Raising the Minimum Wage Makes Good Sense
By Mel Miller
Raising the minimum wage is a key political issue for 2014. There seems to be some hope that the two political parties can reach a compromise similar to one recently reached on the budget.
The current Federal minimum wage is $7.25 ($15,080 per year for a full-time worker), with a minimum wage of only $2.13 per hour for tipped workers. President Obama is pushing for a 40% increase to $10.10. In his State of the Union Address last night, President Obama identified raising the minimum wage as a key policy goal. He said that he will use his executive powers to require any company contracting with the federal government to pay workers at least $10.10 per hour. But the full Congress will need to sign off on increasing the minimum wage for all workers in the U.S.
Congress instituted the minimum wage in 1938 as part of the Fair Labor Standards Act (FLSA). The first minimum wage stood at 25 cents an hour. The last minimum wage increase occurred in 2007, when Congress raised the rate in steps from $5.15 an hour that year to $7.25 an hour in July 2009.
The argument of those who oppose raising the minimum wage focuses on one basic belief which was taught in Economics 101: In a competitive market, artificially raising the price of labor will cut demand for it and the first to lose jobs will be the least skilled. Milton Friedman even went so far as to say the minimum wage was discrimination against the low skilled. He felt a better way to alleviate poverty was to provide public subsidies to the working poor.
Proponents of a higher minimum wage are quick to point out that the economy does not operate as described in textbooks. The labor market is not perfectly competitive. For the market to be perfectly competitive, workers must be able to change jobs at will, which is not the case.
Evidence against a purely competitive labor market is based on the economic theory of “search frictions.” The theory, developed by Peter Diamond, Dale Mortensen, and Christopher Pissarides, won the Nobel Prize for Economics in 2010. Simply stated, employers and job seekers don’t find each other immediately.
The research showed that raising the minimum wage makes workers less likely to quit, which reduces the number of openings at any one given time. The resulting boost in employment offsets layoffs of workers who are no longer worth the higher minimum wage. Workers face costs to switch and in many cases are not able to sell their homes to relocate to where jobs are more plentiful and higher paying. Since workers do in fact face costs to change jobs, employers can set pay below the market-clearing rate.
Given less than a competitive labor market, proponents feel the minimum wage could be raised, boosting wages, without having a negative impact on the number of jobs so long as the minimum wage is not set too high.
If the proponents are correct, what is too high? America’s minimum wage is 27% of the U.S. average pay, the lowest ratio of any member of the Organization for Economic Co-operation except for Mexico. In countries where the minimum wage is a high percentage of the median income, such as France, which stands at 50%, an increase would have a detrimental impact on employment, especially youth. France has an unemployment rate of 26% for 15-24 year-olds.
While raising the minimum wage makes sense for America, since the new higher rate would still be low as a percentage of median income, it will not solve the long-term unemployment problem. It would, however, provide a needed raise to those workers who need it the most. And, since the money is likely to be spent and not saved, raising the minimum wage would also likely have a positive impact on GDP.
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Posted: January 29, 2014