Minimum Wage: Good Cause Or Economic Pariah?

By Matt Cavallaro | January 17, 2012 AAA
Minimum Wage: Good Cause Or Economic Pariah?

Lauded by progressives and rejected by most economists, minimum wage laws are somewhat of a hot button topic. Does the social cause of fighting for a livable wage make up for the negative impact that economic theory states minimum wage imposes?

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A Brief History
It can be beneficial to understand the origins of minimum wage laws. Federal minimum wage laws have been around for over a hundred years. New Zealand and Australia were the first countries to enact a national minimum wage, followed in the early 20th century by Britain and the United States.

In the U.S., President Franklin Roosevelt spearheaded the federal charge for the Fair Labor Standards Act (FLSA) that was passed in 1938. The law mandated a minimum 25-cent-per-hour wage, in addition to setting the maximum amount of hours most employees could work per week at 44. Interestingly enough, the Supreme Court struck down a Washington, D.C. minimum wage law in 1923. The court decided it was actually unfair to workers since they would not be able to set a value for their own labor.

Many countries have minimum wage laws, and some have historically relied on binding collective bargaining, rather than legislation. Over time, labor unions have been one of the strongest proponents of fighting for increases in the minimum wage.

Having been woven into the fabric of modern society, minimum wage impacts a large percentage of the workforce. As of early 2012, about 70% of the 1.4 million minimum wage earners in the U.S. are full-time workers, according to the Economic Policy Institute. The first U.S. minimum wage increase in over a decade was passed in 2007, raising the minimum wage from $5.25 to the current rate of $7.25 per hour. (For more on increases done by other countries, check out 7 Years Raising The Minimum Wage.)

The Case for Minimum Wage
Advocates support the minimum wage primarily because of market mechanisms that produce drastic income inequality and the social motive to help those that need it the most. Specifically, minimum wage is seen as a tool to fight poverty and provide a way for workers in low-earning jobs to have a self-sustainable standard of living.

Additionally, it is believed that a sustainable minimum wage reduces the cost of social welfare programs that might otherwise have to assist low-income workers, and that these individuals are dissuaded from potentially engaging in illegal activities (theft, selling drugs) that reduce aggregate economic progress.

It can also be argued that setting a labor wage floor also enhances work ethic, because employers demand greater productivity from employees who cost more than the market would pay for their labor in the absence of minimum wage laws. Productivity is seen as being augmented even further because some low-paying jobs are eliminated, forcing the low-income workforce to train for more skilled, higher-paying positions.

The Argument Against Minimum Wage
The moral cause for minimum wage is strong. Yet many economists believe that minimum wage mandates are actually harmful to workers. They believe that artificial wage setting prevents market mechanisms from finding equilibrium, and that influences total employment, wages and productivity.

The economics for this case is actually rather simple. By placing a floor below the equilibrium wage (the rate that would naturally be set by market forces), the supply of labor increases (more workers want the higher pay) while the demand for labor decreases (fewer employers can pay the higher rate, and so they offer less jobs). Total employment is effectively reduced.

Another argument against minimum wage is that several other inefficiencies are created, such as:

  • Large businesses are able to absorb higher wage costs better than small businesses, creating an uneven playing field.
  • It excludes low-skilled labor and young, inexperienced youth from joining the workforce.
  • A firm's ability to weather downturns by lowering costs (e.g. labor) is marginalized.
  • Inflationary pressures may increase as producers try to pass through higher costs.
  • The potential for more unemployment increases governmental expenditures (welfare programs). This may increase tax rates needed to fund the additional welfare costs. Higher tax rates have their own unique economic consequences.

The net result is that potential economic activity is reduced. This disproportionately impacts low-income workers, the very same group that minimum wage laws are designed to protect. Moreover, some argue that other methods, such as the earned income tax credit, are more effective at fighting poverty. (To read more on the cases for and against minimum wage, see The Minimum Wage: Does It Matter?)

The Bottom Line
Despite the established economic theory, there is still some active debate regarding the consequences of minimum wage laws. The rate at which the minimum wage is set is another controversial aspect. Obviously, those who oppose it believe minimum wage should not be in place at all. On the other hand, proponents believe it is so low that these workers cannot earn a sustainable living.

Setting a rate that provides workers with a sustainable wage, while minimizing the impact on unemployment, requires a delicate balancing act. Key indicators used in establishing the rate include historical wage rates within the country, relevant standards of living, GDP, inflation expectations, the supply and demand for labor, labor costs and other operating costs.

At the end of the day, it is almost certainly not politically viable for minimum wage opponents to successful advocate the legislative removal of the minimum wage. The practical debate is whether the current rate should be maintained or increased. During his election campaign, President Obama pledged to fight for a minimum wage increase to $9.50 an hour by 2011, index it to inflation and increase the Earned Income Tax Credit. We can safely assume that most Republicans candidates running for President support such a measure. Where do you stand?

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