Effects of Minimum Wage Laws (in the United States)

Executive Summary

The U.S. federal government has imposed a minimum wage since 1938, and nearly all the states impose their own minimum wages. These laws prevent employers from paying wages below a mandated level. While the aim is to help workers, decades of economic research show that minimum wages usually end up harming workers and the broader economy. Minimum wages particularly stifle job opportunities for low-skill workers.

There is no “free lunch” when the government mandates a minimum wage. If the government requires that certain workers be paid higher wages, then businesses make adjustments to pay for the added costs, such as reducing hiring, cutting employee work hours, reducing benefits, and charging higher prices. Some policymakers may believe that companies simply absorb the costs of minimum wage increases through reduced profits, but that’s rarely the case. Instead, businesses rationally respond to such mandates by cutting employment and making other decisions to maintain their net earnings. These behavioral responses usually offset the positive labor market results that policymakers are hoping for.

Increases in minimum wages would be particularly damaging in today’s sluggish economy. Governments should focus on policies that generate low-inflation economic growth and higher worker productivity, which would generate rising wages and more opportunities for all workers.

Key Points

Background

The U.S. federal minimum wage originated in the Fair Labor Standards Act (FLSA) signed by President Franklin Roosevelt on June 25, 1938. The law established a minimum wage of 25 cents per hour for all employees who produced products shipped in interstate commerce. That wage is equivalent to $4.04 in today’s purchasing power.

The Effect of Minimum Wages on Employment

The main finding of economic theory and empirical research over the past 70 years is that minimum wage increases tend to reduce employment. The higher the minimum wage relative to competitive-market wage levels, the greater the employment loss that occurs. While minimum wages ostensibly aim to improve the economic well-being of the working poor, the dis-employment effects of a minimum wages have been found to fall disproportionately on the least skilled and on the most disadvantaged individuals, including the disabled, youth, lower-skilled workers.

In a generally competitive labor market, employers bid for the most productive workers and the resulting wage distribution reflects the productivity of those workers. If the government imposes a minimum wage on the labor market, those workers whose productivity falls below the minimum wage will find few, if any, employment opportunities. The basic theory of competitive labor markets predicts that a minimum wage imposed above the market wage rate will reduce employment.

Evidence of employment loss has been found since the earliest implementation of the minimum wage. The U.S. Department of Labor’s own assessment of the first minimum wage in 1938 found that it resulted in job losses for 30,000 to 50,000 workers, for 10 to 13 percent of covered workers who previously had earned below the new wage floor.

As an example, with the original 1938 imposition of the minimum wage, the lower-income U.S. territory of Puerto Rico was severely affected. An estimated 120,000 workers in Puerto Rico lost their jobs within the first year of implementation of the new 25-cent minimum wage, and the island’s unemployment rate soared to nearly 50 percent.

Similar damaging effects were observed on American Samoa from minimum wage increases imposed between 2007 and 2009. Indeed, the effects were so pronounced on the island’s economy that President Obama signed into law a bill postponing the minimum wage increases scheduled for 2010 and 2011. Concern over the scheduled 2012 increase of $.50 compelled Governor Togiola Tulafono to testify before Congress : “We are watching our economy burn down. We know what to do to stop it. We need to bring the aggressive wage costs decreed by the Federal Government under control. . . . Our job market is being torched. Our businesses are being depressed. Our hope for growth has been driven away.”

The U.S. Congress created a Minimum Wage Study Commission in 1977 to “help resolve the many controversial issues that have surrounded the federal minimum wage and overtime requirement since their origin in the Fair Labor Standards Act of 1938.” The commission published its report in May 1981, calling it “the most exhaustive inquiry ever undertaken into the issues surrounding the Act since its inception.” The landmark report included a wide variety of studies by a virtual ‘‘who’s who’’ of labor economists working in the United States at the time. A review of the economic literature amassed by the Commission by Charles Brown, Curtis Gilroy, and Andrew Kohen found that the “time-series studies typically find that a 10 percent increase in the minimum wage reduces teenage employment by one to three percent.” This range subsequently came to be thought of as the consensus view of economists on the employment effects of the minimum wage.

In 2006, David Neumark and William Wascher published a comprehensive review of more than 100 minimum wage studies published since the 1990s. The review found that “although the wide range of estimates is striking, . . . the preponderance of the evidence points to dis-employment effects” and “the studies that focus on the least-skilled groups provide relatively overwhelming evidence of stronger dis-employment effects for these groups.”

Other Effects of Minimum Wages

Aside from changes in employment, empirical studies have documented other methods by which businesses and markets adjust to minimum wage increases. The congressional Joint Economic Committee published a major review of 50 years of academic research on the minimum wage in 1995. The study found a wide range of direct and indirect effects of increased minimum wages that may occur. These include

● Increasing the likelihood and duration of unemployment for low-wage workers, particularly during economic downturns;
● Encouraging employers to cut worker training;
● Increasing job turnover;
● Discouraging part-time work and reducing school attendance;
● Driving workers into uncovered jobs, thus reducing wages in those sectors;
● Encouraging employers to cut back on fringe benefits;
● Encouraging employers to install laborsaving devices;
● Increasing inflationary pressure;
● Increasing crime rates as a result of higher unemployment.

A final method for businesses to respond to minimum wage increases is to try to push forward the additional costs as higher prices to consumers. However, in a global economy, this is less likely for internationally traded goods because producers facing higher labor costs will be undercut by producers in other countries. If other factors are equal, labor-intensive industries will tend to shift their investment to countries that don’t impose those extra cost burdens. Thus, countries with relatively high minimum wages may have investment, lower job growth, and lower economic growth than would otherwise be the case.

Conclusions

While they are often low-paid, entry-level jobs are vitally important for young and low-skill workers because they allow people to establish a track record, to learn skills, and to advance over time to a better-paying job. Thus, in trying to fix a perceived problem with minimum wage laws, policymakers cause collateral damage by reducing the number of entry-level jobs.

The minimum wage law is most properly described as a law saying employers must discriminate against people who have low skills.”

Seventy years of empirical research generally finds that the higher the minimum wage increase is relative to the competitive wage level, the greater the loss in employment opportunities. A decision to increase the minimum wage is not cost-free; someone has to pay for it, and the research shows that low-skilled workers pay for it by losing their jobs, while consumers may also pay for it with higher prices.

Employers are simply not going to hire workers whose labor produces less than the cost of hiring them. Although a small share of workers may get a raise, others will lose opportunities for employment. Minimum wages generally don’t distribute income to workers from employers, but to a small group of lucky workers from the unlucky workers who lose jobs.

Rather than pursuing policies such as minimum wage increases that create winners and losers, policymakers should focus on policies that generate increased worker productivity, and economic growth with low inflation to benefit all workers. While minimum wages may be a well-meaning attempt to help workers, economic research clearly shows that somebody must pay the price for any increase, and it is usually the least skilled and least fortunate.

Source: The Negative Effects of Minimum Wage Laws, Jun 21, 2012, by Mark Wilson. Cato Institute Policy Analysis 701.

Posted: Nov 18, 2012Updated: Nov 25, 2012