fe. This New Mexico community recently passed a living wage ordinance that establishes a minimum covering all private employers. But like similar legislation in New Orleans and Santa Monica that were recently overturned, the Santa Fe law is being challenged in court.
Higher Wages May Increase Employment
Until recently, most economists strongly believed that minimum and living wages hurt the low-paid, since employers could be expected to respond to the increased cost of labor by employing fewer workers. A recent study by two well-known economists, however, David Card and Alan Krueger, has called this conventional wisdom into question. Card and Krueger looked at data on variations in the minimum wage from state to state to analyze the effects of a higher minimum wage on employment. They found, surprisingly, that the 1992 increase in New Jersey’s minimum wage had a negligible impact on employment, and if anything, may have actually caused a small increase in employment in the fast-food industry.
This finding was initially met with great skepticism. Nobel Laureate economist James Buchanan lashed out at Card and Krueger in the Wall Street Journal shortly after the study:
“…no self-respecting economist would claim that increases in the minimum wage increase employment. Such a claim, if seriously advanced, becomes equivalent to a denial that there is even minimum scientific content in economics, and that, in consequence, economists can do nothing but write as advocates for ideological interests. Fortunately, only a handful of economists are willing to throw over the teaching of two centuries; we have not yet become a bevy of camp-following whores.”
Nevertheless, other recent research by a number of authors leads to the same overall conclusion—moderate increases in the minimum wage have had negligible (or even positive) effects on employment—and the economics profession is now more equivocal about the effect of instituting minimum wages.
The Mirage of Perfect Competition
Historically, economists have assumed that labor markets are competitive. In competitive markets, an employer can hire all the workers it wants at the “market wage”—i.e., the bottom-line wage that overall market supply and demand dictates. To maximize profits, businesses will hire workers until an additional worker no longer generates more added value for the company than the market wage that the business has to pay to that worker. A minimum or living wage increases the market wage artificially, and therefore prompts businesses to lay off workers.
How can we explain positive effects of minimum wages on employment, then? It turns out that labor markets may not be as competitive as economists had assumed. Economists have long recognized that a minimum wage can raise employment if the employer is the only employer in the labor market, or a “monopsonist.” The classic example of such an employer is the coal-mining town of the 19th and early 20th centuries, in which a majority of the miners lived in company housing in “company towns.” These mines were often located in isolated and sparsely populated areas, and miners wishing to change employers had to relocate.
Just as a monopoly sets the price of a product too high from a social standpoint, a monopsonistic employer sets the price of labor—the wage—too low. Although it may actually benefit a monopsonistic business to hire a new employee at a wage higher than it currently pays, the monopsonist does not offer somewhat higher wages and hire more employees, since it would have to pay all its existing workers higher wages as well. A reasonable minimum wage, in such a situation, will raise employment by making it more worthwhile for more potential employees to seek jobs.
The monopsony, or single-employer, argument has generally been dismissed as a theoretical curiosity. Indeed, it is difficult to believe that an industry as competitive as the fast-food industry can be thought of as a monopsony. Nevertheless, recent research by the authors of this article has shown that several of the insights of monopsony carry over to cases where there are many small employers. Whenever a firm does not have an unlimited pool of applicants at the “market wage,” it is (economically) as if only one employer existed in a given market. Given such limits on applicants, a business that seeks to hire more employees must offer higher wages. Even though such a business competes with many other employers in the labor market, in many aspects its behavior resembles that of a monopsonist.
When a minimum or living wage is introduced in such a labor market, labor supplies increase, and individual employers will hire more workers. At the same time, the minimum or living wage also shrinks profits, and some firms will be forced out of business, taking their payroll with them. Taking the two effects together, the net effect of a minimum wage on employment can be positive or negative, but in any case is likely to be small in magnitude. This prediction is in line with recent evidence from New Jersey (discussed above).
Are Federal Minimum Wages a Dinosaur?
It is important to note that the possibility of increased employment only applies for moderate increases in the minimum wage—employment must fall if the wage increase is too high. This has an important implication. Since the prevailing wage in different cities can vary greatly, a federal minimum wage that has a positive or negligible impact on employment in one city may have a significant negative impact in another city. For example, according to the Bureau of Labor Statistics in April 2001, at the bottom of the “food counter, fountain, and related” pay scale, workers earned $6.77 per hour in the New York City metropolitan area but only $5.15 in the Phoenix, Arizona metropolitan area. A federally mandated minimum wage of $7.00 per hour might have a negligible or positive effect on employment in New York City but would in all likelihood cause layoffs in Phoenix. In other words, a federal minimum wage may benefit the working poor in one location while causing severe job losses elsewhere.
This new research therefore suggests that for the goal of increasing the incomes of low-paid workers while having a minimal impact on total employment, a single, national minimum wage is a poor policy tool. If set too low, a national minimum wage helps very few; if set too high, it results in layoffs. It would make more sense to institute different minimum wages that depend upon prevailing labor market conditions in different regions. The precise optimal level for each region easily could be determined through data that the federal Bureau of Labor Statistics publishes on regional labor markets. The current, decentralized U.S. system of wage legislation is somewhat similar to such a location-based minimum wage policy. The federal minimum has, in recent history, been relatively low. With a relatively low national standard, some states have implemented their own minimum wage laws with minimums as high as $7.15 (Alaska). Moreover, some local governments have enacted living wage ordinances. While federal law ensures a relatively low guaranteed wage rate, some states impose higher minimums and some local governments enact living wage ordinances that are higher still.
This is not to say that minimum/living wage laws in their current form achieve the aforementioned goal of raising wages with little or no loss in employment. To begin with, relatively few states (12 out of 50) have enacted their own minimum wage legislation. An even smaller percentage of local governments has enacted living wage ordinances. The 90 or so municipalities nationwide that have living wage ordinances on the books represent a drop in the bucket—the state of Pennsylvania alone has 67 counties and 2,566 municipalities. Furthermore, living wage laws directly impact only a limited set of employers, although such laws have indirect effects on the many non-covered employers. Finally, living wages have in practice been set quite high (some are more than twice the federal minimum wage rate) and, again, a minimum, if set too high, will result in lost jobs.
Every community has its share of minimum wage workers. Public deliberations concerning minimum wages are often fierce, focusing on the impact of minimum and living wages on the economic health of a community. Because economists are traditionally known as minimum wage naysayers, some economists’ new findings on potentially positive effects of minimum and living wages may shift this debate into new territory.
This article appeared in the June 2003 issue of Next American City magazine. SUBSCRIBE NOW!
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