Minimum Wages

The reason is simple: although minimum wage laws can set wages, they cannot guarantee jobs. In practice they often price low-skilled workers out of the labor market. Employers typically are not willing to pay a worker more than the value of the additional product that he produces. This means that an unskilled youth who produces $4.00 worth of goods in an hour will have a very difficult time finding a job if he must, by law, be paid $5.15 an hour. As Princeton economist David F. Bradford wrote, “The minimum wage law can be described as saying to the potential worker: ‘Unless you can find a job paying at least the minimum wage, you may not accept employment.’”2

Several decades of studies using aggregate time-series data from a variety of countries have found that minimum wage laws reduce employment. At current U.S. wage levels, estimates of job losses suggest that a 10 percent in crease in the minimum wage would decrease employment of low-skilled workers by 1 or 2 percent. The job losses for black U.S. teenagers have been found to be even greater, presumably because, on average, they have fewer skills. As liberal economist Paul A. Samuelson wrote in 1973, “What good does it do a black youth to know that an employer must pay him $2.00 per hour if the fact that he must be paid that amount is what keeps him from getting a job?”3 In a 1997 response to a request from the Irish National Minimum Wage Commission, economists for the Organization for Economic Cooperation and Development (OECD) summarized economic research results on the minimum wage: “If the wage floor set by statutory minimum wages is too high, this may have detrimental effects on employment, especially among young people.”4 This agreement over the general effect of minimum wages is long-standing. According to a 1978 article in American Economic Review, 90 percent of the economists surveyed agreed that the minimum wage increases unemployment among low-skilled workers.5

Australia provided one of the earliest practical demonstrations of the harmful effects of minimum wage laws when the federal court created a minimum wage for unskilled men in 1921. The court set the wage at what it thought employees needed for a decent living, independent of what employers would willingly pay. Laborers whose productivity was worth less than the mandated wage could find work only in occupations not covered by the law or with employers willing to break it. Aggressive reporting of violations by vigilant unions made evasion difficult. The historical record shows that unemployment remained a particular problem for unskilled laborers for the rest of the decade.

At about the same time, a hospital in the United States fired a group of women after the Minimum Wage Board in the District of Columbia ordered that their wages be raised to the legal minimum. The women sued to halt enforcement of the minimum wage law. In 1923, the U.S. Supreme Court, in Adkins v. Children’s Hospital, ruled that the minimum wage law was price fixing and that it represented an unreasonable infringement on individuals’ freedom to determine the price at which they would sell their services.

In addition to making jobs hard to find, minimum wage laws may also harm workers by changing how they are compensated. Fringe benefits—such as paid vacation, free room and board, inexpensive insurance, subsidized child care, and on-the-job training—are an important part of the total compensation package for many low-wage workers. When minimum wages rise, employers can control total compensation costs by cutting benefits. In extreme cases, employers convert low-wage full-time jobs with benefits to high-wage part-time jobs with no benefits and fewer hours. David Neumark and William Wascher found that a 10 percent increase in minimum wages decreased on-the-job training for young people by 1.5–1.8 percent.6 Since on-the-job training is the way most people build their salable skills, these findings suggest that minimum wage laws also reduce future opportunities for the unskilled.

A particularly graphic example of benefits reduction occurred in 1990, when the U.S. Department of Labor ordered the Salvation Army to pay the minimum wage to voluntary participants in its work therapy programs. In exchange for processing donated goods, the programs provided participants, many of whom were homeless alcoholics and drug addicts, with a small weekly stipend and up to ninety days of food, shelter, and counseling. The Salvation Army said that the expense of complying with the minimum wage order would force it to close the programs. Ignoring both the fact that the beneficiaries of the program could leave to take higher-paying jobs at any time and the cash value of the food, shelter, and supervision, the Labor Department insisted that it was protecting workers’ rights by enforcing the minimum wage. After a public outcry, the Labor Department backed down.7 Its Wage and Hour Division Field Operations Handbook now contains a special section on minimum wage enforcement and the Salvation Army.8

Minimum wage increases make unskilled workers more expensive relative to all other factors of production. If skilled workers make fifteen dollars an hour and unskilled workers make three dollars an hour, skilled workers are five times as expensive as the unskilled. Imposing a minimum wage of five dollars an hour makes skilled workers relatively more attractive by making them only three times as expensive as unskilled workers. This explains why unions, whose members have historically been highly skilled and seldom hold minimum wage jobs, invariably support legislation increasing minimum wages. As in the Australian case, unions also protect themselves against competitive threats by assiduously helping labor authorities find and prosecute suspected violators.

Many employers in the U.S. construction industry have found it less expensive to hire unskilled workers at low wages and train them on the job. By accepting lower wages in return for training, unskilled workers increase their expected future income. With high minimum wages like those specified for government construction by the Davis-Bacon Act, the cost of wages and training for the unskilled may rise enough to make employers prefer more productive union members. In effect, higher minimum wages reduce the competition faced by union members while leaving the unskilled unemployed. Of course, employers may also respond to minimum wage laws by decreasing overall employment, substituting machines for people, moving production abroad, or shutting down labor-intensive businesses.

While those rendered unemployed by a minimum wage increase are largely invisible, it is easy to calculate the increased income enjoyed by those who keep their jobs after an increase. This asymmetry has led many advocates to mistakenly assume that increasing the minimum wage is an effective way to fight poverty. Using 1997 Census data, D. Mark Wilson found that only 11.7 percent of minimum-wage workers were the sole breadwinners in their families, and that more than 40 percent of the sole breadwinners earning the minimum wage were voluntary part-time workers.9 Richard Burkhauser used 1996 U.S. Census data to identify the likely beneficiaries from the 1996 increase in the federal minimum wage. He concluded that the “20.9 percent of minimum wage workers who lived in poor families only received 16.8 percent of the benefits.”10

Additional evidence on the distributional effect of minimum wages comes from David Neumark, Mark Schweitzer, and William Wascher. Raising the minimum wage increases both the probability that a poor family will escape poverty through higher wages and the probability that another nonpoor family will become poor as minimum wage increases price it out of the labor market. They found that the unemployment caused by minimum wage increases is concentrated among low-income families. This suggests that minimum wage increases generally redistribute income among low-income families rather than moving it from those with high incomes to those with low incomes. The authors found that although some families do benefit, minimum wage increases generally increase the proportion of families that are poor and near-poor. Minimum wage increases also decrease the proportion of families with incomes between one and a half and three times the poverty level, suggesting that they make it more difficult to escape poverty.11

In the early 1990s, after a telephone survey of 410 fast-food restaurants in New Jersey and Pennsylvania, economists David Card and Alan B. Krueger challenged the consensus view that higher minimum wages shrink employment opportunities. Their results appeared to demonstrate that a minimum wage increase resulted in increased employment.12 Because telephone survey data are notoriously prone to measurement error, Neumark and Wascher repeated Card and Krueger’s analysis using payroll records from a similar sample of restaurants over the same time period. The results from the payroll data showed that “the minimum-wage increase led to a decline in employment in New Jersey fast food restaurants relative to the Pennsylvania control group.”13 After an extended academic debate, Card and Krueger retreated from their earlier position, writing that “the increase in New Jersey’s minimum wage probably had no effect on total employment in New Jersey’s fast-food industry, and possibly had a small positive effect.”14

Even without the results from the payroll data, the contrary results from the Card and Krueger study would have had a limited impact on economists’ belief that increasing the minimum wage increases unemployment. As labor economist Finis Welch pointed out, the consensus theory does not predict how any one firm or industry is affected by minimum wage increases.15 Even if nationally recognized fast-food restaurants did not reduce hiring in response to higher minimum wages, Card and Krueger were silent about what happened at less-visible businesses, such as small retailers and local pizza and sandwich shops.

Furthermore, estimates of the overall effect of minimum wage increases often lead people to overlook the fact that regional and sectoral wage differentials average together to produce the national result. A federal minimum wage of $5.15 an hour may substantially reduce employment in rural areas, where it exceeds the prevailing wage, but have little effect on employment in large cities, where almost everyone earns more. Regional studies leave little doubt that substantial increases in the minimum wage can shrink local industries and inhibit job creation in areas with market wages below the new minimum. The growth of the textile industry in the southern United States, for example, was propelled by low wages. Had the federal minimum wage been set at the wage earned by northern workers, the migration of textile workers to the South might never have occurred.

It is also easy to overlook the fact that raising the minimum wage applicable to a relatively small proportion of occupations will not necessarily increase measured unemployment. Some people will lose their jobs in covered occupations and withdraw from the labor market entirely. They will not be included in the unemployment statistics. Others will seek jobs at lower pay in uncovered occupations. Though the labor influx reduces wages in the uncovered sector, people do have jobs, and unemployment may not change. As minimum wage laws cover more occupations, however, the shrinking uncovered sector may not be able to absorb all of the people thrown out of work. The 1989 U.S. minimum wage legislation brought us one step closer to this possibility by extending coverage to all workers engaged in interstate commerce, regardless of employer size.

The fact that gross unemployment statistics do not necessarily reflect the harm done by minimum wage laws with limited coverage probably explains the popularity of the living-wage ordinances now in vogue in American cities with strong union ties. Living-wage ordinances set minimum wages for businesses and nonprofits that receive contracts or subsidies from local government. To arrive at the appropriate minimum living wage, advocates calculate the amount required to pay for a basket of goods containing “decent” housing, child care, food, transportation, health insurance, clothing, and taxes for various family sizes. The minimum is then set at the rate that produces enough money to buy the basket when someone works forty hours a week for a year. Initial empirical studies by Neumark suggest that the trade-off between wages and employment is the same for living wages as for minimum wages.16

In San Francisco in 2001, passage of a living-wage law raised the compensation of airport skycaps from $4.75 an hour to $10.00 an hour plus health insurance.17 By the end of 2002, the Economic Policy Institute, an advocacy group supported by labor unions and liberal foundations, reported that living-wage ordinances had set minimum wages ranging from $6.25 an hour in Milwaukee to $12.00 an hour in Santa Cruz, California.18 In September 2003, the California Assembly passed a $10 minimum-wage requirement for contractors doing business with the state.

By one reckoning, the total cost of the typical basket of worker necessities used to arrive at living-wage minimums exceeds the incomes of almost a third of all families in the United States.19 It will not be surprising, therefore, as the number of cities with “living-wage” laws expands, to see unskilled workers harmed by falling employment, fewer entry-level jobs, and a reduction in job-related training and educational opportunities.