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A minimum wager

Will a rising wage floor lift all workers, or put too many in the unemployment line?

March 1, 2007


Joe Mahon Director, Regional Outreach

For Dave Homstad, the grass always looks greener on the other side of the river.

"Quite frankly, being in Minnesota, we're at a disadvantage," said the owner of the Blue Moose restaurant in East Grand Forks.

Not only does Homstad have to pay his wait staff a higher minimum wage than businesses in Grand Forks, N.D.—$6.15 rather than the federal requirement of $5.15—but under Minnesota law, he can't pay a below-minimum wage to tipped employees like North Dakota businesses can, even though those employees often pull in more than $18 an hour after tips.

Homstad claims that differences in wage rates between the two states made him consider moving to Grand Forks after a devastating flood in 1997. "The temptation definitely was there," he said. "But at that time the minimum wage difference wasn't quite as bad. If I'd have known what Minnesota was going to do three or four years down the road after that, I probably would have considered it a lot more, to be quite honest."

Soon, however, North Dakota's lower minimum wage may exert less of a pull, thanks to the push by the new congressional majority in Washington, D.C., to increase the federal minimum wage to $7.25 an hour by July 2009.

For some, the change is long overdue. Since the last increase 10 years ago, the value of the federal minimum wage has fallen about 17 percent. Adjusted for inflation, the federal minimum now sits at its lowest level since 1950. At the peak of its value in 1968, the federal minimum wage was equal to almost $10 an hour in today's dollars.

This perceived lack of action on the part of the federal government has caused 29 states to raise their own minimum wages, including some in the district (see table). Now fully 80 percent of hourly workers nationwide live in states with minimum wages higher than the federal guideline, as opposed to 5 percent in 1997.

Table: Minimum Wage Laws in District States

It's fair to ask why the federal minimum should be raised at all, since the states have done a pretty good job of keeping up with the times. Supporters of the legislation say it's an important new benchmark, and it will help the working poor in those states that have not yet raised their minimum wages.

Others disagree strongly with this view. They argue that the minimum wage is, at best, an indirect way to help poor families and, at worst, could actually hurt some of the very people it is intended to help by putting them out of work.

Economists' opinions vary on this issue. While virtually everyone agrees that raising the minimum wage much higher—say, to $15 an hour—would cause more harm than good, there is a debate over whether the moderate increase proposed would be a good policy on balance. The first step in assessing the validity of arguments for and against a minimum wage hike is understanding who earns the minimum wage.

Toiling for the minimum

Some critics point out that many minimum wage earners are middle-class teenagers living with their parents, but advocates point to the plight of single mothers who can't earn enough to get by. So who makes the minimum wage anyway?

This can be a difficult question to answer for the Ninth District, because detailed statistics by state are hard to come by and, as noted, some states have created differing wage tiers. Still, many of these state laws are recently enacted, and the U.S. Bureau of Labor Statistics (BLS) has analyzed Census Bureau data for the national workforce. And data available for individual states follow the national picture pretty closely.

The most striking characteristic of minimum wage workers is how they break down by industry. As a rule, low-wage earners perform work that yields low returns, so employers aren't willing to part with as much for the service.

In Minnesota, a restaurant worker is nearly 18 times more likely to earn the minimum wage than a hospital worker, according to research by the state's Department of Labor and Industry. The highest share of minimum wage earners in the state work in food preparation and service; nearly 30 percent of those making the minimum work in this industry. The Wisconsin Labor Standards Bureau reports that about one in four of the state's workers earning $5.15 or less in 2005 worked in a restaurant.

However, these food-industry labor figures come with an important caveat; since most wait staff earn tips, a lot of them take home much more than the minimum wage. Homstad said his servers are "the best-paid people in here. They make more money than I do, and I own the place." Industry surveys indicate that nontipped employees at restaurants—cooks, dishwashers, hosts—usually make a few dollars more per hour than wait staff. Fast food servers and cooks make a little more than the minimum wage on average, according to the BLS.

Other industries with high percentages of minimum wage earners include hotel and accommodations, retail, agriculture and private household services. But none of these comes close to the food service industry in sheer numbers of minimum wage earners.

Another fact that leaps out from statistics is how few workers actually earn the minimum wage. Over time, prevailing market wages have outgrown the regulation. Nationally, about 3 percent of hourly workers made the minimum in 2005, down from more than 8 percent after the last minimum wage increase in 1997.

In some areas of the district, it's hard to find anyone who makes the federal minimum. In South Dakota, a state with comparatively low average wages, only 2 percent of workers earn the minimum. Particularly in thriving metro areas, pay tends to be higher. In Minnesota, only 3 percent of the workforce in metro areas earns the state minimum; in rural areas it's about 5 percent. In some of South Dakota's poorer areas, such as Jackson, Tripp and Fall River counties, it's more than 6 percent.

Teenagers or single moms?

The fact that a relatively small portion of workers currently earn the minimum wage should give policymakers pause. A policy often framed as a poverty-alleviation tool must have a tangible benefit to the poor, but the fewer workers affected by the policy, the less tangible the benefit.

Analyzing the impact of a minimum wage hike involves counting not only minimum wage earners but also workers who make more than the current minimum but less than the proposed one. Federal employment statistics by state aren't that detailed, but minimum wage studies have been done at the state level.

In Wisconsin, an analysis by the state Labor Standards Bureau found that approximately 28,000 workers earned $5.15 an hour or less in 2005, out of a total workforce of about 2.9 million. In addition, about 150,000 workers, or 6 percent of the state's workforce, earn close enough to the minimum wage to be affected by an increase.

However, Wisconsin raised its minimum to $6.50 last year, which means many won't see much change in their wage. "I don't anticipate anything the feds are going to do will have much of an effect in the Midwest," said Bureau Director Bob Anderson.

Nationally, the U.S. Census Bureau estimates that raising the minimum wage to $7.25 will affect about 12 million U.S. workers who make less than that.

Who those workers are matters. Certain opponents of an increase correctly point out that most minimum wage earners are young people at the beginning of their working lives. Workers aged 16 to 19 years account for only 7.3 percent of all hourly workers nationwide, but make up 26 percent of all minimum wage earners. Fifty-three percent of minimum wage earners are younger than 24, and only 40 percent of those holding minimum wage jobs work at them full time.

Since many minimum wage jobs are entry level, those working them often don't spend much time at that pay. "Most minimum wage earners get a raise within the first year; 65 percent of them," said Jill Jenkins, chief economist at the Employment Policies Institute, an industry-funded think tank that opposes minimum wage increases.

There's a flip side to that 53 percent, of course—nearly half of all minimum wage earners are older than 25. Clearly, many people who have been working for low wages for years would benefit from an increase. But a closer look at employment and population statistics suggests that most of those likely to reap the rewards of a minimum wage increase are not the poor laborers and single mothers championed by advocates of a higher minimum wage.

An adult minimum wage earner might not be so poor if the pay of other workers in the household supplements his or her income. Consider workers earning less than $8.25 (about half the national average hourly wage), a group that comprises both minimum wage earners and those whose incomes are low enough to be affected by the proposed increase. Fewer than a third of these workers are the primary breadwinners in their households, according to Census Bureau estimates, and less than 10 percent are the heads of households below the poverty line. Since the majority of low-wage earners are not dependent on their own income and the vast majority do not head poor households, raising the minimum wage will not significantly aid the working poor.

But what about low-paid working single mothers who make such a strong emotional case for raising the federal minimum? About twice as many adult women as men make the minimum wage, in part due to their higher representation as food servers. But Census estimates show that only 8 percent of low-wage workers are single mothers, and fewer than 5 percent are single mothers under the poverty line. Most working single mothers are above the poverty line; their poverty rate is 21 percent. The majority of poor single mothers are unemployed.

The problem with using the minimum wage to fight poverty is that pay alone doesn't determine whether a person is poor. Technically, a single person working full time at the current minimum wage earns an income above the federal poverty line. With dependents, staying above the line is more difficult, but still possible. Just 15 percent of Minnesota minimum wage earners were poor in 2005.

It's also possible to earn much more than the minimum and still be poor, if the earner has several children and other dependents. In Minnesota, 91 percent of workers living below the poverty line earned more than the minimum wage. Other poor people may work part time or seasonally and, of course, many don't have jobs at all. So it seems unlikely that increasing the minimum wage will raise many of the working poor out of poverty.

In fact, research published by the Federal Reserve Bank of Cleveland in 1999 suggests that the minimum wage could exacerbate poverty. A modest increase in the minimum would certainly lift some households on the margin out of poverty. However, other households above the poverty line may be plunged below it if the higher wage causes them to lose their jobs. Even a minimal decrease in employment could wipe out aggregate income gains from a higher minimum wage.

Whether, or by how much, modest minimum wage hikes decrease employment in the real world is the subject of some contention among economists.

You're fired!

Economists, as a general rule, are skeptical of price controls. The role of prices is to communicate information about the relative scarcity and quality of commodities. Messing with the price mechanism diminishes its ability to efficiently allocate resources.

Examples of well-intentioned price controls gone awry pepper economics textbooks: Rent control in New York City in the 1970s, milk price floors in the Midwest in the 1930s and, of course, wage controls like the minimum wage. In a competitive market, price floors encourage producers to send more of a good to market than consumers demand, leading to an oversupply.

In labor markets, this logic means that setting a wage floor above the market level will increase unemployment, causing declines in consumption, greater social ills and increased spending on government services. If minimum wage increases cause a great deal of job loss, they probably make for lousy policy. So why did 659 noted economists, including five Nobel laureates, sign an open letter last fall urging Congress to raise the minimum wage to $7.25 an hour? It turns out that there is some disagreement in the economics community over the consequences of minimum wage increases.

Most of the current debate centers on the validity of the "new economics of the minimum wage" that sprang up in the mid-1990s. The details of the research can be esoteric, but the conclusions can be summarized more simply.

One group of economists looked into the data on past effects of minimum wage increases and found that the impact of wage hikes on employment was hard to discern and, in some cases, the opposite of what might be expected happened-employment in minimum wage industries actually increased.

These findings suggest that real-world labor markets suffer from frictions that prevent them from functioning as textbooks say they should. "That means that the wage isn't perfectly set in a competitive market, and so there's a little room for raising the minimum wage without an employment reduction," said Liz Davis, a labor economist at the University of Minnesota, who favors a minimum wage increase. This school of thought—that the minimum wage can be raised slightly without causing widespread job loss—figured prominently in congressional debates over the last minimum wage increase in 1997.

The response by other economists to this research was quick and harsh. They attacked the methods or data used and pointed to evidence that minimum wage increases do in fact reduce employment. Surveys of economists indicate a consensus that the price sensitivity of labor demand is quite low; a wage increase of 10 percent should cause low-wage employment to drop by about 2 percent. Doesn't sound like much, but it adds up. In Wisconsin, for example, a relatively modest 75-cent increase in the minimum wage would put about 3,600 people out of work. The corresponding figure in Minnesota is about 3,900.

Bracing for change

Job losses in the district may have occurred in the wake of previous minimum wage hikes—back in 2005 in Minnesota, for example, when the Legislature added a dollar to the minimum wage. But showing that employment actually fell is problematic for the same reasons economists have debated the unemployment issue for more than a decade: The available data are noisy.

It's difficult to tell if businesses lay off workers in response to minimum wage increases. Workers earning the minimum wage make up a small fraction of the total workforce, and any job losses tend to be obscured by swings in total employment caused by national economic conditions, seasonal fluctuations and other factors unrelated to the wage increase.

Similarly, statements by employers that a higher minimum wage would force them to fire people or delay hiring are suggestive but not conclusive. In a survey last fall by the National Restaurant Association, 41 percent of restaurateurs said they would cut jobs if the federal minimum wage were raised. For the record, none of the employers contacted for this article said that they planned to cut workers if $7.25 an hour becomes the new federal minimum.

But employers adapt in other ways to minimum wage increases—by raising prices, for example, or asking their current staff to work harder. "If I need them, we're going to have to hire them; I just need to make sure that when they're here they're working and that we're getting the most bang for our buck," said Monica Musich, owner of Valley Dairy gas stations and convenience stores in Minnesota and Wisconsin.

Homstad agreed. "I can't cut back any more. We'll probably have our servers with one more table than normal, just because we have to," he said.

Passing along the cost of increased wages to customers can be dangerous, because raising prices too much can drive away business. Employers must strive to strike the right balance between higher per customer revenue and potentially lower profits. "We will probably raise prices when the minimum wage goes up, and we'll probably lose some customers," said Rick Wizer, accountant and co-owner of Frying Pan restaurants in the Fargo, N.D., area.

Several business owners contacted were bracing for a general "ratcheting up" of wages following an increase in the federal minimum. Employees who make, say, $8 an hour may expect a proportional pay increase when minimum wage workers start making more. When Minnesota raised the minimum wage, Musich felt compelled to give raises to her North Dakota employees, some of whom also worked in Minnesota. "The problem you get is that it's not so difficult changing everybody that starts, but how do you adjust everybody else that feels they should get a raise too?" she asked.

However, there is very little empirical evidence for this ripple effect from past minimum wage increases—perhaps because it is difficult to tease out from earnings data or because the ripples diminish rapidly as they travel up the pay scale.

Winners and losers

All economic policies produce winners and losers, and the minimum wage is no exception. It's still an open question how much a federal minimum wage increase will help or hurt poor families.

Though some evidence indicates a small increase in the minimum will cause few job losses, there remains a tough trade-off: A small increase will yield small benefits, while a larger increase would have its greater benefits offset by greater job losses. If a program intended to benefit the working poor actually hurt them on balance by putting more of them out of work, it would be not only ironic, but also a failed policy.

A relevant issue is whether the winners win more than the losers lose. The Employment Policies Institute estimates that, on average, only about 10 percent of a minimum wage increase benefits workers, after accounting for higher taxes and benefits like food stamps and public housing that can be cut with higher incomes.

If that's the case, 10 cents is not a lot of bang for a buck increase in the minimum wage. So it's worth asking if there are better ways to accomplish the same goal of helping workers on the margin to become economically self-sufficient.

The minimum wage has natural appeal as public policy because it costs politicians little. It appeases some constituents who clamor for income redistribution but don't want to pay more taxes.

But if the goal is reducing poverty, there are more efficient means. A prime example is the Earned Income Tax Credit, a direct transfer payment to low-income families that doesn't distort wages. A recent study by the Congressional Budget Office suggests as much.

The study examined hypothetical alternative schemes to expand the EITC to provide the same benefit to poor families as the proposed federal wage hike. One option would increase payments to childless workers 50 percent, and the other would increase payments to workers with three or more children by 25 percent. The CBO found that either option would more effectively target families in need, even assuming no job loss stemming from a minimum wage increase. More money would go directly to poor families and less to the relatively well off.

Even economists who advocate raising the minimum wage admit that the EITC is a superior instrument of public welfare. In a survey of 95 of the economists who signed the statement advocating pushing up the minimum, a few indicated that they would prefer an expansion of the EITC.

"The [EITC] is a much better anti-poverty program." said Liz Davis. But given Congress' apparent enthusiasm for a higher minimum wage, the EITC isn't likely to be expanded anytime soon.

Joe Mahon
Director, Regional Outreach

Joe Mahon is a Minneapolis Fed regional outreach director. Joe’s primary responsibilities involve tracking several sectors of the Ninth District economy, including agriculture, manufacturing, energy, and mining.