Minimum Wage: Employer vs Employee

Minimum wage re-entered intellectual debate recently when David Card(along with Joshua D. Angrist and Guido W. Imbens) won the Nobel Prize for Economic Sciences in 2021 for his work on minimum wage laws and their effects on employment statistics. So what is minimum wage, and why is it such a polarizing debate among academics, especially economists? To understand that, we need to understand what minimum wage is. The actual definition is quite close to what most people would intuitively think it is. A minimum wage is the lowest remuneration that employers can legally pay their employees — the price floor below which employees may not sell their labour. So what is the final verdict on minimum wage laws? I will answer this with a classic cliché: “I have some good news and some bad news…”

The Good News

Advocates of minimum wage point to several advantages of a minimum wage. Firstly, minimum wage laws help ensure that workers are able to feed, clothe and house themselves and their families. These laws help protect workers from unscrupulous employers and workers who are not part of a labour union. Secondly, if workers are paid well, they enjoy better physical and mental health, leading to higher productivity, improved performance, and motivation to improve existing skillsets. This makes it easier for employers to retain employees because the process of leaving a job for better pay gets disincentivized.

Minimum wage laws also provide macroeconomic advantages to society. Better pay for workers means that workers spend money not only on essentials like clothes and food but also on non-essential things like entertainment, travel, and consumer goods. Thus, a significant portion of the paycheck ends up back in the economy. Businesses in all sectors experience growth because of which they hire more workers, thus decreasing the unemployment rate. Additionally, minimum wage laws increase social stability as people don’t leave their jobs and consequently their communities for better pay. This helps stabilize neighbourhoods, which proves beneficial for all who live there.

The Bad News

People who argue against minimum wages explain that minimum wages hurt the economy step-wise, and blows to the economy are dealt at every step. According to them, workers are paid what they deserve, and the market decides the wage. They feel that if the government intervenes and sets a minimum wage, it upsets the natural equilibrium of the market. They claim that it becomes more expensive for firms to produce goods since wages go up, and hence to compensate, firms increase the prices of their products and services, which leads to inflation. The high prices discourage customers from paying for the products and services, and thus companies let go of low productivity workers to remain competitive as sales go down. Thus ultimately, minimum wage hurts the people it initially set out to help.

Opponents of minimum wage also argue that automation is already threatening the job market, and the workforce is getting less than adequate time to deal with the incoming changes to the labour market. If employers and firms are further disincentivized to hire more workers or further incentivized to fire more workers, the double whammy of automation and minimum wage will deal a body blow to a large portion of the workforce. It hurts low-skilled workers and fresh entrants to the workforce the most. Many of these people are looking for a first job to gain skills and job experience; the pay is not particularly important to them. But minimum wage means employers are often discouraged from hiring these workers as they have to pay these workers as much as a highly-skilled worker or a veteran in the same role gets paid.

What does Dr. David Card have to say?

In the 1990s, David Card and the late Alan Krueger performed a series of “natural experiments” to understand the correlation between minimum wage and employment rates. These natural experiments could be conducted because, in 1992, the state of New Jersey in the U.S. set a new minimum wage, but the neighbouring state of Pennsylvania did not. This provided a laboratory of sorts for David Card and Alan Krueger, who over the next few years studied employment rates in 400 fast-food restaurants in both states since fast-food chains usually hire a significant portion of their labour on wages close to or equal to the minimum wage.

What the two economists found at the end of it all turned upside down, years of conventional economic wisdom. The employment rate in New Jersey went up while it remained the same in Pennsylvania. Subsequent research produced results along a similar line; minimum wage laws had a net positive or zero effect on employment rates.

This map shows the minimum wage in each state in the United States in 2021:

What does recent research say?

The minimum wage in the United States is currently $7.25 per hour, but there have been an increasing number of calls to increase the national minimum wage in the U.S. to $15/hour. A study published in the Harvard Business Review on June 10, 2021 made some fascinating observations about raising the minimum wage beyond a certain limit. The researchers looked at worker schedules and wage data from 2015 to 2018 for more than 5000 workers at 45 stores in California — where the minimum wage was $9/hour in 2015 and has increased every year ever since — and at 17 stores in Texas where the minimum wage was $7.25/hour between 2015 and 2018

The study found that increasing the minimum wage had no significant impact on the number of labour hours employed at the stores in California, which means stores were hiring workers to work for the same overall number of hours despite the increases in the minimum wage. What changed was the allocation of work hours among workers. According to the study, for every $1 rise in the minimum wage, the total number of workers scheduled to work each week went up by 27.7%, while the average number of hours each worker worked per week fell by 20.8%. This resulted in the actual wage of a minimum wage worker in California dropping by 13.6%. The decrease in the average number of hours per worker per week also impacted the eligibility of these workers for benefits like health insurance and retirement benefits. For every $1 rise in the minimum wage, the percentage of workers working more than 20 hours per week(making them eligible for retirement benefits) dropped by 23%, while the percentage of workers working more than 30 hours per week(making them eligible for health insurance) decreased by 14.9%.

This suggests that there is a ceiling beyond which if the minimum wage is raised, employers are going to strategically schedule worker hours to reduce the number of workers eligible for various benefits, which traditionally have been the responsibility of employers.

This map shows the level to which minimum wage discussions have progressed around the world:

This chart shows a comparison of minimum wages(in US dollars) around the world:

Conclusion

The jury is still out on whether the concept of minimum wage proves beneficial from an economic and social standpoint or not. But what cannot be denied is the fact that this debate shines the spotlight on an entity of economics that deserves maximum attention; the worker. This debate brings to the forefront, the human experience and what effect wages have en masse on the people who receive them, not on the firms or businesses that pay those wages.

At a time when the free-market system is coming under intense scrutiny the world over due to rising income inequality, what is needed is an open and honest conversation regarding minimum wage laws, with all the stakeholders present, so that a solution is found to the problem and the best possible minimum wage model with a reasonable and mutually agreed upon minimum wage is implemented globally.

By Yash Trivedi