American Economy, Meet Minimum Wage

One of the most contentious but also consequential debates in economic policy is on whether or not to raise, maintain, or lower the minimum wage, and by how much. There are a great many arguments that circulate about the minimum wage and its effects on the economy, but few that are backed by meaningful data and observation.

The general argument against minimum wage hikes is that they have a deleterious effect on employment and wages. It’s reasoned that by increasing the cost of labor, firms will hire less, and increase prices. It has even been claimed that minimum wage hikes are so destructive to the economy they actually hurt the people they’re designed to protect.

The issue I have with these minimum wage theories is they don’t seem to play out in the actual economy. The U.S. has raised its federal minimum wage many times, and sometimes by a large amount. For example, in January 1950 the federal minimum wage was increased from $0.40 to $0.75 an hour, an 87.5 percent increase. The last time the there was an increase was the summer of 2009 when it was increased from $6.55 an hour to its present level of $7.25.

The purpose I have here is to debunk the notion that our economy today is unable to support a significantly higher minimum wage, which is important because the well-being of so many people are impacted by it. Millions depend on hourly wage jobs that pay substantially below the level of a fair wage. In the 1940’s a fair wage was considered one on which individual could depend to support themselves; an amount sufficient to afford a basic but decent standard of living, including adequate food, housing, energy, and medical care.

In 2020 a full-time worker paid the minimum wage earned just 14 percent more than the federal poverty line, a standard originally invented in the early 1960’s. In most major American cities, $1,100 a month (a full-time minimum wage income after federal taxes) is hardly enough to afford decent housing, let alone clothing, food, utilities transportation, and any level of recreation or entertainment whatsoever.

While it should be evident by simply noticing what demographics are common among low-wage workers, it’s not apparent to many that those working for such remarkably low wages are in fact mostly older adults, employed full time. They are not by and large, as the common mythology would have it, teenagers working over the summer. According to the Economic Policy Institute’s analysis from 2013, a near nine-tenths of minimum wage workers are older than 20, greater than a third are older than 40, and more than a quarter have children!

To make things worse, in particular for those with children, the average minimum wage worker provides just half of their family’s income. There might be an argument to be made for meager wages to low and unskilled employees in an impoverished economy, but no matter how calamitous 2020 may have been, the U.S. is still an extraordinarily productive economy that through the course of the pandemic created over $60,000 in wealth for each man, woman, and child that lives here.

In 2019 gross domestic product reached nearly $85 for every hour put in by American workers. There is no shortage of wealth to guarantee a decent standard of living to every citizen, especially compared to seventy years ago when the real purchasing power of the minimum wage wage greater than it is now. It is perhaps even more important to note that the inflation-adjusted minimum wage wasn’t just greater in than it is now from 1950 to 1988, but significantly greater as a share of GDP per hour worked.

Taking the minimum wage as a share of GDP per hour provides a stark new perspective on the minimum wage. It is the case that from 1950 to 1970 the minimum wage never fell below 17 percent of GDP per hour worked. In fact, the minimum wage peaked in 1950 at 25.3% of GDP per hour worked, which in 2019 would have be equivalent to just under $21.40 an hour, an incredible three times the actual federal minimum wage, and equal to a full-time annual income of $42,800, greater than the current median individual income (which stood at $36,625 in 2019).

Even if we go by state minimum wages, not a single state boasts a minimum wage even close to exceeding 20 percent of gross state product per hour worked. Maine tops the list with a minimum wage in 2019 equal to just under 16 percent of GDP per hour worked, a far cry from the 25 percent federal rate in 1956.

It’s worth remembering something about the 1950’s and 60’s— a roaring economy, robust middle class, and near-full employment. The average monthly rate of unemployment from 1950 to 1970 was 4.7 percent, versus 6.2 percent since. Even if you exclude the tumultuous 70’s, rough early 80’s, Great Recession, and COVID-19 pandemic, looking to the relative boom period of 1987 to 2007, the rate of unemployment still averaged an unsatisfactory 5.5 percent. This, despite the federal minimum wage averaging 8.7 percent of GDP per hour worked as opposed to 20.1 percent from 1950 to 1970.

It’s further worth noting that despite the steep Post-War labor price floor, the economy chugged along in what today is known as one of the greatest U.S. economic booms, the Post-War Economic Expansion. From 1950 to 1970 per capita GDP in the United States grew by nearly 70 percent, supercharged growth compared to the less than 30 and 50 percent growth experienced in the 1999-2019 and 1987-2007 periods respectively. All in the face of relatively extreme minimum wage rates.

Data source for all graphs: FRED

Of course it’s one thing for growth over a longer period to appear uninhibited by a high minimum wage, it’s a whole other thing for minimum wage hikes to be virtually uncorrelated with movements in the rate of unemployment and price level. The correlation between the size of minimum wage hikes from 1947-2019 and the rate of inflation over the subsequent 12 months is 0.15. Further, if I included the data for periods where there were no minimum wage hikes, the correlation would be pretty close to zero.

Even this meaninglessly small correlation is doubtful, as minimum wage hikes were often made to account for changes in the price level, meaning instead of the minimum wage hike causing inflation, inflation caused the minimum wage hike. This is exemplified by the seven near back-to-back minimum wage hikes made from 1974 to 1981, the era of stagflation and double-digit inflation.

If we look more closely 1950-1970, the period of the high minimum wage and large minimum wage hikes, we can see the minimum wage hikes immediately preceded zero notable increases in the rate of unemployment, and in fact preceded not one but two major declines in the rate of unemployment, in 1950 and 1961. While the rate of unemployment increased steeply in 1958, two years after a 33 percent increase in the minimum wage, the gap in time between the hike in wage rate and unemployment would suggest the two events were unrelated, especially as unemployment was relatively static in the period in-between.

The nearly 88 percent hike in minimum wage in January 1950, the largest minimum wage hike in U.S. history in both real absolute and relative terms, appears to have had a positive effect if any, similar to the 15 percent hike in September 1961. Both preceded large and rapid declines in the rate of unemployment, neither of which can be fully accounted for by a reduction in hours worked or labor force participation.

The male labor force participation rate grew modestly in 1950 and 1951, and only fell according to the longer-term trend in 1961-1962, but not before actually climbing in the three months following the 15 percent hike. Really most of these already insignificant effects can be cracked up to an aging population, the disruption of women entering the workforce, government deficits rising and falling, and deflationary real bracket creep resulting from tax brackets not being tied to a price index until the late 1970’s.

Speaking of inflation, there is likely to be some limited relation between inflation and the size of minimum wage hikes. It makes sense that employers will attempt to shift the cost of wage hikes to consumers in order to preserve profits, and I believe that’s born out to some extent in the data. In the chart above we can see how the larger minimum wage hikes in 1950 and 1956 precede large spikes in month-over-month inflation, especially when the rate of inflation shot up from a low of -2.1 percent in the year preceding January 1950 to to 8.0 percent the year following, topping 9.6 percent over the year preceding April 1951.

What is this kind of price response tell us is not that minimum wage hikes are too inflationary, but that they must be done gradually over time to prevent shocks to business earnings and aggregate demand, two flows that create upward pressure on the price level when moving in opposite directions (cash flow down and demand up), as they would in the case of a minimum wage hike.

Though in the long-run a greater minimum wage may yield a net increase in absolute business profits, in the short-run broad wage hikes are bound to hurt corporate income statements before they begin to yield a revenue feedback. Further, less than every dollar added to the wages of low-wage workers will be spent on goods and services provided by other low-wage workers.

Now altogether, despite potential inflation, large minimum wage hikes are doable in a gradual manner. I estimate, based on EPI data, the cost of raising the minimum wage to $16.90 in 2019 (20 percent of GDP per hour) for the appromxately 60 million workers earning below that level would have been $365 billion, roughly 1.3 percent of GDP and 2.0 percent of Personal Consumption Expenditures. Given the fairly small cost of such a larger wage hike relative to household spending, I reason it could be achieved in fewer than five years, perhaps in three.

A minimum wage hike to 20 percent of GDP per hour worked phased-in over five years would shift less than 0.3 percent of GDP in buying power each year, a negligible amount, and one that is not likely to cause a severe increase in inflation. This might especially be the case if the federal minimum wage is tied to regional GDP per hour, as opposed to national. For example, the New York Metropolitan Area might see a $30 an hour minimum wage, while Montana sports a $15 minimum wage.

I expect it to be the case that a larger gross state or regional product per worker is meaningfully correlated with a region’s ability to absorb increased labor costs with net cashflows, or due to most businesses already paying their workers close to what the new wage floor would be.

One thing I neglected to mention yet was the fact that a sufficiently large minimum wage hike could in fact be deflationary due to households being pushed over the eligiblity-threshold or “welfare cliff” for many major programs such as Medicaid and SNAP, potentially reducing the after-taxes and transfers purchasing power of some families.

The Medicaid eligibility threshold for 2019 was $34,846 for a family of four, roughly equal to the full-time earnings of a worker earning 20 percent of national GDP per hour. If a series of wage hikes are not met with a significant change in the employment level (which doesn’t appear likely), the rate of poverty could fall dramatically, likely by double digits.

While CHIP and the premium subsidies from the Affordable Care Act would replace some of the benefit of Medicaid and SNAP, there still may be a general reduction in government outlays as a result of such a significant set of wage hikes. If this is the case, it could be worth cutting taxes or even broadening eligibility for certain welfare programs in order to prevent any net reduction in consumption by low-income families.

In general I think there’s nothing to worry about with regards to raising the minimum wage, even by a significant amount. I believe the benefits of large hikes would outweigh the consequences, whether they manifest as unnoticeable upticks in annual inflation for a few years, or a temporary stagnation in net corporate cashflows.

In 1944 when the GDP per hour was about $20, President Roosevelt proposed a universal American right to a fair and living wage which allowed for a decent standard of living. Have we forgotten the aspirations of the New Deal and American Progressivism?

If a living wage could raise level of aggregate demand, and meaningfully alleviate poverty, it could help to unleash not only the productive potential of the economy, but the potential of millions of families and their children of little means, whose current prospects are to stagnate in the unsatisfactory life of poverty and want. Let’s dream bigger than $15 an hour.

Main photo is from the public domain and depicts the Lawrence Textile Strike. Source.

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