The Region

A Higher Minimum Wage-A Mistake Waiting to Happen

Guest Editorial: Preston Miller, vice president and economic advisor, discusses the merits and demerits of an increasing minimum wage.

Preston J. Miller - Former Vice President and Monetary Adviser

Published September 1, 1999  |  September 1999 issue

The guest editorial is a new Region feature in which authors are encouraged to share their thoughts on current economic policy issues. The Region will consider unsolicited submissions for publication.

A higher minimum wage has been proposed by the president, and it is sure to be passed into law by the Congress. The minimum wage is expected to be raised over two years from the current $5.15 an hour to at least $6.15 an hour. What a shame! This is bad policy.

Critics of the minimum wage commonly maintain that, when it is effective, it raises the cost of labor and lowers employment. Moreover, they cite statistics that suggest well over a half of the beneficiaries of a higher minimum wage are not members of low-income families. While I agree with these criticisms, I am against the minimum wage policy for a more basic reason: It interferes with the operation of a well-functioning market.

If recent global economic developments have taught us anything, it is that free markets work well and messing with them can be extremely costly. A large share of the blame for the Asian financial crisis goes to government interference in the banking and financial sectors, which led to an excessive amount of credit that was inappropriately allocated. A large share of the blame for the high unemployment rates that prevail in Europe goes to governmental interference in labor markets, such as high minimum wages and policies designed to protect jobs-all of which make hiring employees more expensive to employers. In contrast, the United States has performed wonderfully, whether we refer to financial markets, labor markets, output or prices. Much of the success is due to our letting markets work.

The United States has been a leader in developing and using a plethora of new technologies, and the nation has taken advantage of these technologies by letting the private sector adapt to them in an almost unfettered way. The private sector determined where new investment money should be directed, what form of industrial organization would best make use of the new technologies and how workers should be shifted out of industries using obsolete technologies and into industries using the new technologies.

The dynamism in U.S. labor markets has been amazing. Each week on average in the current recovery and expansion period, roughly 350,000 workers have been separated from their jobs, while roughly 400,000 job seekers have found new ones. This process of job destruction and job renewal (a process Cox and Alm call "churning") has allowed workers to be moved to where they are most productive-that is, to industries producing or using the new technologies. In the last few years, employment growth in industries producing information technology has more than doubled employment growth in all industries.

An important beacon to guide people seeking employment comes from the behavior of wages. Jobs related to new technologies tend to be highly productive and thus tend to pay high wages. For instance, the average salary for employees in industries producing information technology is nearly double that for all private employees.

Over the last decade or so, the structure of wages has sent a loud and clear message to Americans of all ages, but especially the young: Stay in school, acquire skills. That is because the reward for education and skills has risen at the same time that inflation-adjusted pay for high school dropouts and the unskilled has fallen. Most economists agree that the main reason for the change in wage structure has been the steady adoption of new technologies. These technologies, such as computers and robots, have substituted for lower-skilled and less-educated workers, while creating a greater demand for their operators, the more highly skilled and educated.

My case against a higher minimum wage is that it distorts the labor market's signals. A falling wage for lower-skilled and less-educated workers is saying that the economy needs fewer of these workers. In contrast, a higher minimum wage encourages more people to take the jobs covered by the minimum wage and so perversely increases the supply of such workers. Similarly, a rising reward to acquiring skills and education encourages students to stay in school. On the other hand, a higher minimum wage encourages students to take low-level jobs and thus not acquire more skills and education. In an empirical study for the United States, Neumark and Wascher found that a higher minimum wage very significantly increases the number of high school dropouts.

Some will say, this free market argument is fine in the abstract, but what about the ones left behind? Not everyone is capable of getting a college degree or becoming a programmer. That is true, but it is a problem that the market can solve, and is solving. Those who have the ability and desire will acquire the skills and education required so they can reap the rewards the market is offering. But as more acquire skills and education, those who cannot or do not desire to travel this path will find that their ranks have thinned. That is, the supply of workers with low skills or education will shrink, and a smaller supply will drive up their wage. This is, in fact, happening. Over the last year in the United States, the number in the civilian population with less than a high school degree has dropped by over 1.5 million, while the number classified as in the labor force with a college degree has increased by over 2 million. Meanwhile in Minnesota's Twin Cities of Minneapolis and St. Paul, where the supply of low-skilled and less-educated workers has been very tight, the starting wage for such employees is reportedly well above the mandated minimum wage. The market without any government interference is raising all boats.

So, the message is clear. The labor market is working. It is allocating labor in an efficient way. Don't mess with it. If the public desires to aid low-income families, don't do it by distorting market wages. Just give them money in more direct ways.

Preston Miller is currently on leave from the Minneapolis Fed, while he lends his expertise to the Congressional Budget Office in Washington, D.C.

References

Cox, W. Michael, and Alm, Richard. 1999. Myths of Rich and Poor: Why We're Better Off Than We Think. New York: Basic Books.

Neumark, David, and Wascher, William L. 1995. Effects of Minimum Wages on Teenage Employment and Enrollment: Evidence From Matched CPS Surveys. Working Paper 5092. National Bureau of Economic Research.

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