Minimum Wage: An Economist's Perspective

Tim Murray, PhD, MBA is an Assistant Professor of Economics at Virginia Military Institute. He got his PhD from the University of Connecticut and MBA from Old Dominion University. His specialty is in labor and health economics. All views are his own and do not reflect that of the Institute.    Email: tim.murray54@gmail.com

Tim Murray, PhD, MBA is an Assistant Professor of Economics at Virginia Military Institute. He got his PhD from the University of Connecticut and MBA from Old Dominion University. His specialty is in labor and health economics. All views are his own and do not reflect that of the Institute.

Email: tim.murray54@gmail.com

In recent years, “living wage” has become a popular phrase among politicians when discussing minimum wage. Depending on which side of the political aisle you fall on, opinions often vary as to its effectiveness.  This is true among economists as well.  Wages are an important issue and are likely to be widely discussed in the 2020 election.  It is critical that we consider minimum wage from an economist’s perspective when discussing this issue. 

What is minimum wage?

In economics, we think of wages as the price that a company must pay you for your labor.  Each person has a wage they would be willing to accept for their labor, often based on education, skills, and experience.  Each industry has its own labor market where companies need a specific type of worker and workers of that skillset seek those jobs.

For jobs that have higher qualifications – higher degrees, more experience, or specific skills – the wage reflects this because there are fewer workers who meet those qualifications. For lower skilled jobs, the wages are often lower as a greater number of people can fill those positions.

Minimum wage laws exist so that companies in the lowest skilled sectors provide a “decent” wage to its employees.  What “decent” means is the debate we are having now.

What does economic theory say about minimum wage?

Any college freshman economics class will teach that minimum wage is shown as a distortion to the labor market.  Minimum wage sets the “price” for some lower skilled jobs above what the market would naturally pay.  The higher wage brings more people to the low-skill market and companies search for fewer workers due to the higher wage.  A minimum wage leads to more workers seeking work in the low-skill sector and fewer jobs available.  As a result, there is an increase in unemployment.

What do we see in practice about minimum wage increases?

In practice, there is large debate as to the effectiveness of minimum wage.  Some studies show that minimum wage increases lead to an increase in unemployment among low-skill workers and others show no change in unemployment.  However, many of these studies analyze the impact of small changes in the minimum wage on unemployment.  The current push for a $15 minimum wage would be a substantial increase, and thus, is not reflected in the results of those studies.

Perhaps a 2017 study that analyzes Seattle’s minimum wage increases in 2015 and 2016 from $9.47 to $13 per hour can provide insight into what might be expected.  It finds that the increases in minimum wage in Seattle to $13 per hour resulted in 5,000 jobs lost and a 6.9% reduction in hours worked for those earning under $20 per hour.  The average worker gained $56 per month due to the increase in the minimum wage but saw their pay decline by $130 a month due to decrease in hours, a net decrease in $74 per month.

While this is just one study of one example and it may not be representative of what large minimum wage increases may look like in other parts of the country, there may be a need to revisit what the goal of minimum wage is and if there are alternatives to it. 

What should the goal of minimum wage be, and can we achieve it other ways?

Ultimately when politicians discuss a “living wage” and minimum wage increases, they are talking about income inequality.  

In the United States, income for the top 20% of earners has risen substantially compared to the rest of the population over the last 40 years. Workers in low-skill and low-wage jobs have not been rewarded with higher pay as productivity has increased, which often makes it difficult for people in these sectors to be able to make enough money from that single job to support themselves or their family.  Too much income inequality can lead to social unrest as workers don’t feel like they can advance and increase their wealth with hard work.  Too little income inequality does not incentivize workers to work hard because there is not reward of higher income.  There is a balance in the middle that promotes a growing middle class and strong economy.  Workers in the low-skill and low-wage sector need to feel like they can move up and better their situation.  This is where the need for a “living wage” is important.  Not being able to afford the basic necessities does not give this group of workers the hope that they can improve their situation.

However, raising the minimum wage may not necessarily be the only or the best way to help this group. According to the Bureau of Labor Statistics, the percent of workers who make at or below minimum wage was 2.1% of hourly workers in 2018.  These workers tend to be under the age of 25 and work in the food and hospitality industry.  Many workers who make minimum wage do not live in households that are below the poverty level and are second incomes to a middle-class family.  Therefore, raising the minimum wage may not actually target the low-skill and low-wage sector.  A worker may make $12 and hour, which is above the minimum wage, but that may not be enough to provide for themselves or their family. 

If what happened in Seattle holds for other states as we discuss raising the minimum wage to $15 per hour, then this group of workers may not necessarily see the benefits to their total yearly income.  Because of this, an alternative proposal to help provide low-skilled and low-wage workers a true “living wage” is to expand the Earned Income Tax Credit (EITC).  The EITC is a tax credit to working low-income households.  The EITC can be expanded to ensure that full-time workers have enough money that would constitute a “living wage.”  It could be phased out so that the lowest income earners get more and as a worker’s income rises the amount, they receive from the EITC declines up to a specific threshold.  There is evidence to suggest that increases in the EITC will put more money in the hands of the low-income households and households below the poverty level than increases in the minimum wage would since not all minimum wage earners live in low-income households. 

As we look to improve income inequality in the United States and ensure all workers can afford the necessities to live, we should be open to all policy options.  Minimum wage increases can be effective but there are also other plausible policy alternatives that may also work and should be discussed and welcomed by politicians across the political spectrum. Holding on to a belief for or against a specific policy based on its political affiliation is not a path towards crafting good policy.  As America looks to tackle this issue, we should entertain alternatives to increasing the minimum wage to provide workers a living wage.  The goal is reducing income inequality and ensure hard working American’s make enough money to cover their living expenses.  We should put forth the best possible policies to achieve and consider economic theory as we proceed.