The logic of a minimum wage hike

There have been a couple articles in the news over the last couple days about the walk-outs in the fast-food industry over labor’s desire to increase the minimum wage in the fast-food industry to $15/hr from $7.25/hr.

I made the mistake of reading through the comments, and one comment from a reader opposed to raising the minimum wage level struck me in particular–the argument was basically as follows: a minimum wage hike is bad because it makes labor more expensive; as such, fast-food establishments (and other companies that employ high percentages of minimum wage workers) will employ fewer people after a minimum wage hike. Raising wages won’t lead to more business down the road either, because “if it did, the fast-food companies would have done so already.”

So I’m not convinced that a minimum wage hike would be great, but the argument above is flawed, so I just wanted to lay out the actual logic of a minimum-wage hike:

1) A huge number of workers (nearly 4 million) earn minimum wage or less–roughly 5% of all hourly workers (3% of the total workforce) are compensated at that level. 50% of those workers (1.9 million people) are over the age of 25.

2) Corporate profits as a percentage of GDP are at their highest level in the post-WWII era. Correspondingly, labor share as a % of the economy is at its lowest level in the post-war era.

3) The evidence for the dis-employment impact of a minimum-wage hike is mixed. Keep in mind–studies that show no impact of a minimum-wage hike are limited to the normal variation in the minimum wage among the states; no state has ever implemented a minimum-wage as high as $15/hr, so no one can be sure of the immediate impact that this will have on employment.

4) The economy is operating below potential due to a lack of demand. This is clear for a number of different reasons which I have explored in other posts, but the strongest evidence for this fact is that unemployment is elevated and inflation is low and falling in spite of the fact that interest rates are at 0 and quantitative easing from the Federal Reserve.

Given the above, the logic of a minimum-wage hike to $15/hr is as follows:

1) You immediately double the purchasing power of nearly $4 million people, along with increasing the purchasing power of all of the other individuals earning between $7.25 and $15/hr. In response to the minimum wage hike, corporate profits as a share of GDP will fall (as increased labor costs eat up some of that profit) and businesses will lay-off employees whose marginal impact on revenue is less than $15/hr. Prices may also rise as businesses attempt to retain their current levels of profitability.

2) Low-income employees who benefit from a minimum-wage hike will spend nearly all of their increase in disposable income. In an economy suffering from a lack of demand, this will benefit overall growth levels. Rising price levels (ie higher levels of inflation) will also serve to erode the real level of private-sector debt; given that many economists think this cycle of de-leveraging is holding back the economy, this will also boost demand and growth.

3) With improved growth and more consumer demand, businesses will re-hire the workers they laid off to meet the necessary increase in production.

In essence, a minimum-wage hike would accomplish what quantitative easing has been unable to–getting businesses to deploy their massive profits back into the real economy instead of holding onto the cash (or dispensing the cash to shareholders through buybacks and dividends). This cash injection into the real economy will boost growth and demand, which, in the medium and long term, will actually benefit the very corporations that employ high percentages of minimum wage workers.

And saying that “a minimum-wage hike can’t benefit businesses because if it would, they would have done it already” doesn’t fly–think about a minimum-wage hike as a collective action problem: if any one company raised their wages, their costs would go up enormously (putting them at a disadvantage relative to other businesses in their industry) but the impact in the broader economy would be negligible. And, businesses can’t coordinate an industry-wide wage hike because their is always the threat that a free-rider would undercut their labor costs and run the businesses that raised wages out of town. So, even in a situation where an industry-wide wage hike would be beneficial to all businesses, the businesses can’t raise wages because of coordination problems. A hike in the minimum-wage by law solves that collective action problem.

I know that some people don’t like to think that the free-market ever fails; but, in reality, collective-action problems are actually quite common. And the solution is an authoritative third-party (cough the government cough) that can come in and ensure that no one free rides (so that all businesses benefit).

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