I was at dinner the other day with a friend who asked me to explain why economists seem to be so split on the advisability of raising the minimum wage.
I was at dinner the other day with a friend who asked me to explain why economists seem to be so split on the advisability of raising the minimum wage. On one side are microeconomists who think it will destroy jobs, and on the other side are those who don’t agree. The second group’s position is not very well laid out in public discourse, but it is pretty straightforward.
My reply to my friend was that the difference lay in the basic model being used by each group of economists. Traditional microeconomic theory uses the basic model of supply and demand that is taught in every undergraduate economics class. For any normal good in a competitive market, which is assumed to include the market for labor, a higher price (or wage) reduces demand for the good while increasing supply. So raising the minimum wage (presumably above the market-clearing level set by the forces of the free market) would lower the demand for labor and result in loss of jobs and an increase in the unemployment rate as more job seekers enter the market.
Another version of this story is more supply-side-oriented. It argues that raising the minimum wage would increase the average costs of production by raising the cost of a key input – labor. This would especially affect small, labor-intensive businesses that operate at the margin of profitability (think McDonalds). Unable to pay the higher wage and remain profitable, and unable to raise prices due to intense competition, they would go out of business and the jobs that they represented would disappear.
On the other side of the minimum wage debate are economists who tend to adopt a macro-economic approach. In this model, raising the minimum wage has the effect of stimulating the demand by workers for goods and services that they previously found unaffordable. In this approach, an increase in the minimum wage is a bit like a tax cut for low income people, putting more money in their pocket that is then spent in the economy. It reminds me of the idea espoused by Henry Ford, who wanted his workers to make enough that they could afford to buy his cars, because he recognized the links between wages paid and consumption of goods.
This school also criticizes the microeconomics group for its assumption that labor markets are workably competitive, or that prevailing wages are set purely by competitive forces. The high cost of searching for and acquiring a new job creates stickiness in labor markets and confers market power on employers that is more aligned with assumptions in conventional macroeconomic models than conventional microeconomic models.
What do the data say? In general, the reason that this is a war of theories is that the data show very little impact on jobs arising from differences in minimum wages. http://www.social-europe.eu/... It is at this point that the debate shifts from the effect of the minimum wage on overall employment to one that addresses the differential impact on lower-skilled workers. In this view, the microeconomists argue that a higher wage will drive employers to hire higher skilled workers, whose productivity warrants the higher level of pay. The claim is that this will squeeze out of the labor market the low-skilled and less experienced workers, especially the young and uneducated. While this argument is theoretically valid, again, empirical studies find only negligible effects. (http://truth-out.org/...)
In sum, the data do not support the view that raising the minimum wage will cause devastating impacts on jobs or on the low skilled workers. Rather it appears that the main impact is to increase spending and economic activity.