By Ron Prettiman and Jenn Weir
For Dr. Doina Vlad
Principles of Macroeconomics
SEC 102-98
Seton Hill University
December 20, 2007
Introduction
The federal minimum wage law has been around for more than 70 years. Earlier this year, it was increased to $5.85 per hour, with future increases planned for 2008 and 2009. Like other government policies, minimum wage does not come without controversy. While its purpose is to help our lowest paid members of society to maintain a standard of living and to escape poverty, many argue that it creates joblessness and increases welfare participation, thereby hurting those who it was intended to help. Others argue that since it raises the cost of labor it will also raise the costs of our goods and services, thus causing inflation. In order to determine whether the minimum wage law actually serves its purpose, it is important to understand who actually benefits from minimum wage and what effects it has on the economy.
History of Minimum Wage
In order to understand the controversy about the increase of minimum wage today we need to take a look at how the minimum wage was created and what economic and social impact it had on our society almost a hundred years ago. At the turn of the twentieth century our country was in an industrial revolution where there were enough jobs for every man, woman, and child willing to work. Of course the working conditions were terrible and the wages were even worse. Basically the wages were what ever the company could get away with, paying men an hourly wage of $0.20 per hour, women $0.12, and children $0.08. In the state of Massachusetts around 1910 at a textile mill that was employed by mostly women, there was the first strike by employees for higher wages and better working conditions. The strike did not work, but in 1912 a commission was formed which recommended a non-mandatory minimum wage for women and children after a social outrage due to newspaper reports of the strike. The minimum wage was actually designed to stop the abuse and the unfair wages for the underage children used in the mills. This did not work either but in approximately1920, there were minimum wage laws passed in thirteen states and the District of Columbia. But because of the influence of business owners, the United States Supreme Court ruled that the minimum wage laws were unconstitutional. The court believed that a mandatory wage would interfere with the negotiations of wage contracts with the employees and the business owners.
The first attempt for establishing a national minimum wage was in 1933 as apart of the Nation Industrial Recovery Act which enacted a $0.25 per hour standard rate in the United States. In 1935 the United States Supreme Court ruled that this act was unconstitutional and the minimum wage was once again abolished. During the depression and the continued decline of economic conditions, the Fair Labor Standards Act in 1938 re-established the compulsorily minimum wage requirements at $0.25 per hour ($3.58 in 2006 dollars), roughly 40 percent of the actual hourly rate. Even though this was a very low hourly rate and only applied to a limited number of workers, there was substantial negative employment from the very beginning. The government estimated that between 30,000 and 50,000 jobs were lost as a direct result of the Fair Labor Standards Act. In Puerto Rico, since the laws applied there as well, there was a 70 percent decline in the export of needle work as a result of enforcing the minimum wage act.
There were additional provisions in the Fair Labor Standards Act which provided additional increases in the minimum wage over a designated period of years. The original $0.25 per hour rate was to begin October 24, 1938, which would be in effect for a period of one year. This would be followed by an increase to $0.30 over the next six years and in 1945 was adjusted to $0.40 per labor hour. After this, the rate went unchanged until about 1950 where the wage was increased to $0.75 per hour, which represented about half of the average hourly wage. The rate continued to increase through the next couple of decades until 1968, where the minimum wage was adjusted to $1.75 per hour (in today’s dollars would represent about $9.47). This date was significant because at that point in time, the real dollar value of the minimum wage decreased due to the constant increase in inflation. In 1997 the wage was increased to $5.15, from a rate of $4.25 in 1991, which was the last increase enacted by Congress.
President Bush has recently signed a bill that was passed by Congress that will increase the minimum wage by $2.10 and has come into affect May 24, 2007. The increase will be in three increments: the first increase of $0.70 would occur by the end of summer in 2007 bringing the wage up to $5.85 per hour; in the summer of 2008 an increase of another $0.70 will make the wage $6.55 per hour; and the final increase of $0.70 will bring the minimum wage to $7.25 by the summer of 2009. This minimum wage increase will affect the earnings of 13 million American workers or 9.8% of the workforce (including minimum wage, below minimum wage, and low hourly wage earners). Since its first enactment, it has sparked a debate between the political parties over the effects it will have on the economy and unemployment.
Minimum Wage Controversy
United States Representative (Texas) and Democrat Sheila Jackson Lee is a strong supporter of the Fair Minimum Wage Act, which was passed by Congress earlier this year. In the March issue of Congressional Digest, Jackson Lee defends her stance on why America is in need of a boost to the minimum wage . She believes that increasing the minimum wage “is likely to have a greater impact on reducing poverty” (Jackson Lee, 93). She also believes this increase will help women, single parents, and minorities by offsetting the rising costs of health care, oil, and education.
According to Jackson Lee’s statistics, “an estimated 6.6 million workers (or 5.8 percent of the workforce)” would benefit from an increase to minimum wage (Jackson Lee, 92). She also describes something called “spillover effects,” or ripple effect, where people earning within a dollar of the minimum wage could also see an increase in their pay – another “8.2 million workers (or 6.5 percent of the workforce). So far, according to Jackson Lee, the minimum wage increase could potentially help up to 14.8 million workers (or 12.3 percent of the workforce) to earn better wages.
Another United States Representative (California) and Democrat George Miller makes a significant point about why it is necessary to increase minimum wage. Also in the Congressional Digest, he says, “They [minimum wage workers] have been working at a 10-year-old minimum wage but they have been paying 2007 bread prices and milk prices and energy prices and rentals. Where is the decency?” (Miller, 78-79). As you can see from the following graph, minimum wage began to lose real spending power in the early 80’s because of the increase in the Consumer Price Index.
Another United States Representative (Illinois) and Democrat, Jan Schakowsky, contributes further support for the raise in minimum wage. She asks how it came to be that people who take care of our children and aging in daycares and nursing homes are only paid $5.15 per hour while CEOs of large corporations make up to 1,025 times that amount. She reasons: “Those CEOs must really be special compared to the woman who changes their mothers' diapers or cleans their toilets. If she is a single mom with two children, she has to work three minimum wage jobs to provide for her family, according to Wider Opportunities for Women” (Schakowsky, 88).
Unfortunately, Ms. Sheila Jackson Lee’s numbers are exaggerated and the other two Representatives are misinformed as to the extent of this problem. She suggests that roughly 14 million workers or 12% of the working force earns low wages and she portrays them as adult, minority, single mothers who work hard for little pay to support their children. However, according to Bureau of Labor Statistics, her construal of the minimum wage earner is a little skewed.
The Department of Labor and Bureau of Labor Statistics web site reports that 75.6 million Americans were paid hourly in 2006 (almost 60% of the workforce). Of those 75.6 million hourly workers, only 1.7 million (or 2.2%) made minimum wage or less (some restaurant employees or employees in training make less). 1.7 million is a far cry from the 6.6 million Rep. Jackson Lee suggests in the Congressional Digest. Her claim of several million people earning a low minimum wage doesn’t seem to be factual.
Reps. Jackson Lee and Schakowsky paint a picture of a poor minority woman who struggles to make ends meet. The Bureau of Labor Statistics web site defines a much different person. About half of minimum wage earners (or those earning less) were ages 25 or younger; one quarter were ages 16-19. So, of the 143,099,000 some odd people who worked last year, only about ½% or 850,000 workers who earned minimum wage were actually over the age 25. The BLS reports that most minimum wage employees work part-time (less than 30 hours per week) and have never been married. Also, only 2% of hourly wage workers were black or Hispanic. Thus, the typical minimum wage earner appears more likely to be a high school or college student than a single mother raising children in poverty. A person struggling to feed a family would not choose to work part time. And, in these times of low unemployment, it seems unlikely that someone would have to settle for part time work.
According to the graph below created by the Employment Policies Institute, a majority of minimum wage earners live with their parents.
So who will benefit from the minimum wage law and the recent increase in the minimum wage rate? If employers will have to pay all employees prevailing minimum wage (whether high school student, college student, or struggling single parent), will they still look to the inexperienced and less educated or will they eliminate many of these unskilled labor positions altogether? In order to answer that question, it is important to understand the economic laws and their effects on the labor market.
The Negative Effects of the Minimum Wage Law on Unemployment
The effect due to the increase of the minimum wage is a typical example of the law of supply and demand. This law states that when the price of a product or service increases the demand decreases, the same thing happens in the job market where the price of labor goes up, the demand for that labor decreases.
This does not affect the majority of workers because their wage is above the minimum wage, but it does affect the teenagers and the minorities because of their low skill level and little work experience. These workers need to find entry level jobs in order to gain experience for finding a better paying job, to develop good work habits which enables them to become a more productive employee, and to create a sense of independence with self reliance to become meaningful member of society. Usually entry level jobs in the first year receive an average raise of 14 percent and move out of the minimum wage in nearly two-thirds of the workers. These opportunities will be taken away from them when small business is unable to afford the wage increases because they can not justify the low productivity entry level workers and the amount of training it will take to make them more productive. Most studies conclude that for every 10 percent increase in the minimum wage, the teenage employment decreases by 1 to 3 percent. If you figure that the minimum wage will increase by 41 percent that means that the teenage unemployment will decrease by 4 to 12 percent.
The other problem that politicians forget to inform the public is that the people most likely to lose their jobs are the least educated; if all things being equal would an employer rather lay off someone with or without a high school diploma? A high minimum wage encourages teenage students to drop out of school and take jobs away from the less educated labor force. This also decreases the competitive workforce by encouraging people to enter the job market instead of pursuing a higher education. With the minorities being the ones with less education, or the lack of an English speaking parent at home, it is usually the poor minorities that suffer the most, The additional problem that the increased minimum wage encourages is racism. If by chance an employer is racist and now has to pay everyone the same wage, instead of hiring minorities at a lower rate, he will choose to hire the whites instead of the Mexicans or Hispanics.
There is also a ripple effect in raises for people who make more than the minimum wage in business. The people who make a wage just above minimum wage will be looking for a raise in order to justify their position in the company, which will set off a chain reaction for every other employee in that company. So now you have everyone making $2.10 more an hour, where does this money come from? If you raise the price of your product to pass along these wage increases, the company has a chance of losing their share of the market, but if you don’t raise the price then the increase will have to come out of your profits, which is not a good business practice either. Faced with these options the employer will either reduce the minimum wage positions and keep the current wage structure, or put a freeze on hiring as people retire which will put more pressure on the existing employees to work harder and produce more. Some of these problems will affect small business from being competitive with larger companies and will eventually go out of business. The exception to this negative ripple effect is the employees that are part of a union, their wage scale is based on the minimum wage and as soon as the wage is increased, everyone that belongs in that particular union gets a raise. This is one of the reasons that the large unions constantly lobby the politicians for the minimum wage increase.
The Negative Effects of the Minimum Wage Law on Poverty
Another area where the minimum wage law has gone awry is in addressing poverty. Minimum wage was designed to protect our lowest paid and entry level workers and keep them from needing to rely on welfare. Often unskilled, sometimes uneducated, minimum wage earners are paid just above the national poverty level, presently $10,210 for a single person . The most recent minimum wage increase was the first in over ten years. Prior to July 2007, minimum wage employees were earning only $5.15 per hour – hardly enough to support one person, let alone an entire family.
For those people who must support themselves or their families on low incomes, workers must evaluate whether it is better to seek a minimum wage job with little benefits or apply for public assistance. In many states, the value of cash assistance, food stamps, and Medicaid health coverage is worth more than the minimum wage.
In 1995 Michael Tanner, Stephen Moore, and David Hartman published a paper that examined the dollar value of welfare benefits and compared it to the minimum wage. For example, in Pittsburgh, Pennsylvania, the 1995 value of public assistance benefits was $17,189 annually or about $8.43 per hour – tax free. These benefits included: cash assistance, food stamps, Medicaid, housing assistance, utilities assistance, the WIC nutrition program, and the free commodities program. At that time the minimum wage was only $4.25 per hour. Obviously, a person eligible for welfare benefits has little incentive to work a minimum wage job.
Value of Welfare in Selected Cities, 1995
City, State Welfare Benefit Level($)a Local Income Tax Rate (%)b Pretax Income Equivalent($)c Hourly Equivalent
New York, NY 23,743 4.20 30,700 14.76
Baltimore, MD 19,543 2.50 23,600 11.35
Detroit, MI 18,580 3.00 22,700 10.91
Indianapolis, IN 18,260 0.70 21,100 10.14
Cleveland, OH 17,631 2.00 20,000 9.62
Pittsburgh, PA 17,189 2.88 20,000 9.62
In a transcript of a Congressional testimony presented by Joanne Spetz, research fellow of the Public Policy Institute of California, to the United States House Committee on Education and the Work Force, expounds upon the effects of minimum wage. She and her coauthors found “… that a 10 percent increase in minimum wages is associated with a 2 percent increase in welfare caseloads” (PPIC, 1) . Spetz explains the reasons for this positive increase as being a reduction in job openings and increased competition for higher paying minimum wage jobs. Instead of enticing people to enter the labor force and keep people out of poverty, minimum wage increases keep people on welfare and force more people to apply for public assistance benefits.
Recommendations
It is difficult to make recommendations on a situation that seems to have no answers. This problem will not go away because in our free society there will always be a segment of the population at the bottom of the financial curve. This is part of the inherent system of democracy which provides the opportunity for each of us to become successful, but all at different levels.
Perhaps instead of minimum wage increases, the government could implement a program giving training and education incentives, thereby enabling people to earn higher wages. The government could also allow tax incentives for businesses to operate apprenticeship programs. This would afford employers the ability to train workers for entry level positions instead of eliminating them.
A “living wage” versus a minimum wage might be more practical. Instead of random increases at the whim of our politicians, a living wage could be set by local Consumer Price Indexes instead of establishing a wage across the board for the entire country. There also needs to be an evaluation of the welfare system to see if there are real incentives for people to look for work instead of government transfers.
Finally, there ought to be a resolution of how we make foreign immigrants a legal productive part of our society and to integrate them into our workforce. While it is a noble obligation to help the poor and disadvantaged, it should be approached in such a way that these people are helping themselves, regardless of political agendas.
Conclusion
After reviewing all the facts and figures we have come to the conclusion that the decision to raise the minimum wage is more politically motivated than a moral justification to help the poor. Throughout history it has been proven repeatedly that by raising the minimum wage the outcomes are harmful to the economy and the people that it was intended to help. There is a direct relationship between minimum wage increases and a higher level of unemployment and an increase to welfare caseloads. This increase in unemployment affects the poor and the disadvantaged by not allowing the job market to hire the teenagers and minorities at the entry level positions. The minimum wage increase also puts a financial burden on businesses because of the ripple effect it will have with the wage structure of the higher paying positions. The end results will be the elimination of low level job positions which could eventually disrupt the labor force and cause a recession. The minimum wage increase sounds like the right moral decision to make, but with the economy slipping into a potential recession, this act could add the fuel to the fire that would make the recession a reality.
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