America s Minimum Wage!

Transcription

1 America s Minimum Wage How much, how soon how effective? The case for a moderately increased federal minimum wage with the potential for a better solution Nick Caggiano ENGL 138T Professor Kyle King

2 2 TABLE OF CONTENTS INTRODUCTION... 3 A History of Minimum Wage in the United States... 4 A Changing Argument... 5 TODAY S MINIMUM WAGE RATE DISCUSSION... 6 The Classical Economic Model... 6 Problems with the Classical Model A More Complex Analysis: CBO Report A POSSIBLE SOLUTION The Federal Minimum Wage Rate Should Be Raised Is Adjusting the Federal Minimum Wage Rate Effective? Conclusions References... 22

3 INTRODUCTION 3 INTRODUCTION In January 2014, President Barack Obama issued an executive order raising the minimum wage for federal contract workers to $10.10 per hour, effective in However, the scope of this order is limited, and President Obama and other lawmakers are now pushing to achieve a $10.10 federal minimum wage rate, which applies to all workers in the United States, an increase from its current rate of $7.25 reached in 2009 as a result of the Fair Minimum Wage Act of , 3 Proponents of a minimum wage hike offer varying specifics, from the minimalist $9.00 initially proposed by President Obama in his 2014 State of the Union address, 4 to a $22.00 rate supported by Massachusetts Senator Elizabeth Warren that would correlate the minimum wage with worker productivity, which has increased greatly since a minimum wage was first instituted in the United States. 5 In August 2013, several thousand fast food workers organized one-day protests in seven cities across the United States to demand a $15 hourly wage, maintaining that $7.25 is not enough to live on. 6 The argument for a living wage is the basis for many arguments in favor of increasing the minimum wage. A full-time (40 hours per week) minimum wage worker will receive an annual salary of $15,080. According to the US Census Bureau, that amount is enough to support a single person, for which the poverty threshold is $12,119, but not enough to support a household with one adult and one child, for which the poverty threshold is $16,057. 7

4 INTRODUCTION 4 Some opponents, however, maintain that the minimum wage jobs are not intended to be full-time, primary positions in the first place. Arguments against a raise in the minimum wage are mostly based on the belief that an increase in the minimum wage will in fact not benefit as many workers as supporters claim and instead lead to an overall decrease in employment as businesses react to the increased cost of labor, thus making workers who retain their jobs slightly better off while many others are laid off. 8 As the discussion of minimum wage legislation gains momentum, it seems inevitable that the issue will be addressed with legislative action in the near future. And while President Obama declares, It s time to give America a raise, the time and the raise are still up in the air. It is a complex economic issue with many variables to be considered, with one critical question: What effect will a raise in the federal minimum wage rate actually have on the United States economy? A History of Minimum Wage in the United States America s legislative commitment to its laborers on a national scale came to fruition in the form of the Fair Labor Standards Act of 1938, passed by President Franklin D. Roosevelt as part of his New Deal initiatives after the Great Depression. 9 At the time of its passage, it stipulated an initial federal minimum hourly wage rate of $0.25, with scheduled increases on an established timetable. After several amendments to the law over the ensuing years, the minimum hourly wage rate has increased faster than the rate of inflation, reaching its current rate of $7.25 per hour in Many states and municipalities, however, have independently established minimum wage rates higher

5 INTRODUCTION 5 than the national rate; Washington state currently has the highest state rate ($9.32 per hour), 11 while the city of San Francisco leads the nation with a minimum wage rate of $ A Changing Argument The economic and societal effects of establishing such a minimum wage have been long discussed and debated by politicians, economists, and citizens alike. However, before discussion reached the potential societal and economic implications, minimum wage legislation had to make it past a more formidable obstacle: the US Supreme Court. Prior to 1938, states had attempted to enact minimum wage regulations, specifically for the benefit and protection laborers (especially women and children), who often faced extremely long hours with few breaks and low pay. Supreme Court cases such as Adkins v. Children's Hospital (1923) and Morehead v. New York ex rel. Tipaldo (1936) repeatedly concluded that neither states nor the federal government had the power to impose minimum wage regulation on business owners. 13, 14, 15 After many months in Congress, the Fair Labor Standards Act of 1938 finally passed with the urging of President Roosevelt, and the Supreme Court had also begun to soften to the idea of a national minimum wage. In contrast, today s discussion of minimum wage legislation, now accepting of the federal government s authority to institute such legislation, is more grounded in the economic effects associated with wage rate regulation in essence, is raising the minimum wage rate beneficial to the state of the economy and the welfare of laborers?

6 TODAY S MINIMUM WAGE RATE DISCUSSION 6 Due to the variable nature of economics as a social science, multiple conflicting conclusions have arisen from the analysis of the situation through a variety of economics models and assumptions. On one side of the spectrum a theory proposes that any increase in the minimum wage rate will also increase the unemployment rate, thus benefitting only those who retain their jobs as business owners respond to the increased wage rate by reducing the quantity of labor they contract. As a result, the increase in the minimum wage rate will have an overall negative effect on the economy as a whole, as some workers increase their income while others earn no wage. At the opposite end of the spectrum a counter argument maintains that the overall increase in unemployment is negligible and therefore an increase in the minimum wage rate will have an overall positive effect on the economy and on society. Still other viewpoints are based not on the unemployment argument but on the competition between unskilled and skilled laborers. TODAY S MINIMUM WAGE RATE DISCUSSION The Classical Economic Model A foundation of any course in economics includes the laws of supply and demand. These laws provide a method for analyzing and predicting the behavior of an economic market. In the context of the labor market, they can be stated as follows: 1. The quantity of labor supplied (the number of workers that are willing to work for a given price) will increase as the wage rate increases and will decrease as the

7 TODAY S MINIMUM WAGE RATE DISCUSSION 7 2. wage rate decreases. That is, more people are willing to work for higher wages, and fewer people are willing to work for lower wages. 3. In contrast, the quantity of labor demanded (the amount of labor hired by firms) will decrease as the wage rate increases and will increase as the wage rate decreases. That is, as the cost of labor increases, employers will hire fewer workers as a result of the increased cost. Conversely, they will hire more workers if at a lower cost. The outcome of this predicted behavior of the buyers (employers) and sellers (laborers) is that the market will settle to a wage rate where the employers and laborers effectively meet in the middle. This is called the market equilibrium, which can be represented by the following graph (Figure 1). Figure 1. The Labor Market (Classical Model) 16 In Figure 1, a graph of the labor market, the horizontal axis measures the quantity of labor, while the vertical axis measures the wage rate. The Labor Supply is the green, upwards sloping line, while the Labor Demand is the blue, downwards sloping line. The

8 TODAY S MINIMUM WAGE RATE DISCUSSION 8 behavior of the supply and demand curves obeys the laws previously described the quantity of labor demanded increases as the wage rate decreases, and the quantity of labor supplied increases as the wage rate increases. Where the two lines intersect, denoted by the red dashed line, represents the market equilibrium. At this point, the wage rate is at a level where the employers want to hire the exact number of laborers at that price as the number of laborers who want to work at that price. This wage rate is labeled W*, and the quantity of labor supplied/demanded is labeled L*. These values are theoretical values in our model; the actual wage rate and quantity of labor are dependent on the specific market being modeled. However, it is important to note the concept of the model and that it can theoretically be applied to any labor market (we ll get into the details later). But now let s delve into the big question: what will happen to the classical model when a minimum wage is imposed? Let s investigate what will happen with another graph. Figure 2. The Labor Market (Classical Model) with Minimum Wage 17

9 TODAY S MINIMUM WAGE RATE DISCUSSION 9 Figure 2 represents the same model as displayed in Figure 1, only this time a minimum wage has imposed on the market, presumably by a regulating authority such as a federal, state, or local government. This horizontal dashed line represents the level below which the wage rate is not legally allowed to fall. However, as can be seen on the graph, the employers and workers have been prevented from reaching the free market wage (the market equilibrium). There is a discrepancy between the quantity of labor demanded and the quantity of labor supplied. Why does this occur? According to our laws of supply and demand, employers will want to hire fewer workers at the higher wage rate (quantity demanded). However, at the same time a greater number of laborers want to work for the higher wage (quantity supplied). It is important to note that because businesses are freely allowed to decide how the quantity of labor they hire, only the quantity of labor demanded by the firms will be hired. Thus, some laborers who would like to work at the higher minimum wage rate will ultimately not be hired. The difference between the quantity demanded and the quantity supplied represents the number of unemployed workers in the market. Hence, in our classical model, we have seen that imposing a minimum wage on the market has made some workers better off at the expense of rendering other workers unemployed fewer are hired, but those who are hired receive a higher wage (the minimum wage). Herein lies the basis for one of the principal arguments against raising the minimum wage the belief that a higher price of labor will decrease the quantity of labor hired by businesses, thus leading to layoffs and increased unemployment across the nation. 18 But how do we actually know that will happen? Is there something our classical model is missing?

10 TODAY S MINIMUM WAGE RATE DISCUSSION 10 Problems with the Classical Model A closer analysis of the classical model we have just investigated reveals that while it is an effective depiction of a labor market for study in an introductory course on economics, it is not the best picture of an immense nationwide market for labor the US economy is more complex than two intersecting lines. A major caveat of the model is that it relies on several major assumptions about the labor market because it models a perfectly competitive labor market, which carries strong implications regarding market behavior. One such assumption is that no firm (employer) has any market power. In other words, no single employer has enough power to have any influence over the wage rate the market will settle into an equilibrium, a process driven by economic forces that cannot be stopped by any one entity. The conclusion that follows is that all firms are wage-takers. Since no firm has any power to influence the wage rate, it must hire laborers at the equilibrium price dictated by the market. This critical assumption does not hold in a real market such as the US labor market. Large firms do exists for example Walmart and McDonalds that hire vast quantities of low-wage labor. Walmart alone has 1.3 million employees in the United States alone (2.2 million globally). 19 Such firms that employ millions of workers cannot simply be assumed to have no effect on the market. If a large firm such as Walmart were to raise its wage rate to, say, $12/hour, it is likely that many workers with $7.25 hourly wages might seek employment at Walmart instead. A dramatic move by a large firm will likely have an effect on the labor market as a whole, as in this case it may prompt other employers to raise their wage rates to compete with Walmart (otherwise no one would want to work at those other businesses at such a low rate). Therein the second part of the assumption has been invalidated as

11 TODAY S MINIMUM WAGE RATE DISCUSSION 11 well Walmart, and any other employer has the power to change the wage rate it pays to its employees (as long as it is not below the federal minimum wage). However, firms are smart; they won t raise their wage rates since a) it would voluntarily decrease profits, and b) they realize that any change they make will influence the market as a whole and therefore eliminate any competitive advantage that is temporarily created. Another major assumption of the perfectly competitive labor market is the absence of frictional forces, 20 forces which do exist in the real economy. Frictional forces are forces that keep laborers in their current jobs. For example, the process of quitting a current job, sending out applications to other employers, the uncertainty that the laborer will in fact find another job, and the lost wages in the transitional period are all factors that tend to keep workers in their current positions. The classical model, since it assumes that these forces do not exist, would thereby predict that if Walmart increased their wages by even one penny, all laborers would flock to Walmart from their current positions. This is simply not the case; it is unlikely that a worker at the Burger King down the street will quit his job for the extra penny an hour. Now of course if Walmart were to increase its wage rate to $12/hour as previously mentioned, that large increase could overcome the frictional forces acting on laborers, as the benefit of a much higher wage offsets the cost of the job transition. A More Complex Analysis: CBO Report The classical, perfectively competitive model is a good starting point, but the multitude of variables in the US labor market makes it difficult to pin down the expected market

12 TODAY S MINIMUM WAGE RATE DISCUSSION 12 behavior. A typical economics textbook will provide values for the Labor Supply and Labor Demand curves, which will enable the market equilibrium as well as expected unemployment to be calculated. In the real world, determining the exact market supply and demand is near impossible, and yet it is the very shape of those curves that will determine the equilibrium wage rate and quantity, as well as the magnitude of the expected unemployment resulting from a minimum wage. Every business behaves differently, and each will respond differently to a rise in the price of labor in an effort to preserve its bottom line. A firm that employs a large quantity of low-wage laborers and for which the cost of labor is a large percentage of its total costs will be affected more by a wage increase than a firm that employs a relatively small quantity of laborers. The large firm must increase the wage of thousands or millions of workers, a large cost that the firm may not be able to absorb, thus prompting the layoff of some workers. However, simply reducing the number of laborers employed is not the action a firm can take to react to an increased minimum wage rate. Firms may lower costs by reducing worker benefits such as health insurance, pensions or free meals, by substituting other inputs in place of labor (i.e. replacing or supplementing humans with automatic machines), by reducing the hours of workers, by reducing the operational hours of the business and/or its production output, or by passing on the increased costs to consumers by raising the price of its goods and services. 21 The decisions a firm makes depend on a variety of factors, such as its financial structure, the type of goods or services it provides, as well as the market to which it sells its products. In fact, the behavior of the consumers who buy a company s products can have a significant effect

13 TODAY S MINIMUM WAGE RATE DISCUSSION 13 on the firm s response to an increased minimum wage. If consumers will respond to a slight price increase on a particular product by greatly reducing the quantity they buy called elastic demand the firm won t be able to pass as much of the increased cost of labor to the consumer for fear of losing its market. The firm may therefore be more prone to layoff workers. However, if the amount of the good purchased by consumers changes little as a result of a price change called inelastic demand the firm may raise the price of its product without impacting its sales, thus reducing the need for layoffs. With the large number of variables and unknowns all contributing to the overall economic effect of minimum wage policy, it is evident that a more complex analysis is needed to predict the outcome of a minimum wage hike. That is where the Congressional Budget Office (CBO) comes in. The CBO has access to a vast amount of United States economic data years of data for all economic sectors and for the economy as a whole. In a February 2014 report entitled The Effects of a Minimum- Wage Increase on Employment and Family Income, the CBO published its findings on the effects of a potential federal minimum wage increase. The report analyzed two potential options for such an increase: 1. $10.10 option - Increase the federal minimum wage in three increments (in 2014, 2015, and 2016), and upon reaching $10.10 in 2016 the rate would be indexed annually to the consumer price index to account for inflation.

14 TODAY S MINIMUM WAGE RATE DISCUSSION $9.00 option - Increase the federal minimum wage in two increments (in 2015 and 2016), and upon reaching $9.00 in 2016 the rate would not be indexed to the consumer price index. An important different between the two options is not only the dollar amounts but that the $10.10 option also stipulates that the minimum wage would increase every year to account for inflation, which continuously erodes the value of the US dollar at a typical rate of 1 to 2 percent annually. The consumer price index is the statistic used to measure the rate of inflation, so linking the minimum wage to this index would preserve the value, or purchasing power, of the minimum wage over time. This is a significant departure from historical precedent although lawmakers in the past have enacted bills with scheduled increases in the minimum wage for future years, never before has the federal minimum wage rate been directly linked to the rate of inflation to allow for an automatic yearly increase in the rate. In the end, the CBO report concluded that raising the federal minimum wage would probably result in a reduction of employment across the economy, but not on the large scale suggested by opponents of a minimum wage hike. CBO estimated that the $10.10 option would cause a loss of around 500,000 workers, or 0.3% of the labor force, and raise 900,000 people above the poverty threshold, whereas the $9.00 option would cause a loss of around 100,000 workers, 0.1% of the labor force, and raise 300,000 people above the poverty threshold. However, due to the inherent uncertainty in the estimation process and in predicting the effect on such a large economy, CBO also

15 A POSSIBLE SOLUTION 15 included a probability range for the employment prediction: a two-thirds chance that the $10.10 option would cause a very slight decrease to a reduction of 1 million workers and a two-thirds chance that the $9.00 option would cause a very slight decrease to a reduction of 200,000 workers. A POSSIBLE SOLUTION We have looked at differing viewpoints in the discussion of federal minimum wage rate reform, and we have now delved into the economic analysis of such reform. The ultimate decision, however, remains: What should we do? Here one possible course of action to address the United States minimum wage discussion will be presented, but ultimately minimum wage policy has the potential to take on a variety of forms before lawmakers can agree on a final approach. The Federal Minimum Wage Rate Should Be Raised The federal minimum wage rate should be raised gradually and it should be indexed to the consumer price index so that it automatically increases with inflation on an annual basis. The CBO report indicates that a greater increase in the minimum wage (the $10.10 option) will lift more people above the poverty threshold and will increase the wages of more workers than the $9.00 option (which is logical considering that there are more workers receiving less than $10.10/hour than workers receiving less than $9.00/ hour). However, this would occur with a greater predicted loss of jobs as much as an

16 A POSSIBLE SOLUTION 16 estimated 1 million for the $10.10 option as compared to up to 200,000 for the $9.00, although no one can say for sure. So which one should lawmakers choose? The Fair Minimum Wage Act of 2007 increased the federal minimum wage rate incrementally from $5.15, ending at $7.25 effective July 24, In the years since 2009, however, inflation has eroded the buying power of that $7.25; it would take $7.99 in 2014 dollars to match the value of $7.25 in 2009 dollars. 22 In order to preserve the value of $7.25 in 2009, assuming a high rate of inflation of 3% annually, the minimum wage rate would have to be set at $8.48 in 2016, an amount that is more closely in alignment with the $9.00 option considered in the CBO report (which would reach $9.00 in 2016). The $9.00 option could be a viable route of action after one modification: indexing to the consumer price index to adjust for future inflation. A rate of $9.00 preserves the value of the last minimum wage change and adds an additional $0.50 or so on top. However, without future adjustment for inflation the value of the wage will simply decrease again, as it has after all prior minimum wage increases. If the federal minimum wage seeks to preserve the welfare of low-wage workers, it at least needs to preserve the value of the wage over time. A once annual adjustment for inflation, which could amount to a roughly $0.25 increase per year under 3% inflation, would preserve the real value of the wage while also potentially eliminating the need to reconsider the minimum wage rate repeatedly.

17 A POSSIBLE SOLUTION 17 Another key feature of the $9.00 option (and any minimum wage increase) is to increase the minimum gradually to $8.10 on July 1, 2015 and $9.00 a year thereafter. This gradual increase is important for businesses, because budget and resource planning takes time. While low-wage workers should receive a wage, businesses should also be granted ample time to plan for rising costs and to determine their own actions. A sharp increase in the minimum wage too fast could cause firms to layoff even more workers due, as that is one of the easiest ways to reduce operating costs quickly. However, if a business has more time to determine how best to compensate for the increased price of labor, it may be able to retain for workers in the long run. Firms would also be able to plan better for future increases as the rate is adjusted for inflation, as each incremental change would likely be in the neighborhood of a quarter per hour, and firms would be able to anticipate that annual change. Advocates for a federal minimum wage of $10.10 (or more) could be dissatisfied with such a compromise, but they would likely agree with indexing the minimum wage to the consumer price index. Opponents of raising the minimum wage, on the other hand, hopefully will be able to understand the need to preserve the value of the wage if they agree that the minimum wage should exist in the first place. After all, what is the benefit of the minimum wage if it does not accomplish the task it was designed to do protect the welfare of low-wage workers? Another caveat is that, with President Obama s order to raise the minimum wage of federal contract workers to $10.10, regular minimum wage workers may feel slighted. Still, some increase is better than none, and a gradual increase to a $9.00 minimum wage could serve as an effective compromise between

18 A POSSIBLE SOLUTION 18 the raise or hold arguments on minimum wage and therefore be more likely to pass through Congress and onto the desk of President Obama. Is Adjusting the Federal Minimum Wage Rate Effective? After all the discussion of the federal minimum wage, there is still another question to be addressed: Is adjusting the federal minimum wage rate the most effective option for preserving worker welfare in the first place? Certainly it is effective to some extent it ensures that all workers in the United States (except for those working in certain exempt industries) are paid at least that rate. However, adjustment of the federal minimum wage rate, while necessary, could be supplemented with more state and local level regulation of minimum wages. The federal rate is a catch-all solution, relying on national averages of the cost of living in order to establish a fair rate. But the cost of living including food, housing, transportation, and other commodities varies drastically across the United States. In general, it costs more to live in urban areas than in rural areas. So why not make the minimum wage in New York City, where goods cost on average 20 to 30 percent more than the national average, greater than the minimum wage in central Pennsylvania, where the cost of living is comparatively lower? In fact, some cities and states have enacted their own minimum wage rates to account for the local cost of living. A report from New York City Comptroller John C. Liu, published in July 2013, makes the case for implementing a minimum wage in New York City to compensate for the city s high cost of living. 23

19 A POSSIBLE SOLUTION Figure 3. Nominal Minimum Wage Rate23 Figure 3 shows the minimum wage rates set by selected cities in the United States as compared to the federal minimum wage rate of $7.25 (the horizontal line). Figure 4. Effective Minimum Wage Rate (Adjusted for Cost of Living)23 19

20 A POSSIBLE SOLUTION 20 At $10.55, San Francisco s minimum wage is the highest in the nation, but when that rate is adjusted for the city s higher cost of living, it is only $6.27. The same calculation for New York City yields a meager $4.00. It seems that the more important argument surrounding minimum wage regulation especially if it is a tool to ensure worker welfare should focus on the effective minimum wage rate, which varies widely across the nation. A federal minimum wage baseline is still a good idea, but states and cities are able to implement minimum wage policies that correspond with their respective costs of living. If more states and municipalities set their own minimum wage, perhaps the federal rate wouldn t be as much of an issue. It is true that raising the minimum wage in a locality could prompt more workers to commute to that location from areas where it costs less to live, and as a result the increased local minimum wage may not benefit as many people who actually live in the locality where the cost of living is high. However, state and local minimum wage policy should at least be included in the discussion of America s minimum wage, as although it may not be the best option everywhere, with further refinement and development it could prove to be a more effective policy tool in the future. Conclusions Economics is a social science. The study of economics in situations such as the federal minimum wage rate discussion can help guide lawmakers in crafting policy that they believe will have a positive impact on the US economy. However, while economic analysis can give us a numerical indication of the outcome of policy, its results are as

21 A POSSIBLE SOLUTION 21 much qualitative as they are quantitative. The analysis of human and corporate behavior cannot be precisely rationalized with great certainty, although economics strives to achieve rationalization of decision making to some degree. Therefore, it is ultimately impossible to predict the precise outcome of any policy change, and even after the policy is implemented it could still be difficult to discern its effect due to the presence of many colluding variables in the scheme of the vast United States economy. Additionally, political views have as much to do with minimum wage policy as economics perhaps even more so. Any legislation will have to be agreed on by members from both major political parties, and the outcome will likely be a middle ground between two poles. However, regardless of the political debate surrounding America s minimum wage, hopefully the underlying economics of the issue will provide a more grounded method for attempting to evaluate the results of any potential policy implementation.

22 22 References (all accessed April 2014) 1 "Obama to Raise Minimum Wage for Contractors to $10.10" /obama-to-raise-minimum-wage-for-contractors-to html 2 "With Eye on Midterms, Obama Pushes rise in Minimum Wage" /03/06/us/politics/obama-presses-case-for-higher-minimum-wage.html?_r=0 3 "What is the minimum wage?" 4 "The impact of a $9 minimum wage 5 "$22 minimum wage: Elizabeth Warren pays $7.19 for 'a No. 11 at McDonald s'" "Will fast-food protests spur higher minimum wage? business/2013/08/05/will-fast-food-protests-spur-higher-minimum-wage/ / 7 Poverty 8 "The Minimum Wage Delusion, And The Death of Common Sense" sites/jamesdorn/2013/05/07/the-minimum-wage-delusion-and-the-death-of-common-sense/ 9 "New Deal Achievements" 10 "History of Federal Minimum Wage Rates Under the Fair Labor Standards Act, " 11 "State Minimum Wages 2014 Minimum Wage By State" 12 "Minimum Wage Ordinance (MWO)" 13 "Troubled passage: the labor movement and the Fair Labor Standards Act +Standards+Act.-a "Adkins v. Children's Hospital (1923)" landmark_adkins.html 15 "Morehead v. New York ex rel. Tipaldo U.S. 587 (1936) cases/federal/us/298/587/case.html 16 "The Classical Production and the Labor Market %20402/CN_intromacro_3.pdf 17 [Image] 18 "Why some economists oppose minimum wages" economist-explains/2014/01/economist-explains "The 10 largest employers in America" /08/22/ten-largest-employers/ / 20 The impossibility of a perfectly competitive labour market content/31/5/775.full.pdf+html 21 "The Effects of a Minimum-Wage Increase on Employment and Family Income" "CPI Inflation Calculator 23 Working But Still Struggling: The Case for a New York City Minimum Wage comptroller.nyc.gov/wp-content/uploads/documents/nyc_minimumwage.pdf