EconoMonitor

Thoughts From Across the Atlantic

Is the Minimum Wage an Effective Way to Reduce Poverty or Inequality?

There is a growing interest in increasing the federal minimum wage in the U.S. and minimum wages at the state and city level (News and Observer). President Obama has already decreed a higher minimum for workers on Federal contracts, and he has proposed raising the Federal minimum from $7.25 to $10.10. Interest in the minimum wage has been influenced by concern about poverty and observed increases in inequality of income and earnings in the US and many other countries.

WHO EARNS THE MINIMUM WAGE?

The vast majority of employed workers earn more than the legal minimum, and they are not directly affected by changes. In 2013, 96% of wage earners received more than the legal minimum (Congressional Budget Office, U.S. Department of Labor). Some workers are exempt from the legal minimum, including the self-employed (10% of the work force), volunteers, trainees, and salaried workers with management responsibilities. There have been some recent controversies about whether certain low wage workers are self-employed contractors, who are exempt from minimum wages, or employees of a firm who are subject to the minimum wage. Also to enforce the minimum wage one must define and measure hours of work, which is becoming more difficult when more than 80% of American workers are employed in the service sector, where many jobs are performed outside a factory or office. For example, some employees claim that when employers give them iPhones, Blackberries, and other digital devices and expect them to answer late-night calls, these should be treated as work hours for purposes of minimum wage and overtime pay calculations (Wall Street Journal).

What are the characteristics of workers who currently earn the minimum wage? They are largely young, inexperienced, and part-time. In 2013 50% were below the age of 25, and 64% worked part-time (less than 35 hours per week) and concentrated in a few service occupations. Food service and preparation was the largest occupation for minimum wage workers, and it was twice as large as the next largest occupation, personal care and service. Minimum wage workers are often members of households in which other members earn higher incomes. Minimum wage workers are not necessarily members of low income households. They are distributed fairly evenly across low, middle, and high income households (MaCurdy 2015). Also households in poverty often have no one in the workforce, and wage levels do not influence their incomes. In general, there is not a high correlation between low wage earners and households in poverty.

ECONOMIC EFFECTS OF RAISING THE MINIMUM WAGE

What are the main economic effects of raising the minimum wage? First, workers who keep their jobs and earn the higher wage receive higher incomes. These are the people who most proponents of minimum wages have in mind. Secondly, at the higher wage some employers hire fewer workers, and those workers who lose current jobs or fail to get new jobs are harmed. Higher wages without a job do not help them. Employers could substitute machines for workers by automating, they could substitute foreign for domestic workers by offshoring certain tasks, or they could reduce total production. Thirdly, since all employers face higher labor costs, businesses could shift some of the additional costs onto consumers by raising prices, as they do with higher sales taxes. The net result of these three effects on poverty is the sum of their quantitative effects on poor households. The first effect is favorable for impoverished workers who keep their jobs. The second effect is harmful for impoverished workers who lose their jobs, and the third effect is harmful to all impoverished households that have to pay more for their goods and services.

The total value of the gain to poor workers from higher wages is limited by the small percentage of minimum wage workers whose household incomes are below the poverty line.  Because many low wage workers are part of higher income households, the percentage of minimum wage workers in middle and high income households is approximately the same as in low income households (Congressional Budget Office, MaCurdy 2015a). Many minimum wage workers are young and part-time. Thus, most of the additional earnings from higher wages go to households that are not in poverty. In a recent CBO study of the proposed increased in the minimum wage, 19% of the higher earnings would accrue to households below the poverty threshold, with 81% going to households with higher incomes. Of the gains to higher income households,  ”29% would accrue to families earning more than three times the poverty threshold” (CBO).This point does not seem to be appreciated by the general public. Gains to households currently in poverty would move 900,000 people out of poverty out of a total of 45 million people in poverty (CBO).

How many jobs would be lost due to higher minimum wages, and who loses them is more difficult to measure (Neumark and Wascher). The CBO showed a loss of 500,000 jobs as a result of the proposed increase in the minimum wage from $7.25 to $10.10. Job losses are likely to fall predominantly on young and part-time workers. Prior to the introduction of the minimum wage in the 1930s, there was no significant difference between teen age and overall unemployment rates, but since then teenage unemployment has been continuously higher, and typically when the minimum wage has been increased the teenage unemployment rate has risen relative to the overall rate.

Thomas MaCurdy (2015a, 2015b) has tried to separate the job loss effect from the other effects of the minimum wage. He analyzed the most favorable case for a higher wage by assuming no jobs would be lost and employers of minimum wage workers would not reduce their total output. What remains is the favorable effect on some impoverished households from higher earnings relative to the unfavorable effect on all poor households from paying higher prices. He found that the net effect of a higher minimum wage on poor households was negative, because the gains from higher earnings accrued to a small percentage of poor households, but the losses from paying higher prices were borne by all poor households.

EARNED INCOME TAX CREDIT AS AN ALTERNATIVE TO THE MINIMUM WAGE

The minimum wage is usually justified as an anti-poverty policy, but it suffers from two problems. (1) It discourages employers from hiring and retaining low-skill workers, and (2) it is poorly targeted toward low income households. Relative to these issues, a superior alternative is the Earned Income Tax Credit (Buffett, Tax Policy Center). It rewards people for working, and it can be targeted to households at specific income levels. If has been in place for 40 years, and it can be adjusted to any level of desired benefits. Most proponents think of it as a superior alternative to a higher minimum wage, but the Obama administration has proposed higher levels for both policies (U.S. Department of Treasury).

It is possible that a higher minimum wage could reduce inequality of income, even if it does not reduce poverty. However, since minimum wage workers are spread evenly among rich, middle income, and poor households, that outcome seems unlikely. MaCurdy (2015a) divided households with minimum wage earners by quintiles, and the richest 20% of households gained approximately the same amount from higher minimum wages as the poorest 20%. As consumers, poor households were harmed more because a higher percentage of their budgets were spent on goods and services whose prices were raised by the minimum wage. We do not have good evidence on the distribution of job losses by household income. A more fundamental problem is that there is no unambiguous optimal distribution of income. Presumably some egalitarians would favor lowering the share of the richest 20% of households and raising the share of the lowest 20%. But what if a policy change lowered the share of the richest 20%, but all of the income lost by the richest 20% was transferred to the next richest 20%, with no effect on the lower 60%. By some measure, that would be a reduction in inequality, but is it a clear improvement?

LEGAL MINIMUM WAGES IN THE EUROPEAN UNION

What has been the experience with the minimum wage in other countries? The United States has a federal minimum wage that covers all states, but it allows states and cities to have higher minimum wages. In the European Union, there is no single minimum wage for the entire Union, but instead there are national minimum wages that vary substantially across countries. Six countries (Austria, Cyprus, Denmark, Finland, Italy, and Sweden) currently have no legal minimum, and Germany had none until 2015. It is not easy to compare EU countries with and with legal minimum wages, because all countries without a legal minimum have some form of collective bargaining that may have some effect on the pattern of wages. The chart below shows the levels (in Euros per month) in 2014 for EU members that have legal minimum wages.

Figure 1

Translating EU minimum wages into U.S. dollars per hour is influenced by variation in hours worked per month and changes in the dollar/Euro exchange rate. For example, the dollar value of Euro minimum wages has decreased considerably from January 2015 when the exchange rate was $1.21 per Euro to June 2015 when the dollar appreciated to $1.09 per Euro. The highest legal minimum is in Luxembourg, where its minimum wage is more than ten times the lowest minimum wage in Bulgaria. If we consider only larger countries, such as France and Germany, their minimum wages are about five times the minimum in Bulgaria. These large differences in legal minimum wages are correlated with differences in income per capita and in average wages across member countries. Luxembourg has the highest income per capita and the highest average monthly wage and Bulgaria has the lowest income per capita and lowest average wage. According to Hanke (2014), EU countries with a minimum legal wage on average tend to have significantly higher unemployment than those without a minimum wage. This is in particular true for youth unemployment levels. At the same time looking at the subset of EU countries that do have a legal minimum wage we found no significant correlation between minimum wage levels and unemployment rates. This result might occur if governments set minimum wage levels about the same percent above equilibrium levels that would prevail for wages of unskilled workers in absence of a legal minimum. It would be interesting to see how higher minimum wages would affect poverty in the EU, but we are not aware of studies of European labor markets comparable to that of MaCurdy for the U.S.

CONCLUSION

Higher minimum wages have been proposed to reduce poverty in the U.S. However, in the U.S., the total value of the gains to poor households is limited by the fact that most minimum wage earners are not part of impoverished households. Conversely, all poor households are harmed by higher prices paid for products produced by minimum wage labor. MaCurdy’s (2015a) analysis indicates that the net effect of higher minimum wages would be unfavorable for impoverished households, even if there are no job losses. To the extent that some poor households also lose jobs, their net losses would be greater.

EU minimum wages vary substantially across countries in contrast to the uniform federal minimum in the US. Some countries have no legal minimum. The pattern of legal minimum wages is consistent with the hypothesis that countries keep their legal minimum wage not far above the equilibrium wage for unskilled workers that is highest in countries with highest incomes and highest wages. At the same time data shows that EU countries with a minimum wage have higher unemployment levels than those without a minimum wage.

REFERENCES

Buffett, Warren. 2015. “Better than Raising the Minimum Wage”.  Wall Street JournalWi. May 22.

Congressional Budget Office.2015. “The Effects of a Minimum Wage Increase on Employment and Family Income”. February.

Economist.2015. “Economics of Low Wages”. May 2, p18.

Hanke, Steve H. Let the Data Speak: The Truth Behind Minimum Wage Laws. Cato Journal. 2014

Hipple, Steven. 2010. “Self-Employment in the U.S.”Monthly Labor Review

Neumark, David, and William L. Wascher. 2010. Minimum Wages. Cambridge: MIT Press.

MaCurdy, Thomas. 2015a. “How Effective is the Minimum Wage at Supporting the Poor? Journal of Political Economy 123(2):497-545.

MaCurdy, Thomas. 2015b. “The Minimum-Wage Stealth Tax on the Poor“.  Wall Street Journal, February 22.

News and Observer. 2015. “Los Angeles Passes $15 Minimum Wage”. May.

Tax Policy Center. 2015. “Taxation and the Family: What is the Earned Income Tax Credit””. 2015.

U.S. Department of Labor, Bureau of Labor Statistics. 2014. “Characteristics of Minimum Wage Workers, 2013. BLS Report 1048, March.

U.S. Department of Treasury. 2014. The President’s Proposal to Expand Income Tax Credit. March (2015 is 40th anniversary of EITC).

Wall Street Journal.2015. “Overtime Pay for Answering Late-Night Emails?” February 21.

9 Responses to “Is the Minimum Wage an Effective Way to Reduce Poverty or Inequality?”

burkbraunJune 3rd, 2015 at 2:49 pm

I find the advocacy of the EITC puzzling. Sure, employers like Buffet like it because it reduces their costs and does not come out of their hide. Why should it be good public policy, however, to have taxpayers pay people who are putatively employed and earning a "living"? It makes no sense to me. It is like Walmart telling its employees how to apply for food stamps- again, not good public policy, at least not for the rest of us. It simply supports feudalism.

The proposition of income loss for the poor due to price rises /wage increases is also problematic. Firstly, the author, as a WSJ contributor, is immediately cast as biassed, ideological, and unscientific. Many other studies have found very few harmful economic effects from minimum wage increases. If all the costs of the increased wage were passed on to prices, the net effect, in theory, would be seem to be beneficial, since it is a competition between the rate of poor people making the minimum wage (very high), and the rate of sales from their workplaces to poor people (probably less high). Though all this can be turned on its head if you call the poor lucky duckies, of course!

Conscience WarriorJune 3rd, 2015 at 4:05 pm

The US could credibly relax minimum wage laws, in emulation of European countries, if we were willing to move toward 20th- and 21st-century European-style labor protections, and away from "you're on your own, pal"-style laissez-faire policies.

ThomasGrennesJune 3rd, 2015 at 5:07 pm

Yes, minimum wages are ineffective ways to either reduce poverty or inequality. The earned income tax is just one way to transfer income without discouraging work. However, be careful about generalizing about European countries. There are huge differences in current minimum wages within the EU and also large differences in the levels of other safety net policies. You may be thinking of high income countries, such as Sweden that has no minimum wage but generous safety net policies. However, the more recent additions, such as the Baltic countries, Romania, and Bulgaria are much poorer and have less generous safety nets.

ThomasGrennesJune 3rd, 2015 at 5:25 pm

EITC is superior to the minimum wage in achieving the same goal without adverse effects on employment and better targeting of low income workers. Whether using the government to transfer income is a broader question.

Criticizing someone's idea because it appeared in the WSJ is a low blow. MaCurdy also has a more technical paper in a professional economics journal that provides statistical justification for his results. The survey by Neumark and Wascher also reviews the technical literature. You may be thinking about some disagreement about the size of the disemployment effect. That is why MaCurdy puts that issue aside and concentrates on the small benefit to minimum wage workers relative to other workers. Also the CBO paper concludes that most of the benefits go to people not in poverty. There is not much disagreement about minimum wage workers being heavily young and part-time.

Leave a Response