Effects of Federal Minimum Wage Increment on Unemployment and Local Prices
The subject of minimum wage has attracted controversies among policymakers and economists in the United States. The federal minimum wage was first enacted in 1938 (Neumark et al., 2004). However, before the Fair Labor Standards Act was passed, minimum wage was a critical issue in the political arena. There had been attempts at the state level to establish a wage floor, but the Supreme Courts declared the initiatives unconstitutional. In 1933, President Franklin Roosevelt also attempted to enact a federal minimum wage, but the efforts were equally thwarted (Neumark et al., 2004). In 1938, Congress eventually passed the FLSA, with the minimum wage at 25 cents per hour. The enactment of the FLSA spurred fierce debates among economists; some claimed that the minimum wage would affect the low-wage labor market, which only performed better as a competitive market while others profusely opposed the concept. For instance, Stigler (1946) as cited in Neumark et al., while supporting the theory that a higher minimum wage could boost employment, argued that the new law would displace low-wage labor markets (2004). Lester challenged Stigler’s perspective by stating that treating labor markets like commodities results in erroneous conclusions. Despite these unsettled debates, Congress increased minimum wage through the 1960s and 1970s. By 1975, over 90% of the workforce had complied with the federal minimum wage, and in 1981, the minimum wage was raised to $3.35 per hour (Neumark et al., 2004). Since then there have been massive researches on the economic effect of the minimum wage. These researches gained prominence towards the end of the 1980s when there was a 30% decline in the value of the federal minimum wage, which occurred after nine years of no action on the policy. The researches have mainly focused on the effects of the minimum wage policy on unemployment and local prices. They indicate that a rise in the Federal Minimum Wage directly correlates with a rise in teenage unemployment, loss of labor hours, and the monies gained from wage surplus are taken up by rising industry prices in the food and restaurant industry, and possibly other industries (File 260733879).
An increment in the federal minimum wage leads to youth unemployment. When the minimum wage is raised, highly experienced individuals will compete for minimum wage positions, which will lead to the displacement of younger, inexperienced workers, especially teenagers. Teenagers are at the bottom of the wages distribution, and since they make up a larger fraction of the low-paid employees, the research on the effects of minimum wage increment has revolved around the youth labor market (Card, 1992). A study conducted by Card (1992) supports the above inference by examining the trends of teenage employment and wages after the April 1990 wage increment. In 1989, before the minimum wage increment, a quarter of teenagers between 16 and 19 years old earned between $3.35 and $3.80 per hour. In 1991, the minimum wage was raised to $4.25 per hour. The study involved the high-wage groups, which are the 16 states that had enacted state-specific minimum wage over $3.35 per hour, the low wage groups, which are the 11 mountain and southern states, and the medium-wage group that comprises the remaining 22 states (Card, 1992). The notable trend in the survey was that the rise in federal minimum wage majorly affected low and medium-wage states. In both states, there was a significant drop in the number of teenagers earning $3.35 – $3.79 per hour after the minimum wage expansion law (Card, 1992). While the average earning in high-wage states showed a slight gain, the wage trends in low and medium-wage states indicated a sharp increase in wages. The research revealed that teenage employment dropped more in high-wage states compared to the other two groups. However, the research also indicated teenage employment growth in low-wage states (Card, 1992). These variations can be attributed to the economic downturn in 1990. Card concluded by stating that the 1991 increment in minimum wage significantly affected teenage employment.
A tight compensation budget leads to low recruitment. If employers are forced to comply with the increased minimum wage, it implies that they will not afford to expand their workforce due to the tight compensation budget. The Federal Reserve Bank of Chicago reported that when the minimum wage is lowered by 10%, low skill employment is reduced by 2 – 4% while the average restaurant employment goes down by 1 – 3% (Gorry & Jackson, 2016). Sabia, in his 2008 study, challenged the proponents of minimum wage increase who deduce that the hike in minimum wage has little effect on the retail employment. Basing on the monthly data from 1979-2004 Current Population Survey, Sabia examined the effect of minimum wage raise on retail employment and labor hours (Sabia, 2008). He found out that a 10% increase in the minimum wage corresponds to a 1% drop in retail trade employment hence the weekly labor hours. These results were prominently manifested among the less experienced employees in the retail industry. Gorry & Jackson (2016) cite a study conducted in 2014, which indicated a 1.5% decline in youth employment. Due to the competitive model of the youth labor market, an expansion of the minimum wage decreases youth employment rates. Another study by the EU also revealed a negative effect of minimum wage growth on employment of teenagers (15-19 years old) and young adults (20-24 years old) (Gorry & Jackson, 2016). Research that exploited the effects of minimum wages in OECD countries similarly revealed the negative impact on youth employment. These effects, however, vary across countries whereby the more restrictive a state is on issues of labor standards, the greater the effects. The effect of increased minimum wage is little in states with stronger employment protection policies that aim at finding and creating jobs for the unemployed. Countries with weak labor markets laws tend to experience higher impacts of increased minimum wage (Gorry & Jackson 2016).
Another notable effect of an increase in the minimum wage is the dwindling of on-the-job training opportunities especially for younger inexperienced workers. Sectors like grocery stores, which are most likely to employ youths, often offer on-the-job training at the beginning of the employment. This gives youths an opportunity to increase their productivity over time and thus, growing earnings (Gorry & Jackson, 2016). Therefore, imposing higher minimum wages might affect the grocery stores’ ability to offer on-the-job training. Due to increased compensation budget, some employers might forego the training, which will then reduce the employees’ productivity and lifetime income. Noting this impact, some EU and U.S. states have mandated employers to provide sub-minimum or training compensations for youths in order to boost the employment of younger, unskilled workers (Gorry & Jackson, 2016). For instance, Nordic labor markets have separate minimum wages for the youth. In the U.S, the special consideration of minimum wage for younger workers has vastly reduced the negative effects of increased minimum wage for this group of employees. These minimum wage exemptions applied on the state level include young workers that are below the age of 18, and according to reports by OECD countries, the provision of a sub-minimum wage for young workers significantly reduces the negative effects of increased minimum wage of youth employment (Gorry & Jackson, 2016). Lastly, increased minimum wage will result in low turnover rates since employees will be satisfied with their earning and retain their jobs for long. This will, in turn, delay most youths’ entry into the labor markets, hence economically disadvantaging them. While numerous studies have associated unemployment to increased minimum wage, others have found less or no evidence on the matter. The researchers argue that the studies, which follow the competitive model of the youth labor market to show the negative impact, are due to methodological flaws (Neumark et al., 2004). These opposing studies state that when spatial correlation is considered, the negative effects of increased minimum wages will disappear. Spatial correlation refers to the similar employment trends in neighboring countries due to underlying geographic features, demographic characteristics, and labor force since labor markets do not always follow political boundaries (Neumark et al., 2004). Furthermore, other economists have associated increased minimum wages with more job opportunities. According to Berfield & Coy (2013), “A higher minimum wage would boost workers and bring America in line with the rest of the world.” When individuals have more money to spend, the economy will grow and businesses will need to expand the workforce to match increased sales. Additionally, with increased minimum wage, individuals will easily accumulate capital to start businesses, therefore, creating more employment opportunities. However, Berfield & Coy further explained that “helping the least fortunate will require a whole lot more” (2013). While the FLSA aims at improving the lives of low-income earners and reduce poverty, some economists claim that the increased minimum wages only benefit a fraction of low-income individuals with jobs while the bigger portion languishes in poverty. According to Halvorson (2014), increasing the minimum wage policy does not reduce poverty but increases the economic class gaps (Berfield & Coy, 2013).
Another issue of concern is the effect of minimum wage on local prices. While the response of youth employment to the minimum wage increment has been widely studied, there is limited research on the effect on local prices (Aaronson, 2001). The U.S. food industry is the largest employer of minimum wage workers; it accounts for a third of the total number of low wage employees in the nation (Aggarwal et al., 2017). This implies that higher minimum wages will have a direct effect on the labor costs, which may be reverberated in the cost of foods. Aaronson (2001) states that, “firms set output at a level at which price is equal to marginal cost and changes in the minimum wage are fully passed to the consumer.” Therefore, higher minimum wages tend to increase the cost of labor and thus leading to an increase in food prices (Aggarwal et al., 2017). However, the magnitude of these effects may vary according to various factors including convexity of demand, demand elasticity, competition, and elasticity of marginal cost in relation to output (Aaronson, 2001). Another determinant of the magnitude of these effects is whether the minimum wage policy is implemented at a federal or local level (Aggarwal et al., 2017). Aggarwal et al. cite a 2000 research that attributed a 1% increase in food prices to the 0.050% increase of the federal minimum wage in 1992 and 1997 (2017). Similarly, another study conducted in 2012 indicated that if the federal minimum wage were increased by 33%, food prices would go up each year by less than 0.5%. However, since both of the above studies used stimulated data, there is no probability that more localized or larger wage increases would produce different results (Aggarwal et al., 2017).
More studies have revealed linear effects of increased minimum wages on local prices. In 2017, Allegretto & Reich examined internet-based restaurants menus to determine how food prices responded to the 2013 minimum wage legislation (2018). Allegretto and Reich studied the menus of 884 internet-based restaurants in California before and after the 2013 25% minimum wage law. They found out that the increased minimum wage resulted in the food price growth of averagely 1.45% (Allegretto & Reich, 2018). While there is a notable increase in restaurant prices in response to increased wage bill, Aaronson notes the higher magnitude of price response during high inflation periods in 1970s and 80s (2001). Furthermore, high price responses occur in the first quarter after the enactment of the legislation. Conversely, other studies have found no correlation between higher minimum wages and local food prices. For instance, a research conducted by Aggarwal et al. to determine the effect of Seattle’s minimum wage legislation on supermarket food prices gave negative results (2017).
The FLSA was primarily implemented to improve the well-being of low-income earners and their families, which raises the question, “does the FLSA serve its purpose?” To answer this, many researchers have conducted studies to determine the economic effect of the minimum wage policy particularly on employment and local prices. Most studies have concentrated on youth employment since they make up the largest fraction of low-income earners. These surveys, which have been consistent with the competitive model of the youth labor market, have found out that an increase in the minimum wage leads to youth unemployment. This is because increased minimum wage attracts experienced workers to average jobs thus reducing employment opportunities for younger, inexperienced workers. When the minimum wage is hiked, businesses will be unable to put up with the tight compensation budget hence youths will lack employment opportunities. Increased minimum wages have also been associated with a growth in food prices due to the high cost of labor that forces businesses to hike food prices. Other studies have, however indicated no evidence in the above findings. While the enactment of minimum wage policy aimed at improving the lives of low-income earners, a rise in the federal minimum wage directly correlates with a rise in teenage unemployment, reduced labor hours, and increased food prices. Due to this impact, some EU and U.S. states have adopted a special policy requiring states to provide sub-minimum or training compensations for young workers in order to minimize the impact of increased minimum wage. This can also be embraced by other states to ensure teenagers are not affected by these policies.
Aaronson, D. (2001, Feb). Price pass-through and the minimum wage. Review of Economics & Statistics, 83(1), 158-69. Retrieved from https://static01.nyt.com/packages/images/opinion/01divide-aaronson_prices.pdf
Aggarwal, A., Buszkiewicz, J., Tang, W., Long, M., Vigdor, J., Drewnowski, A. & Otten, J. J. (2017, Sep 9). The impact of a city-level minimum-wage policy on supermarket food prices in Seattle-King County. International Journal of Environmental Research And Public Health, 14(9). Retrieved from doi:10.3390/ijerph14091039
Allegretto, S., & Reich, M. (2018). Are local minimum wages absorbed by price increases? Estimates from internet-based restaurant menus. ILR Review, 71(1), 35-63. Retrieved from http://journals.sagepub.com/doi/abs/10.1177/0019793917713735
Berfield, S. & Coy, P. (2013, Nov 28). What a higher minimum wage does for workers and the economy. Bloomberg. Retrieved from https://www.bloomberg.com/news/articles/2013-11-27/what-a-higher-minimum-wage-does-for-workers-and-the-economy
Card, D. (1992, Oct). Using regional variation in wages to measure the effects of the federal minimum wage. Industrial and Labor Relations Review, 46(1), 22. Retrieved from http://www.jstor.org/stable/2524736
Gorry, A., & Jackson, J. J. (2016, March 9). A note on the nonlinear effect of minimum wage increases. Contemporary Economic Policy, 35(1), 53-61. Retrieved from doi:10.1111/coep.12175
Neumark, D., Schweitzer, M., & Wascher, W. (2004). Minimum wage effects throughout the wage distribution. Journal of Human Resources, 39(2), 425-450. Retrieved from https://econpapers.repec.org/article/uwpjhriss/v_3a39_3ay_3a2004_3ai_3a2_3ap425-450.htm
Sabia, J. (2009, March). The effects of minimum wage increases on retail employment and hours: New evidence from monthly CPS data. Journal of Labor Research, 30(1), 75-97. Retrieved from https://link.springer.com/article/10.1007%2Fs12122-008-9054-1