How the Minimum Wage Destroys Jobs

Report Jobs and Labor

How the Minimum Wage Destroys Jobs

February 19, 1987 15 min read Download Report
Bruce E. Fein
Senior Research Fellow

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564 February 19, 1987 HOW THE MINIMUM WAGE DESTROYS JQBS INTRODUCTION Bruce Bartlett E.L. Wiegand Fellow Congress last boosted the federal minimum wage in 1977, gradually raising it to $3.35 per hour where it has been since 19

81. Thanks to inflation, the minimum wage, in real terms, has declined by 27 percent in the past six years minimum wage be raised. Congressman Mario Biaggi, the New York Democrat, has introduced legislation to raise the minimum wage to 5.05 over the next five years and automatically index it to 50 percent of average hourly wages thereafter. The proposal has the strong backing of organized labor and has been p laced at the top of the legislative agenda for the Senate Committee on Labor and Human Resources by its new chairman, Edward Kennedy, the Massachusetts Democrat. Secretary of Labor William Brock has not yet \{ ndicated whether the Administration will oppose t he legislation This is prompting liberals to urge that the I There is no evidence that boosting the minimum wage would benefit the incomes of low-paid workers it would destroy jobs and thus reduce employment for many workers especially minority youth. On t his, professional economists are virtually unanimous. If Congress were to ignore this evidence and raise the minimum wage to the extent proposed by Biaggi, between 400,000 and 1,200,000 Americans could be made jobless. The impact There is substantial evid e nce that 1. See Kenneth B. Noble Now, Maximum Interest in the Minimum Wage The New %ark Times January 7, 1987; "Administration Is Undecided On Raising Minimum Wage The Washineton Post, January 14, 1987; "Raising the $3.35 Minimum," Time, January 26, 1987, p 19. I would be worse for black youths, who generally come into the job market with less education and poorer job skills than whites and therefore cannot justify the payment of 3.35 per hour.

For this reason, inflation ironically has helped minority youth at least in one respect wage, it has made it possible for employers to offer jobs to many minority youths whom they otherwise could not have afforded to hire.

Consequently, short of abolishing the minimum wage--which would be the best way to create jobs for disadvantaged teenagers--Congress'at least should leave the minimum wage where it is I By eroding the real value of the minimum SUPPORT FOR THE MINIMUM WAGE Theoretical economics always has held that any measure that raises wages above their llmarket - clearingln (that is, free market level will create unemployment the minimum wage could safely argue for a minimum of, say 100 per hour. Obviously, any politician attempting to make the argument for a 100 minimum wage would not be taken seriously, since th e adverse effects on employment would be too obvious. The same effects'apply to any increase in the minimum wage the level of the minimum wage is smaller, the negative effects are smaller and more easily missed Were this not the case, advocates of The only difference is that, when A key reason why minimum wage laws continue to be supported is that many Americans believe they actually raise the wages of low-paid workers and that the rise in income for such workers offsep the loss of income by those thrown ou t of work by the minimum wage labor unions seekshigh minimum wage levels-to reduce competition from nonunion workers. If the legal minimum wage, for example is lonly slightly lower than the union wage, then employers have little incentive to try to dislodg e a union. The result: high minimum wages help unions maintain above-market wage rates do with the efforts by lawmakers representing areas with high'wages to prevent businesses from migrating to areas with low wages.

Representatives from high-wage northern states, for instance A more important political reason for the minimum wage is that A more subtle reason why minimum wage laws are supportedlhas to 2. Sar A. Levitan, Programs in Aid of the Poor, 5th ed Baltimore: The Johns Hopkins University Press, 1985 p. 125 3. Milton Friedman and Rose Friedman, Free to C hoose (New York: Harcourt Brace 1 Jovanovich, 1980 p. 2

37. I I I I 2traditionally have supported the minimum wage to block business expansion in the South. Economist H. C. Simons commented on this po int in 1944, writing Southern workers may be intrigued by the wage expectations held out by organizers from northern states and by the Fair Labor Standards Act [that is, the federal minimum wage law but, if they get much employment at such wages, it will b e only in spite of the intentions of the northern unions and the Massachusetts senators It is simply contrary to the interests of northern workers to permit competitive expansion of southern industry in their respectiye fields and prevent it they will if t he power is theirs They may in a few cases get such wages I I EFFECT ON EMPLOYMENT I Though liberals once argued that the minimum wage had no.effect on employment, today they generally admit that any rise in the minimum wage creates some unemployment. The y insist, however, that such unemployment increase would be minimal. The evidence they cite most often is the congressionally mandated Minimum Wage Study Commission which released its report in 1981 and estimated that a 10 percent increase in ,the minimum w age would reduce teenage employment by about one percent teenage jobs. The Biaggi bill's 50 percent boost in the minimum wage thus suggests a loss of some 400,000 jobs This one percent translates into a loss of 80,000 I The impact almost surely will be hi g her. Many economists have found far higher unemployment effects from increases in the minimum wage than did the Minimum Wage Study Commission, which was dominated by liberals. Several studies have found that a 10 percent minimum 4. Henry C. Simons Some Re f lections on Syndicalism Journal of Political Economv March 1944, p 10. For further elaboration on Northern support for the minimum wage against Southern interests, see Marshall R. Colberg Minimum Wages and the Distribution of Economic Activity in Simon Ro ttenberg, ed., The Economics of Lepa 1 Minimum Wanes Washington, D.C.: American Enterprise Institute, 1981), pp. 247-263; and Marshall R!

Colberg Minimum Wage Effects on Florida's Economic Development Journal of Law and Economicg, October 1960, pp. 106-1

17. Interestingly, a New York Times editorial referred to the 1977 increase in the minimum wage as a measure that would force the South to "pay fairer dues See "Paying Fairer Dues in the South The New York Times, August 20, 19

77. I 5. ReDort of the Minimum Wage Stu dv Commission (Washington, D.C U.S. Government Printing Office, 1981), Vol. I, p. 38 I I 3 I wage hike estimates cuts teenage employment 2,to 3 percent, with far higher for black male teenagers. In light of these hi gher 1 estimates, the Biaggi bill would increase the potential job loss to 1.2 million.

Ironically, the minimum wage seldom raises the unemployment rate. rate does not measure the number of working age Americans without jobs but only those actually seeking work who cannot get it. Thislrate tends not to be affected substantially by raising the minimumlwage because the raise prompts potential job seekers to withdraw from the labor force. Rises in the minimum wage apparently cause many low-skilled workers to b ecome so discouraged at their prospects for obtaining employment at the higher minimum that they no longer look for work. Since they are no longer part of the labor force, they are no longer counted in the unemployment figures. Thus the minimum wage could create heavy unemployment without any significant rise in the unemployment rate. Indeed, the Minimum Wage Study Commissionjadmitted that its low estimate for the unepployment effects of minimumiwage increases was due to this factor 1 This seeming paradox s tems from the fact that the unemployment I The minimum wage can affect employment in many other ways. Among them I 1) The minimum waae encouraaes emnlovers to automate and substitute commters and other labor-savina eauhment for workers I As the cost of em p loying workers in low-wage, manual labor jobs increases with rises in the minimum wage, the cost of mechanizing or automating such jobs becomes competitive automated teller machines, more self-service gas pumps, and the like lower Thus there are more than when the minimum wage was 6. For a survey of recent studies, see Charles Brown, Curtis Gilroy, and Andrew Kohen The Effect of the Minimum Wage on Employment and Unemployment," Journal of Economic Literature, June 1982, pp. 487-5

28. I 7. a, u Commi i n OD . cit 8. This does not mean that jobs are destroyed in the aggregate, because automation creates jobs as others are destroyed. See Bruce Bartlett Is Industrial Innovation Destroying 1 Jobs Cat0 Jo urnal, Fall 1984, pp. 625-643 I I I I i I 4I I 2) The mini m um waae drives workers out of jobs covered bv the minimum waue into jobs not covered bv minimum wacre If the minimum wage is raised, this may lead to an expansion of the so-cfilled underground economy, which already employs millions of workers I 3) The mi n imum waue increases aaareaate unemDlovment durinq Employers do not have the option of asking workers employed at business cvcles just above the minimum wage to reduce their wages temporarilylduring a recession if that would cause their wages to fall below the legal minimum. Thus such workers tend to be laid off This is especially true if such workers are Rerceived to be secondary workers (that is not heads of households I 4) EmDlovers tend to reduce frinae benefits in favor of cash waaes as minimum waae ra tes rise.

This allows employers to avoid increasing labor costs while still complying with the law decline in fringe benefits has an ippact on all workers, not just those affected by the minimum wage An important implication of this is that the 5) Minimum waae laws make emlovers more choosv about whom thev emDlov. encouraaina them to fire less Droductive workers more auicklv and take more time to fill Darticular jobs l 9. For evidence on shifts in employment due to incomplete coverage, see Finis Welch Mini m um Wage Legislation in the United States Economic Inauirv, September 1974 285-318; and Yale Brozen, "Minimum Wage Rates and Household Workers," Journal of 'Law and Economic$ October 1962, pp. 103- 109 10. See Peter M. Gutmann Are the Unemployed, Unemploye d Financial Analvsts Jo urnal.

September/October 1978, pp. 26-29 I 1 I 11. Marvin Kosters and Finis Welch, "The Effects of Minimum Wages on the Distribution of Changes in Aggregate Employment American Economic Review, June 1972, pp. 323-332 Finis Welch, Mi nimum Wmes Issues and Evidence (Washington, D.C.: American Enterprise Institute, 1978). pp. 38-

41. I I

12. Walter J. Wessels, Minimum Wanes. Fringe Benefits. and Wo rkinp Co nditions Washington, D.C.: American Enterprise Institute, 1980).

I 5 I I In this way, minimum wage laws can increase the overall rate of unemployment without actually reducing the number of jobs available 6) Minimum waue laws tend to increase unemnlownent most in Door areas of the countrv.

The reason for this is simply that more w orkers are employed at the minimum wage in these areas, and the efpfct of the laws on a worker's employability is more significant 7) The minimum waue causes emnlovers to be less inclined'to accommodate snecial interests of their workers, such as nrovidin q part-time and temnorarv emnlovment for workers unable to work reaular full-time iobs I This is particularly important for women who often prefer part-time or temporary employment because it allows them to care for their children. In 1981 69 percent of al l women in the labor force worked part-time (which explains, in partie much of the difference between male and female earnings levels I 8) The minimum waue may exacerbate inflation.

The minimum wage can have this effect because it increases production cost s and encourages workers employed just above the 4 I 13. Robert E. Hall, "The Minimum Wage and Job Turnover in Markets for Young Workers," in Richard B. Freeman and David Wise, eds., The Youth Labor Market Problem: Its Nature Causes. a nd Consea uences (C h icago: University of Chicago Press 1982 pp. 475-492 14 Ronald J. Krumm, The ImDact o f the Minimum Wave on Regional Labor Markets Washington, D.C American Enterprise Institute, 198 1 15. Finis Welch, "The Rising Impact of Minimum Wages," Renulation, Novem b er/December 1978, p. 31 16. Earl F. Mellor and George D. Stamas Usual Weekly Earnings: Another Look at Intergroup Differences and Basic Trends," Monthlv Labor Review, April 1982, pp. 20121 6minimum to press for higher on to consumers in the form wages of h igher prices i This costI7increase then is passed 9) The minimum waue drives down waues in sectors not covered bv This effect occurs as workers forced out of their jobs by the the leuislation b minim8m wage begin to compete for jobs not covered by the min i mum wage I EFFECTS ON MINORITIES I The negative effects of the minimum wage are greatest for minorities, especially black male teenagers. The reason: it makes employers more choosy about whom they hire and encourages them to hire only proved, dependable e m ployees. The higher the minimum wage, the more dependable, skilled, and productive the candidate for a job must be if he or she is to produce more for the employer than the higher wages. This is why the impact is mainly on lower-skilled teenagers and not o n adults, why the impact is greater on males than on'females and why the impact is greater on blacks than on whites. I I Economist Walter Williams of George Mason University concludes that the minimum wage laws encourage discrimination. He writes The raci a l effect of the minimum wage laws exists in the absence of racial preferences on behalf of employers The minimum wage law gives firms effective economic I incentive to seek to hire only the most productive employees, which means that firms are less willin g to hire and/or train the least productive employee, which includes teenagers particularly minority teenagers. But assuming away any productivity differences between black and white I 17. Professor Raburn M. Williams of the University of Hawaii, for examp l e, estimated that the January 1, 1979, increase in the federal minimum wage from $2.65 to $2.90 added,"about one-third of a percentage point to the 1979 inflation rate Raburn M. Williams Inflation: Money. Job s. and Politicians (Arlington Heights, Illinoi s : AHM Publishing Corp 1980), p 90. Of course, many other economists believe that excess money creation is the only cause of inflation and that "cost-push" factors, such as an increase in the 1 minimum wage, have no effect. See J. Huston McCulloch, "Macroe conomic Implications of the Minimum Wage," in Rottenberg, OD. cit, pp. 317-326 18. John M. Abowd and Mark R. Killingsworth, "The Minimum Wage Law's Winners and Losers,"

The Wall Street Journal, September 10, 19

81. See also Jacob Mincer Unemployment Effec ts of Minimum Wages Journal of Political Economy, August 1976, part 2, pp S87-SlO4 7 I I workers, minimum wage laws give firms incentive to racially discriminate in hiring law lowers the private cost of &iscriminating against the racially less preferred p erson.

In other words, the minimum wage lowers the cost of racial or any Even the most bigoted employer would have to think twice The reason is that the minimum wage other form of discrimination, because it prevents those who may be objects of discriminati on from being able to offer their labor at lower wages about discriminating against a qualified black worker if that worker were willing to work for less than a comparable white worker.: If the employer has to pay the same to both, then it costs him nothi n g to discriminate. a white worker is morally defensible-it is simply that it is preferable to a situation where the law allows an employer to discriminate without cost I the development of apartheid in South Africa. Minimum wage laws were enacted explicit l y to prevent white employers from hiring blacks who were willing to work for less than whites. The South Africa& minimum wage laws have reduced black and increased white employment enactment of the first minimum wage law in the 19308, many of its proponen ts argued that their key objective was to prevent southern blacks from competing for I1whitel1 jobs. They eventually succeeded.

In the 1940s and early 19508, before the minimum wage reached,its current high level and wide coverage, black male teenage unemployment rates were lower than those for xhites and their labor force participation rates were higher. Today, the black male tee n age unemployment rate is much higher than that of whites This is not to say that paying a black worker less than I It is for this reason that the minimum wage has been essential to 4 In the U.S. Congress, in fact, during the debates preceding The effect o f the minimum wage on black youths is tragic. By depriving many of them of the opportunity to reach the first critical rung up the economic ladder, it has denied them essential training and condemned them to a lifetime of unemployment and underemployment.

Economist Martin Feldstein of Harvard explains I 19. Walter E. Williams, The State Against Blackg (New York: McGraw-Hill, 1982), p. 40 20. P. T. Bauer, "Regulated Wages in Under-Developed Countries," in Philip D. Bradley, ed The Public Stake in Union Powe r (Charlottesville: University of Virginia Press, 1959 pp. 345-3

48. See also Walter Williams, "Minimum Wage--Maximum Folly and Demagoguery I Journal of the Institute for Socioeconomic StudieL Winter 1983-84, pp. 30-

32. I

21. Williams, The State Against Blacks, pp. 35-

39. See also Walter Williams Government Sanctioned Restraints that Reduce Economic Opportunities for Minoritibs,"

Policv Review, Fall 1977, pp. 7-

15. I I aI At the root of this problem is the hard economic reality that firms cannot af ford to offer useful on-the-job training to a broad class of young employees. A firm can generally provide the opportunity to acquire new marketable skills-by on-the-job training, detailed supervision, or even just learning by experience--only to a worker whose net product durina the period of traininq is at least equal to his wage. Unfortunately, the current minimum wage law prevents many young people from accepting jobs with low pay but valuable experience. Those who come to the labor market with substan t ial skills and education need not be affected by the minimum wage. They are productive enough to permit employers to pay at least the minimum wage while also providing further training and opportunities for advancement. But for the disadvantaged young wor k er, with few skills and below-average education, producing enough,to earn the minimum wage is incompatible with the opportunity for adequate on-the-job learning. For this group, the minimum wage implies high short-run unemplopent and the chronic poverty o f a life of low-wage jobs.

Many liberaks now accept the reality that minimum wage laws most penalize blacks. This is certainly what prompts many black groups such as the National Conference of Black Mayors, to support a lower minimum wage for teenagers low er minimum wage would boost black youth employment. Although Congress refuses to act on the reduced minimum--or youth opportunity--wage proposal of the Reagan Administration, recent estimates indicate that a minimum wage for youth that is one-quarter lowe r than the standardz5minimum would create between 250,000 and In the view of these orgafiizations, the I 430,000 jobs for teens. I I 22. Martin Feldstein, "The Economics of the New Unemployment The Public Interest Fall 1973, pp. 14-

15. See also David T. E llwood Teenage Unemployment: Permanent Scars or Temporary Blemishes in Freeman and Wise, OD. cit, and Masanori Hashimoto, Minim'um Wapes and On-the-Job T raininq (Washington, D.C.: American Enterprise Institute, 198 1 23. See, for example, Paul A. Samuels on, Economics 7th ed New York: McGraw-Hill 1967), p. 3

77. I I 24. Juan Williams, "Brock Backs Youth-Wage Trial The Was hinaton Post May 7, 19

85. See also "37% of Blacks Found in Favor of Lower Wage Floor The New York Times June 17 1981 25. Daniel S. Ham ermesh Minimum Wages and the Demand for Labor Economic Inauirv July 1982, p. 378 I I -9i CONCLUSION I Despite the mountain of evidence, many peophe cling to the idea that the minimum wage is good for all Americans. The truth is that it does little good an d much harm the minimum wage to provide an acceptable living standard foritheir families out of the job market For one thing, few Americans need For another, the minimum wage pushes low-skilled %ericans There are not many Americans who must support themse1 v es:and their families on the minimum wage. In fact, almost all Americans earning close to the minimum wage are secondary workers-teenagers working wives, and retired people-living in households along with workers who earn above minimum wages As a conseque n ce, there is virtually no connection between family incomes and wage rates. For this.reason, most economic research concludes that the minim* wage does little to improve the distribution of income. Economist'Edward Gramlich of the University of Michigan, for example, found that most of the Ilbenefitsll of a&se in the minimum wage actually go to upper-income families I I i rising minimum wage of course also offsets the potential of the minimum wage to raise the incomes of the poor.

Kosters of the American Enterprise Institute estimates that, for every dollar earned by thosgwho benefit from the minimum wage, 50 cents is lost by those harmed.

Accepting this fact, The New York Times recently argued that the right minimum wage should be zero wage to overcome poverty is old, honorable--and fundamentallyiflawed,ll the Times said. llItls time to put this hoary debate behind us, and find a better way to improve the lives of people who work very hard for very little.1129 Congress wo u ld do well to accept this judgment The lost wages of those forced out of the labor market by a Economist Marvin The idea of using a minimum 26. See Sar A. Levitan and Isaac Shapiro The Working Poor Deserve a Raise," The New 27. Edward M. Gramlich Impact o f Minimum Wages on Other Wages, Employment, and Family Incomes," Brookines PaDers on Economic Activitv, No. 2, 1976, pp. 443-4

49. See also Carolyn Shaw Bell Minimum Wages and Personal Income," in Rottenberg, OD. cit, pp York Times March 30, 1986, p. F

2. I 439-458 28. Marvin Kosters An Increase Would Hurt Teen-Agers," The New York Times March 30, I 1986, p. F

2. I 29. "The Right Minimum Wage 0.00 The New York Times, January 14, 1987 10


Bruce E. Fein

Senior Research Fellow

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