The War over the Minimum Wage
The Covid-19 pandemic and President Joe Biden’s push to raise America’s minimum wage have forced the issue back into the economic and political spotlight.
The idea of a minimum wage has sparked fierce debate among economists and politicians for many years now. It is often fed by media that the minimum wage will end up hurting the very people who are seeking help, whilst more traditional economists once believed that it would lead to severe job losses. Decades of research has led to a rethink and shift in bias, with 90% of countries having some form of minimum wage. However, the question of why the minimum wage continues to be so divisive, remains unclear.
To fully appreciate the evolution of the minimum wage, we must consider its origins. It is recorded since the 18th century, worker revolutions and strikes fought for a minimum wage. Finally, in 1894, New Zealand initiated the first attempts for a nation-wide base pay. Since then, the take up of minimum wages in the rest of the world has been varied.
Though the concept is simple, workers are paid a legal base rate for their work, most economist believed the minimum wage could destroy jobs. This emanates from the most basic of economic models — supply and demand. As labour becomes more expensive, employers might want less of it, or in other words, unemployment.
America’s first federal minimum wage wasn’t introduced until 1938. President Franklin Roosevelt proposed a path of 25 cents per hour to aid the low-income workers during the Great Depression. However, problem began as the federal minimum wage in America fell behind inflation and the value stagnated. Today, the national minimum wage of America stands at $7.25 per hour meaning that in real terms it peaked around $12 in 1968.
In response to these low federal minimum wages rates, some state and county politicians raised it locally themselves. This resulted in different wage floors all across America, as governors continued to aid the people of their area. Eventually, by 1991, the federal minimum wage went up to $4.25 about $8 in today’s money.
A year later, 24 states had the same minimum wage rate and five states had rates higher than it. This patchwork of different minimum wages gave economists an opportunity to measure the real-world impact and a study that would turn economic thinking on its head.
Two economists conducted this study, David Card and Alan Kuregar from Princeton University. They observed the changes the minimum wage had on employment at fast food restaurants in 2 states with different policies: New Jersey, where the minimum wage for workers increased and its neighbouring Pennsylvania, where it stayed the same. A conventional approach at the time would tell you that employment would fall in New Jersey relative to Pennsylvania. But what Card and Krueger found is actually the opposite, despite the minimum wage going up in New Jersey employment increased.
This strange result was eventually theorised by the idea of monopsony power. In the case of the fast-food company, something which employers of the observed companies possessed to a degree. A monopsony is the opposite of a monopoly — there is one sole buyer of goods or employer of workers. In the case the employers of the fast-food companies in the two states had a degree of monopsony power. With less competition the employer can set the wage for their workers meaning wages can be kept artificially low.
Card and Krueger found that a small wage increase didn’t lead to redundancies because wages were already below market rates. But most notably employment increased, suggesting that perhaps the higher wage may have attracted new workers to the market. This influential remark proved for the first time that raising the minimum wage doesn’t necessary destroy jobs. Furthermore, it challenged conventional wisdom on minimum wage in America, as similar policies of minimum wages spread across the world. These included: China in 1994, Britain in 1998, Ireland in 2000 and Germany in 2015.
Further analysis by the two economists, led to a new focus on empirical data as opposed to theory. Yet gathering empirical data continuous to be difficult and can give contradictory result so far from providing clarity the study only served to reignite the debate. Economist and politician began to question the isolated groups the minimum wage should impact, which served to be far from straight forward.
This is the case in Seattle, a seaport city on the west cost of America. It has been the forefront of the minimum wage debate since the historic law in 2014 was passed, that set the minimum wage at $15 an hour by 2021. Two studies exploring low paid jobs a year apart gave very different results. The first, published in 2017 looked at aggregate data or average of data on hours and earnings. It found an increase in minimum wage led to employers reducing hours in low-paid sectors meaning employees overall lost out on monthly wages. The second in 2018 looked at individual workers and found that low paid workers earned more on a weekly basis after the minimum wage has been increased, but some of the gain was because workers were picking up shifts in other jobs.
Both studies accurate, but seemingly contradictory, this goes to the heart of the minimum wage debate. Fundamentally, what these two studies shows is that the minimum wage is really an empirical question rather than a theoretical one. It depends on what sectors people are working in, how easily replaced by machines they are, what sort of profit margins their employers have, what their pricing power is and what policy makers and economists need to keep in mind is that they need to keep on checking data and keep examining the evidence of the impact these policies are having.
In America, this time on a national scale, President Joe Biden aims to raise the federal minimum wage to $15 an hour. Such an ambitious objective is no longer just going to cause economic controversy, but also political. Biden may struggle to push this through Senate undoubtedly causing uncharted routines with the real minimum wage higher than ever before. Having addressed, the ever-growing importance of empirical data, ultimately, some economists, will still fear it is too high for firms to handle and could lead to job losses. However, if Joe Biden does manage to raise the federal minimum wage to $15 an hour, it looks to be a big historical moment, but likely to be argued by economists and politicians for years to come.
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Dinil Wanni Arachchige
