Minimum Wage: Why Minimum Wage Should be Increased

Introduction

Heidi Wissel

President Roosevelt established the federal minimum wage in 1938 as part of the Fair Standards Labor Act. The minimum wage was designed to protect workers from exploitation by their employers. Originally set at $0.25, minimum wage has been periodically increased as it is devalued by inflation. From 1997 to July 2007 the federal minimum wage was $5.15, and then increased to $5.85, where it stands today. Workers and economists argue minimum wage does not pay a sufficient amount to stay out of poverty. To supplement the low national minimum wage, 31 states have enacted higher minimum wages, but the remaining 19 states still abide by the nation minimum wage. The federal minimum wage can and should be increased as a tool to reduce poverty and stimulate the economy.

In 2005 the Fair Minimum Wage Act was signed by 15 noble laureates and 650 of their colleagues in favor of raising the minimum wage to $7.25, benefitting the labor market, workers and the economy.

Theoretical Model

Allison Jordan

Initial minimum wage laws were introduced during the 1930s in response to the falling output, falling prices, and falling employment during the Great Depression. The National Industrial Recovery Act (NIRA) tried to help the situation by establishing price floors and minimum wage. In 1935, the US Supreme Court decided that NIRA was unconstitutional, and forced the initial minimum wage agreements to cease. In 1938 the Fair Labor Standards Act (FLSA) established a national minimum wage ($0.25 per hour), restricted child labor, and required that overtime be paid for work over 40 hours per week.

Under the assumptions that (1) the labor market it perfectly competitive, (2) the minimum wage covers all workers, and (3) worker productivity is unaffected by the wage rate, the introduction of a minimum wage results in unemployment in those labor markets in which the equilibrium wage rate is below the minimum wage.

In the model, w* represents the wage equilibrium and L* represents the level of employment. The minimum wage is above the equilibrium, lowering the level of unemployment to LD. The diagram shows that when a minimum wage is implemented, the number of workers demanded is lower than the number of workers supplied, creating unemployment. Many people are against raising the minimum wage, because it would theoretically lead to an increase in unemployment. Recent studies conducted by David Card, Alan B. Krueger, and Lawrence F. Katz have suggested that moderate increases in minimum wage do not have this effect on unemployment.

Monopsony and Efficiency Wage Models

In a monopsony, there is only one buyer that sets the price. Sellers can then choose to sell or not. The buyer will set an artificially low price to maximize utility. A monopsony firm will hire fewer workers than in the perfectly competitive labor market because the marginal factor cost, the cost of hiring an extra worker, exceeds the wage rate. The diagram below shows that an employer will hire the optimal quantity of labor where the firm’s marginal revenue product (MRP) equals the marginal factor cost (MFC).

In a monopsonistic market, a minimum wage brings the supply and demand equilibrium closer to its most efficient levels. Therefore, minimum wage can actually reduce unemployment under this theory. Whether the labor market is actually monopsonistic has been debated, but the argument is a better explanation of labor markets than the supply and demand model.

The theory behind the efficiency model is that if firms pay workers a higher wage, they will be more productive. Higher wages also theoretically result in less labor force turnover, lower training costs, and better motivated workers. Assuming that the rise in productivity is fairly significant, an increase in minimum wage would not reduce unemployment.

New Jersey and Pennsylvania Case Study

Employment Per Store Before and After Rise in New Jersey Minimum Wage

Minimum Wage: A New Look to the Traditional Teaching

David Card and Alan B. Krueger, two leading economists, however, believe that small to moderate increases in the minimum wage will not increase unemployment. These two economists observed the impact of minimum wage on employment by researching 410 fast-food restaurants in New Jersey and Pennsylvania before and after a minimum wage rise. In April of 1992, New Jersey’s minimum wage rose from $4.25 to $5.05, Pennsylvania’s minimum wage remaining constant.

Under the traditional theory, the increase in New Jersey’s minimum wage would predict higher unemployment. The study, on the other hand, suggested that raising the wage floor would in fact open new jobs. Card and Krueger also introduced the idea of wage levels influencing productivity. Higher productivity may offset the increased production costs. The minimum wage increase occurred during a recession in the New Jersey economy. Secondly, New Jersey’s economy is greatly influenced by nearby states due to its small size. However, when minimum wage increased, full-time employment increased in New Jersey relative to Pennsylvania full-time employment.

One reason why employment will increase despite an increase in minimum wages is an increase in full-time workers. As a response to an increase in the minimum wage, stores may increase the proportion of full-time workers. In fact, the fraction of full-time workers increased in New Jersey by 7.3 percent relative to Pennsylvania. Another reason why the rise in minimum wage did not lower employment was a reduction in non-wage compensation. New Jersey employers did not change either their wage profiles or their supplemental benefits to counterbalance the increased minimum wage.

In conclusion, Card and Krueger determined that minimum wage would increase employment regardless of whether one compares a New Jersey store with an initial wage of $5.00, a Pennsylvania store of a constant wage of $4.25, or a New Jersey store with an initial higher wage.

Small Business

Heidi Wissel

Affect of Minimum Wage on Small Business

Economically conservative lawmakers traditionally argue that raising the minimum wage hurts small businesses because they cannot afford to pay higher wages, and therefore are forced to layoff workers, further augmenting poverty. In a study done by the Levy Institute, the vast majority of small business owners interviewed said a raise in minimum wage would not cause them to layoff workers, or decrease the number of new workers they could hire. The Levy Institute interviewed 560 businesses with under 500 workers each, asking them questions about their hiring practices, particularly with regard to a possible increase in the minimum wage. Of those businesses, only 6.2% said a raise in the minimum wage would negatively affect their hiring practices. When the minimum wage was increased in 1997, economists and lawmakers feared there would be significant job losses, but instead it was the best job market in 30 years. This shows the demand for labor is wage inelastic; meaning changes in wages does not affect the amount of labor demanded.

Benefits for Small Business of a Higher Minimum Wage

Higher wages decreases job turn over, especially in less specialized occupations. Workers receiving wages above the federal minimum wage, either because their employer chooses to pay more or they live in a state with higher minimum wage laws, become more committed to the company and therefore are less likely to look for a different job. The decreased job turn over increases productivity and saves the employer the cost of training new workers. Some economists feared this would decrease the growth rate of industries typically paying at or near minimum wage, particularly the retail and food industries. The opposite proved to be true. In Oregon the minimum wage is $7.25, about $1.50 above the national wage. The job growth rate in Oregon is twice that of the national average, demonstrating higher wages are beneficial to worker and the employer.

The main problem with the current minimum wage

The Problem with the current Minimum wage is that it has failed to keep up with inflation and rising cost of living. This means that over time the purchasing power of the minimum wage has decrease. The current minimum wage is not longer enough to keep working families from meeting their most basic needs such as cost of housing and food, health care, education and child care. According to Economist Jared Bernstein from the Economic Policy Institute the cost of basic necessities has increase by almost 50% between 1991 and 2007. As a result low income families are stock in poverty and the income gap between the low and high class is continuously increasing.

The federal poverty guideline released in 2007 shows that the minimum wage is insufficient. A minimum wage worker that works full time: 40 hours a week, 52 weeks a year will only earn about $12,000 annually. This means that at the current minimum wage, a full time worker earns 40% below the poverty guideline. The established federal poverty guideline for a family of three is approximately $17,000

The graph illustrates the gap between the salary of a full time minimum wage worker and the 2007 poverty guidelines

The minimum wage was not raised since 1997, not until another eight years. This was the longest period of congress inaction since the minimum wage was established by the Fair Labor Standards Act in 1938. For every year that congress did not increase the minimum wage, workers lost purchasing power. As a result minimum wage workers live in poverty.

Facts about the Minimum Wage

1)The current minimum wage is insufficient for low income workers and families to meet basic needs.

2)High costs of living, places families that earn the minimum wage, below the federal poverty level. As a result tax payers have to pay more for public assistance.

3)A person who earns the minimum wage and works full time (40 hrs/week, 52 weeks/yr) only earns about $12,000 a year. This is almost $5,000 below the poverty line for a family of three ($17,000).

4)The federal minimum wage did not increase in almost eight years, from 1997-2005. The minimum wage did not keep up with the inflation rate and raising costs of living.

5)Cost of basic necessities such as food, clothing, housing, health care, education and fuel have raise significantly. The minimum wage has not kept up with inflation.

Benefits of increasing the minimum wage

1)Raising the minimum wage can increase the annual income of working families and aid families to get out of poverty.

2)Raising the minimum wage will create a “ripple effect” by benefiting those workers who earned more than the previous minimum wage but less than the new minimum wage. Employers will pay these workers a higher wage to keep compensation differences among workers.

3)Raising the minimum wage increases spending. With a higher minimum wage consumers would be more likely to spend more, which in turn puts money back into the economy.

Economists In Support

In October of 2006 the Economic Policy Institute (EPI) released a statement entitled, “Hundreds of Economists Say: Raise the Minimum Wage”. Fifteen leading economists, that is, Henry Aaron, Kenneth Arrow, William Baumol, Rebecca Blank, Alan Blinder, Peter Diamond, Ronald Ehrenberg, Clive Granger, Lawrence Katz, Lawrence Klein, Frank Levy, Lawrence Mishel, Alice Rivlin, Robert Solow, and Joseph Stiglitz, endorsed the statement. Not only do these 15 individuals endorse an increase in minimum wage, but 650 of their fellow economists agree. By signing the statement the economists believe that “a modest increase in the minimum wage would improve the well-being of low-wage workers and would not have the adverse effects that critics have claimed. As economists who are concerned about the problems facing low-wage workers, we believe the Fair Minimum Wage Act of 2005’s proposed phased-in increase in the federal minimum wage to $7.25 falls well within the range of options where the benefits to the labor market, workers, and the overall economy would be positive.”

650 Fellow Economists

Katherine G. Abraham University of Maryland Frank Ackerman Tufts University F. Gerard Adams Northeastern University Randy Albelda University of Massachusetts - Boston James Albrecht Georgetown University Jennifer Alix-Garcia University of Montana Sylvia A. Allegretto Economic Policy Institute Abbas Alnasrawi University of Vermont Gar Alperovitz University of Maryland - College Park Joseph Altonji Yale University Nurul Aman University of Massachusetts - Boston Teresa L. Amott Hobart and William Smith Colleges Alice Amsden Massachusetts Institute of Technology Bernard E. Anderson University of Pennsylvania Robert M. Anderson University of California - Berkeley Bahreinian Aniss California State University - Sacramento Kate Antonovics University of California - San Diego Eileen Appelbaum Rutgers University David D. Arsen Michigan State University Michael Ash University of Massachusetts- Amherst Glen Atkinson University of Nevada - Reno Rose-Marie Avin University of Wisconsin M.V. Lee Badgett University of Massachusetts-Amherst Aniss Bahreinian Sacramento City College Ron Baiman Loyola University Chicago Asatar Bair City College of San Francisco Katie Baird University of Washington - Tacoma Dean Baker Center for Economic and Policy Research Radhika Balakrishnan Marymount Manhattan College Erol Balkan Hamilton College Jennifer Ball Washburn University Brad Barham University of Wisconsin - Madison Drucilla K. Barker Hollins College David Barkin Universidad Autonoma Metropolitana James N. Baron Yale University Chuck Barone Dickinson College Christopher B. Barrett Cornell University Richard Barrett University of Montana Francis M. Bator Harvard University Rosemary Batt Cornell University Sandy Baum Skidmore College Amanda Bayer Swarthmore College Sohrab Behdad Denison University Peter F. Bell State University of New York Dale L. Belman Michigan State University Michael Belzer Wayne State University Lourdes Beneria Cornell University Barbara R. Bergmann American University and University of Maryland Eli Berman University of California - San Diego Alexandra Bernasek Colorado State University Jared Bernstein Economic Policy Institute Michael Bernstein University of California - San Diego Charles L. Betsey Howard University David M. Betson University of Notre Dame Carole Biewener Simmons College Sherrilyn Billger Illinois State University Richard E. Bilsborrow University of North Carolina - Chapel Hill Cyrus Bina University of Minnesota - Morris Melissa Binder University of New Mexico L. Josh Bivens Economic Policy Institute, Stanley Black University of North Carolina Margaret Blair Vanderbilt University Law School Gail Blattenberger University of Utah Robert A. Blecker American University Barry Bluestone Northeastern University Peter Bohmer Evergreen State College David Boldt State University of West Georgia Roger E. Bolton Williams College James F. 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Bush California State University - Fresno Alison Butler Wilamette University Antonio G. Callari Franklin and Marshall College Al Campbell University of Utah James Campen University of Massachusetts - Boston Maria Cancian University of Wisconsin - Madison Paul Cantor Norwalk Community College Anthony Carnevale National Center on Education and the Economy Jeffrey P. Carpenter Middlebury College Francoise Carre University of Massachusetts - Boston Michael J. Carter University of Massachusetts - Lowell Susan B. Carter University of California - Riverside Karl E. Case Wellesley College J. Dennis Chasse State University of New York - Brockport Howard Chernick Hunter College, City University of New York Robert Cherry Brooklyn College - City University of New York Graciela Chichilnisky Columbia University Lawrence Chimerine Radnor International Consulting, Inc. Menzie D. Chinn University of Wisconsin - Madison Charles R. 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