By executive order, President Barack Obama recently raised the minimum wage to $10.10 per hour for workers in federal employment and for those employed by private firms under contract with the federal government. Moreover, the president supports the Harkin-Miller bill, which would extend this minimum to the national labor market.
Opponents warn that such an increase in the price of labor will lead to increased unemployment and poverty, hurting those the policy is targeted to help.
The claim that jobs will be lost comes from the inverse relationship between price and the amount of goods and services that people want to buy. This inverse relationship is so commonly observed that it is often referred to as the "law of demand." But does this frequently observed "law" describe the demand for labor? How have employers reacted to past increases in the minimum wage? Did they move jobs out of the country? Did they substitute robots for their workers? Did they simply accept somewhat lower profits?
Researchers analyzing past increases in the minimum wage found that on average the reduction in employment was "inelastic," that is, cutbacks in employment were not large. The primary impact of past minimum wage increases was to raise worker income; the decrease in jobs was very small. The Congressional Budget Office recently issued a report showing that for every job reduced by the proposed increase, there would be 30 people with higher incomes.
Even this small estimate has come under fire from economists who note that the studies conducted since 2000, using the most up-to-date methodology and employing more complete data sets, show dis-employment at about half that rate.
To understand why the impact on employment is estimated to be so small, we need only to examine why workers are hired in the first place. They are hired because they produce a net gain for the employer — a positive difference between the value of their productivity and the wage they are paid.
Since 1980, labor productivity has risen faster than inflation while the minimum wage has risen only by adjustments somewhat less than inflation. Consequently, a large gap has grown in the labor market between the value of worker productivity and wages.
If employers calculate that an increase in the minimum wage narrows this gap, but does not eliminate it, they can capture the remaining net gain by retaining their workers. Conversely, if their calculations show that the value of worker productivity is less than this new wage, workers will be let go.
Consider the following: If the value of a worker's productivity is $20 an hour and the wage is $7.25, the gap is $12.75. If the minimum wage were raised to $10.10, the remaining profit differential ($9.90) is still substantial. Therefore, the employer has an incentive to retain the worker despite the higher wage.
On the other hand, if the value of a worker's productivity is only $9, then the new minimum wage of $10.10 would result in a net loss for the employer and that worker would be let go. It is this latter eventuality that the statisticians are finding to be relatively rare.
With more take-home pay after a wage increase, minimum wage earners are able to spend more in their low-income neighborhoods, enhancing the local economy and improving employment prospects there.
The higher wage enables workers to lead less desperate lives, as they more easily pay the rent, put food on the table, seek medical care and afford transportation. This is not just a benefit for the worker, but can also lead to a benefit for employers as their workers are healthier and more productive, helping to offset the higher hourly wage.
William L. Holahan is emeritus professor of economics at the University of Wisconsin at Milwaukee. Charles O. Kroncke, retired dean of the College of Business at UW-M, is also retired from USF. They are co-authors of "Economics for Voters." They wrote this exclusively for the Tampa Bay Times.