Why A Higher Minimum Wage Doesn't Kill Jobs

Freshman year economic theory doesn't apply.

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Momentum is building for raising the minimum wage. But opponents of the minimum wage say that raising it will kill jobs. So what’s the reality here? How do we sort out the conflicting claims?

Let’s face it: The opponents’ argument has a certain logic to it. It’s Economics 101: When the price of something goes up, people buy less of it. In this case, they argue, if the price of labor goes up, business owners will buy less labor. They will hire fewer people, which means employment will fall. The hardest hit will be the workers in low-wage, low-skilled jobs – the same workers that minimum wage laws are designed to help.

It’s a plausible account, even though it doesn’t explain what actually happens. Nevertheless, we owe it to ourselves to understand just why the conventional Economics 101 idea doesn’t apply.

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First, let’s deal with the confusing range of studies that have been brought forward by advocates on both sides. Unfortunately, many of the studies are biased. Some are funded by partisans on the right, such as a restaurant trade association. Others are funded by partisans on the left. But the strongest studies are large and honestly done. They look at what happens when one state raises the minimum wage and a neighboring state doesn’t. They examine employment along the border between the two states, and they contrast what happens in directly adjacent areas with similar economies and similar demographics.

The most robust and carefully conducted studies actually show little if any decrease in employment as a result of raising the minimum wage. Some show no decrease at all. Others show a small and narrowly focused decrease: a low, single-digit percent drop in employment concentrated in industries that are predominantly low-wage, notably fast-food. And within those industries, the effect is concentrated on those with the lowest skills, such as teenagers.

So why is conventional economic wisdom wrong? Why doesn’t raising the minimum wages kill jobs? It’s hard to say for sure, but several factors appear to explain the difference:

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1. Employers don’t have much flexibility to reduce staff without cutting their revenues: In the conventional Economics 101 narrative, people switch their buying habits when prices change. If apples become more expensive, you don’t eat less; you simply buy more oranges or grapes and fewer apples. But if you’re running a fast food restaurant, you don’t have that option. You can’t offshore the fry cook’s job to China. You can’t replace the cashier with a robot. You’re not going to diversify into a new line of work like tax preparation, with staff who are unaffected by the minimum wage law. No, the typical fast food owner will retain most of his or her minimum wage employees and compensate by investing in better equipment and work processes that make them more productive. The owner will pass through a small price hike to cover the remaining cost.

2. Higher minimum wages stimulate the local economy and bring in more business: When low-wage workers get a raise they usually spent it rather than sock it away in a mutual fund. In many cases, they will spend the money in the same places that hire a lot of low-wage workers: They spend it in fast food restaurants and low-end retail chain stores which account for many of America’s minimum wage jobs. So these stores get more business, which offsets much of what they lose by paying higher wages.

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3. Better-paid employees are more productive and loyal: When employees are paid more, they value their jobs more. They work harder and more productively. They have a better attitude, which means they provide better, friendlier customer service. They are less likely to quit. All of this helps the employer by reducing turnover and training costs, and making customers happier and more likely to return.

4. The minimum wage in the U.S. is quite low to begin with: The risk that a minimum wage hike would reduce jobs depends on the starting point. In France, for example, unemployment among youth is terribly high, in the range of 26 percent. This has been blamed on its minimum wage. But France’s minimum wage is more than 60 percent of the French median wage, so the portion of jobs affected is vastly higher. And France has other structural constraints in its economy that the U.S. does not have; for example, it‘s much harder to lay off workers in a downturn, which makes employers reluctant to add to payroll. In contrast, the U.S. federal minimum wage is 38 percent of median income, which is among the lowest levels in the developed world.

The minimum wage debate reminds us that what sounds good in economic theory does not necessarily turn out to be true in the real world. Raising the federal minimum wage from its current low level would have little if any effect on jobs and employment, while dramatically helping those who labor in these jobs. It’s easy to see why the oversimplified ideas of freshman economics fail to explain the opportunity.