We are, once again, faced with the periodic debate about the effects on the general economy of a hike in the minimum wage.
Opponents argue that raising the wage leads to greater unemployment and harms the least productive. Proponents counter that the wage hike provides a modest boost for the economy since individuals at the bottom of the economic ladder will certainly spend the increased wage on other goods and services, thereby slightly stimulating aggregate demand.
While economists have long studied whether minimum wage increases affect unemployment, no serious correlation has been found. This is probably because the minimum wage has always been set at modest levels since its inception in 1938.
Measured in constant dollars (adjusted for inflation), the minimum wage was at its peak in 1968. The current rate of $7.25 per hour went into effect in 2009 and has been diminishing in buying power since.
President Obama is supporting the proposal of Sen. Tom Harkin (D-Iowa) to raise the minimum wage in three steps of $0.95 each to $10.10. This is not a real increase in the minimum wage but simply tries to maintain the purchasing power of the minimum wage.
The president further proposes to have the minimum wage indexed for inflation, the same treatment we give to income tax brackets. This would ease the periodic but recurring fights over the minimum wage.
Classical economic theory holds that a worker is paid (under the laws of supply and demand) in accordance with the worker’s relative productivity. If the marginal productivity of a worker is higher than his or her wage, the employer will raise the employee’s pay or the employee will find work elsewhere where the pay is on par with productivity.
However, many recent economic studies show that from the end of World War II to the end of the 1970s, increased productivity and increased wages went hand in hand. Since that time, productivity has increased at a much higher rate than wages.
Furthermore, some studies have shown that the after-tax rate of return on capital investments has exceeded the growth in productivity during the same time period.
No doubt, these overall trends are due, at least in part, to international competition, more open markets and the fact that the economic benefits of technological improvements, at least at first, accrue to highly skilled individuals.
I do not argue that Congress can raise everyone’s living standards simply by passing a law. In the long run, the more skilled the worker, the more compensation he will earn. Improving the skills of the U.S. workforce is the best long-term antidote to poverty.
Some may argue that increasing the minimum wage would provide more incentive for mechanization, but the rush to mechanize production of unskilled labor began over a century ago. Modest changes in the minimum wage will not affect the mechanization process.
However, the free market system is loaded with imperfections. If the market system were perfect, there would be no gap between worker’s pay and productivity.
So providing a floor for the least-skilled is a small-scale “distortion” of the market that can marginally improve people’s lives and provide them slightly more purchasing power. This seems like a reasonable trade-off, in light of the fact that many people of modest income have a hard time making ends meet. We should not permit a system in which individuals who work full time cannot afford to live.
The minimum wage will never be a panacea for this moral and economic dilemma, but it is a modest step in building a safety net for these workers, at little perceptible damage to the overall economy.
Richard Nordan of Raleigh is a CPA and attorney, concentrating in estate planning and taxation.