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Further Discussion of the Minimum Wage

Coauthored by Brenda Procter and Graham McCaulley, Personal Financial Planning Extension Professors, University of Missouri Extension

Last week’s Financial Tip featured a well-written article on the relationship between the minimum wage and poverty, mainly through a theoretical lens. This week, we’ll continue the conversation by looking at some related empirical evidence on the subject and consider additional perspectives on the implications of minimum wage increases.

Does increasing the minimum wage increase unemployment?

Viewing the minimum wage through the theoretical lens of supply and demand in labor markets can lead to the conclusion that raising the minimum wage results in a surplus of workers and a decrease in employers’ ability to hire, which means there will be more unemployed workers. Increases in the minimum wage should then predictably be correlated to increases in the unemployment rate. However, this simple relationship is not what’s often observed.

The picture in MO

minwageMissouri has a higher state minimum wage than the federal minimum wage and the second highest minimum wage of the states it borders. Missouri’s unemployment rate, however, ranks in the middle compared to those states.[i] Further, in 2014 the majority of all states with higher unemployment rates than Missouri also had a minimum wage that was less than or the same as Missouri’s.[ii],[iii]

Missouri’s changing minimum wage and unemployment rates over time shows a similar disconnect between the minimum wage and employment.[iv][v]

The picture nationally

We know that the nominal federal minimum wage has increased over time, but its real value has not kept up with inflation. The value of the federal minimum wage peaked in 1968 at $1.60. To have the same purchasing power today it would have to be $10.75, which is much higher than the current minimum wage of $7.25.[vi] The declining real value of the minimum wage means that employers have taken in greater revenue for their goods and services while paying less for labor. In theory, we should be able to see a consistently dropping national unemployment rate over time. However, this is not the case.[vii]

Although these data are fairly simple, why aren’t they showing the basic theoretical relationship between unemployment rates and the minimum wage? This is likely because the relationship is a bit more complex than a static model can represent. A supply and demand curve requires assuming that other variables are held constant. It is difficult to estimate effects based on a static model while not factoring in variables such as regional differences, labor mobility and responsiveness, and even shifts in demand for goods and services that may result from increasing the minimum wage.

The relationship between the minimum wage and employment has been one of the most studied economic topics, and meta-studies (studies of studies) on this body of research consistently conclude that there is no discernible effect of the minimum wage on employment. [viii]  A recent comprehensive review of studies on the minimum wage found evidence suggesting that a fuller picture has to be considered when explaining the relationship between the minimum wage and employment, including relevant outcomes such as reductions in labor turnover, improvements in organizational efficiency, reductions in wages of higher earners, and small price increases. Another often-cited study on the topic found that economists’ suggestion of a positive relationship between the minimum wage and unemployment was often based on regional and local differences in employment trends that were unrelated to minimum wage policies.[ix] Simply put – understanding how increasing the minimum wage affects employment requires considering a range of other factors.

Does increasing the minimum wage fail to help the poor?

One argument against raising the minimum wage to $10.10 is that only 19% of the higher earnings would go to families below the poverty threshold. Although that may be true, official poverty thresholds have been critiqued as outdated and failing to include many workers who still struggle to meet basic needs. Considering this critique requires us to consider how the official poverty threshold is calculated.

Findings from the 1955 Household Food Consumption Survey showed that U.S. families of three or more people spent about one-third of their income on food.  Based on these findings, Molly Orshanksy of the Social Security Administration created an official poverty threshold measure in 1963 as the War on Poverty was gearing up.  She started with the least costly of four USDA food plans (an economy food plan) which was designed to constitute a “nutritionally adequate diet for temporary use when funds are low.” After some minor adjustments, she multiplied its cost by three because of the 1955 survey.[x] Poverty measures are still calculated using the Orshansky method and adjusted yearly for price changes in the cost of the economy food plan.  In 2013, based on this calculation, a family of three would have been considered “in poverty” if their family income was below $19,530.[xi]

Although the cost of the economy food plan has been adjusted over the years for inflation, the full calculation used in the official poverty threshold measure has not been adjusted for changes in family spending patterns since 1955.  In 2013, the average family only spent about 13% of their income on food, significantly less than 1/3.[xii] Adjusting the multiplier to reflect what families actually spend on food, the poverty threshold for a family of three would be more than $49,000 (over $23 per hour), which is about two and a half times the current poverty threshold.[xiii]

In the mid 1990s, recognizing that the official poverty measurement had become dated, Dr. Diana Pearce of the Center for Women’s Welfare began working on a more realistic measure of a bare bones family budget that would provide the minimum income to meet basic needs without public or private assistance.  This resulted in the creation of the “Self-Sufficiency Standard.”  It is based on actual costs of all the major budget items faced by working adults (housing, child care, food, health care, transportation, taxes and miscellaneous costs).[xiv] In Missouri, the Self-Sufficiency Standard for a household with one adult and two children is approximately $44,000 (over $21 per hour), which is more than twice the official measure.[xv]

Whether the official poverty measure is updated for today’s spending patterns or rethought completely, the conclusion either way is that official poverty estimates do not give a full picture of “the poor.” Although it’s true that these approaches also don’t capture the full value of public benefits or transfers, concluding that the minimum wage will only help less than 20% of those in poverty overlooks the complexities surrounding poverty measurement and labor markets. 

Further considerations

Another argument against raising the minimum wage is that the typical minimum wage worker is a teenager earning extra spending money.[xvi]  According to the Department of Labor, this is not true.  About 88% of those who would benefit from a rise in the minimum wage are age 20 or older and 55 % are women.[xvii]

Those who are against raising the minimum wage often argue that a rise in the minimum wage would result in job losses. While a theoretical case can be made for this point of view,14 empirical evidence does not bear this out.  Further, the economic concept of marginal propensity to consume could mean that employers see a greater demand for their goods and services because low-wage workers are more likely to spend the next dollar they earn than are higher-wage workers. The result of a minimum wage increase could be businesses doing additional hiring for the production of the goods and services low-wage workers are now more able, as well as more likely, to buy.

More than 600 economists signed onto a letter that supports raising the minimum wage to $10.10 by 2016 and a 2014 survey found that over 60% of business owners support increasing the minimum wage to $10.10. As with most social issues, there is research and support on both sides of the argument. Academics often reach different conclusions even when looking at similar data. As last week’s article pointed out, there is disagreement among economists about whether or not the minimum wage should be raised and the implications of doing so. Comprehensive policy analysis requires an understanding of the theories used to make predictions, what’s actually been observed through data collection, and how researchers, theorists and policymakers approach their investigations. Although this article muddies the waters on the topic, we hope it complements last week’s article by broadening the discussion of a complex topic.