Should We Raise The Minimum Wage?

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This week, President Obama announced that he would push to see the minimum wage raised to $10.10 per hour, and would use his executive powers to raise wages on new federal contracts. There are economic and political arguments both in favor and opposed to raising the minimum wage. Let's take a look at a few of the economic arguments on both sides:

No, we should not!

  1. The minimum wage is classic example of a price floor - a regulation that prevents prices from going below a certain level. In this case, the price is the price of labor for (generally) unskilled workers. In the classic model, there is an equilibrium price (say $8 per hour) that is below the minimum wage. There are some firms that are willing to hire somebody for $8 an hour, but not for $10. The result is that the increase in the minimum wage leads to fewer jobs and more workers who are willing but unable to find jobs.
  2. Forty-nine percent of minimum wage workers are under 25, so these jobs may be part-time jobs during school, or entry level jobs. In these cases, low wages aren't really contributing to poverty or overall income inequality. No offense to students, but the goal is to help those in poverty, not high school students working to earn pizza money.
  3. The minimum wage puts the burden of higher wages on companies that employ more unskilled workers. Apple and McDonald's are two companies that are doing quite well, and both rely on the work of low wage workers. However, McDonald's workers are largely in the US and paid by McDonald's (or their franchises) while Apple chooses to use contractors in developing countries. Raising the minimum wage means that one of these companies has to pay a significant burden, while the other bears no costs. If we are trying to use policy to reduce income inequality, there should be a more equitable way of paying for it.
  4. Increasing labor costs will lead to more investment in automated processes. Self-checkout lines are now commonplace. As wages increase, you may find that you are placing your own order at restaurants, and the burgers are being flipped by machine. While this is happening anyway, an increase in wages will only accelerate this phenomenon.
  5. The number one axiom of economics is that "there's no such thing as a free lunch." Increasing the minimum wage is somewhat popular at least in part due to the fact that it seems cost less to most of us. It doesn't require government spending or taxes or much else. However, some of the costs will certainly be passed on to the consumers in the form of higher prices.
  6. Other policies, such as the Earned Income Tax Credit, all-day kindergarten, and subsidized health care would do as much or more to alleviate poverty without the negative side effects that come with an increase in the minimum wage.

Yes, we should!

  1. More complex economic models incorporate search costs to suggest that wages are often too low. In short, employees generate significantly higher output for companies than what they get paid. In a classic market, they could go elsewhere and get paid more, but switching jobs takes time and risk. The bottom line of this argument is that increases in the minimum wage will mostly be absorbed by companies and offset by modest price increases, and there will be little effect on overall unemployment.
  2. Increasing the minimum wage will boost the economy, and offset any negative impact on most businesses. Since low wage workers tend to spend all of their income, this will result in a large boost in economic activity that will increase an otherwise tepid economic outlook. The argument is that Wal-Mart workers will have more money to spend at McDonald's, and vice versa, so that the impact is largely offset, even though no single employer would be better off by unilaterally raising wages.
  3. Income inequality is too high from both a moral and economic growth perspective, and given political realities, programs like the Earned Income Tax Credit are unlikely to be expanded.
  4. The proposed minimum wage of $10.10 sounds like a lot to middle-aged people who had a job that paid $4.25 an hour 25 years ago. However, when adjusting for inflation, this is more than $8.00 an hour. Most people have no appreciation for how hard it is to live on $7.25 an hour.

There are compelling arguments on both sides. Serious action needs to be taken to make sure that the richest nation gives an opportunity for all of its citizens. A higher minimum wage is a somewhat flawed policy, but better than doing nothing.

Kyle Anderson is an economist at the Kelley School of Business. In the summer of 1988, he earned $4.25 an hour sweeping floors, an awesome $.90 over the minimum wage. You can follow him @kyleanderson1 where he earns less than minimum wage for tweeting.