Despite Critics, Hiking Minimum Wage May Make Good Sense

President Clinton’s modest proposal to raise the minimum wage in two steps to $5.15 from its present $4.25 figure, set four years ago, has raised a chorus of objections. It would raise unemployment, we are told, by making it impossible for employers to hire low-productivity workers. Hence, it would hurt those it is intended to help.

Conservative columnist Paul Craig Roberts charges in the April 24 issue of Business Week that to argue that an increase in the minimum wage may raise employment denies “the law of demand, the cornerstone of economic science.” Richard R. Berman, executive director of the Employment Policies Institute, funded by manufacturers, restaurants and retailers, wrote in the March 29 issue of the Wall Street Journal that arguing that “raising the price of labor increases the demand for it . . . (in) the dry field of labor economics . . . is akin to declaring that Columbus was right and the world was flat after all.” But it is the insistence that raising the minimum wage must reduce employment that corresponds to the flat-earth view. Over half a century ago, economists pointed out the three-dimensional complications that negate this.

For, as economists and business men all now know, it is not just price and quantity but the additional dimension of the marginal or incremental costs and benefits that count. Imagine a small firm paying $4 an hour to 10 employees. It has enough business to warrant hiring an additional employee if one could be found. It indeed has a help-wanted sign in the window offering $4 an hour, but it has no takers. Why not then offer the $5 an hour that would turn up a new job seeker?

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The difficulty quickly becomes obvious. The added profit to the firm from having one more worker might well be $10, much more than the $5 the worker would be paid. But the firm cannot pay a new worker $5 without raising the wages of its existing workers to $5. The cost of this would be 10 times $1 or $10. Added to the $5 for the additional worker, we find the total marginal or incremental cost is $15, far more than the $10 of added return from having an additional worker. Hence, the firm does not raise the wage and makes do with 10 workers.

Now suppose we introduce a minimum wage of $5 an hour or raise a minimum wage from $4 to $5. The firm is forced by law to pay all existing workers that $5. Hiring an additional worker under these circumstances no longer means raising wages of the existing workers. It will thus cost only an additional $5 an hour. This is less than the $10 of additional return, and the firm goes ahead and hires the additional worker. Thus, raising the minimum wage increases employment.

Of course, the higher minimum wage could force the firm out of business, so employment could go down. That is why the ultimate results--whether raising the minimum wage increases or reduces employment or leaves it about the same--is an empirical question.

But there is nothing theoretically implausible about a minimum wage or a higher minimum wage increasing employment. The current minimum is so low at $4.25 as to hardly matter.

Knowledgeable economists were therefore not surprised by the results of careful studies by Princeton economists David Card and Alan Krueger, currently chief economist in the Department of Labor.

Comparing changes in employment in fast-food restaurants in New Jersey, following a 1992 increase in the state’s minimum wage, with changes in employment in such restaurants in Pennsylvania, where there was no increase, the economists found employment increased more where the minimum wage had been raised. This result may not hold everywhere. Raising the minimum wage may or may not increase employment, but the work by Card and Krueger does not support the view that it must reduce employment. It is in fact consistent with the round-earth theory--that it is not merely price and profits but the third dimension of incremental costs and benefits that matters.

And Card and Krueger found in further studies that, contrary to a common view, over two-thirds of those affected by the two-step 1990-91 federal increase of 90 cents in the minimum wage were adults, not teen-agers, and were predominantly women and minorities.

They also found that increases in the minimum wage in relatively low-wage states were associated with significant boosts in wages both in the middle and at the bottom of the wage distribution. About one-third of the earnings gains accrued to families in the lowest 10% of the family earnings distribution.

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Raising the minimum wage is no panacea. Even at the proposed $5.15, it would imply an annual income for someone working full time of only $10,700, far below the poverty level for families.

We also need additional supplements to worker earnings, such as an increased earned income tax credit and incentives to employers to hire the unemployed and those on welfare. And, in the long run, we need major investments in education and training, of which the Clinton Administration’s proposed $10,000 tax deduction for post-secondary education costs is a small beginning. Making workers more productive is the ultimate answer to low wages.

But raising the Federal minimum wage to at least restore it in real terms to what it was four years ago before being eaten away by inflation, will help. We should not allow either callousness or misunderstood economic theory to stand in the way.