Raising the Minimum Wage
A co-worker sent me a link to this page a few days ago. He mentioned the part about raising the minimum wage and noted that it wasn’t very good.
1. Raise and index the minimum wage to half the average hourly wage. At $5.15, the federal minimum wage is at its lowest level in real terms since 1956. The federal minimum wage was once 50 percent of the average wage but is now 30 percent of that wage. Congress should restore the minimum wage to 50 percent of the average wage, about $8.40 an hour in 2006. Doing so would help nearly 5 million poor workers and nearly 10 million other low-income workers.
The implication here is that raising the minimum wage is only a good thing. If this is the case why not simply raise it to a level sufficiently high enough to eliminate poverty amongst minimum wage earners. That is if the minimum wage level necessary to eliminate poverty amongst minimum wage workers is $22.89/hour and since there is no down side to raising the minimum wage then morally one should insist on the higher wage and not the $8.40/hour that would still leave some people in poverty.
Now one reason they don’t go for the higher wage is that there are downsides to a high minimum wage. At our hypothetical of $22.89/hour there will almost surely be an increase in the drop out rate from high school. Why stay in high school where you are struggling, getting crappy grades and are going to end up with the minimum wage anyways? Nobody really wants to promote a policy that will promote ignorance.
Another thing is that the raising the minimum wage is likely to have little impact in some markets. Think of it this way, suppose we have not just one low skill labor market, buy several that are regional. In some regions the prevailing wage will be the minimum wage. In others, such as where I live, many low skill workers will earn more than the minimum wage. In these latter markets the wage rate is already above the minimum wage so if the minimum rises to a point still below the market clearing wage, then there is no harm done…no benefit either, but no harm.
There is also some issue about the efficacy of what is being done here in terms of economic growth. It is possible to replicate the effects of the minimum wage with a tax and transfer scheme. This means that there is a deadweight loss associated with the minimum wage as well. This deadweight loss are lost economic transactions to society that are simply gone. There is no way to spin this as a good thing save to argue that the increased welfare from the minimum wage accruing to those earning the minimum offsets the losses suffered who are bearing the burnt of the deadweight loss. Also, when you tax somebody, say $100, and give it to another person, it is not clear that the economy will grow more. After all we took $100 from one point in the economy, and injected that same $100 at another point (assuming a costless transfer program). In short, the transfer merely re-arranges who has money, it doesn’t create new money or output.
And the last reason nobody advocates this is that there would be serious problems with unemployment. While there are debates over how much unemployment, if any, raising the minimum wage a $1 or $2 causes, raising the minimum wage to something like our hypothetical would cause massive widespread unemployment. Why? Value added. Firms are only going to employ a worker when that worker adds value to the firms output at least equal to the worker’s wage. And for many low skill jobs the value added is slight. What is the value added by a McDonald’s worker? Certainly isn’t $22.89/hour. At the prices McDonald’s would have to charge given such a high minimum wage I’ll go home and make my own burgers, fries and milkshake thank you very much.
So while there is lots of debate and quite a bit of uncertainty as to the positive and negative impacts of changing the minimum wage a little bit; there are still potential problems with large changes. This kind of thing should not be ignored, especially when the topic of a living wage comes up. If a living wage is large enough it could actually end up hurting the very people that it is trying to help.