Friday, April 10, 2009

Minimum Wage 101

Taking a break from analysis of political news, polls and projections is something that I've only done a few times in this space. But, with congress on it's Easter recess, the news cycle relatively slow (unless you want me to do a history on bowing to Saudi Arabian leaders or whether Lindsay Lohan should get the rights to do a Fleetwood Mac movie), I thought now would be a great time to touch on a topic that impacts a relative few directly, but drives a great deal in our economy: the minimum wage.

The subject is timely because in July a national minimum wage hike is due to take effect. The minimum wage will increase from $6.55 / hour to $7.25 / hour, as part of a 3-year increase, approved by the Democratic congress and signed by President George W. Bush in 2006 that took the minimum wage from its then level of $5.15 / hour in 2006 to $7.25 / hour in 2009, the largest three-year dollar increase in the minimum wage ever.

It actually surprises me, given the current economic conditions, that there has been little discussion about this hike -- one would expect free-marketers to rail against a greater than 10% hike when the economy is depressed and businesses are losing money. I suspect that we haven't heard anything because Democrats are in favor of the increase and Republicans don't want to be seen as dumping on the poor, so the present law will likely stand.

So, the minimum wage will be at historically high levels, right? A look at the nominal (absolute dollar) value of minimum wage over time would make you think so:
Look at that slow upward tick, followed by the explosion in the past 3 years. Of course, this chart actually doesn't mean much. To understand what the minimum wage is worth, we have to account for inflation.

The chart below shows the real dollar value of the minimum wage over time (in 2009 dollars.)

Paints a bit of a different picture, huh? By this perspective, the real value of the minimum wage steadily increased from its inception in 1938 until it peaked in the early 1970s at a 2009 value of just over $10/hour. Since then, it has steadily declined until at 2006 it hit near $6/hour in 2009 dollars. Now, with 3 straight increases, it has closed some of the gap but is still almost 30% below its high in the 1970s and is still lower than at any point from 1956 through the mid 1980s.

But even the inflation adjusted picture doesn't tell the whole story. To truly understand the relationship of the minimum wage to our economy, you have to understand the relative value of the minimum wage to per capita GDP.

Let me explain why this measurement matters. The GDP is the total value of all the goods and services produced in the United States in a year. By dividing the GDP by the number of people in the country you get the per capita GDP or the value of the goods and services each person would get if we all got the same amount. Of course we don't, we aren't a socialist country, but understanding the minimum wage "floor" that we set in terms of our per capita GDP -- that is, the ratio of what the poorest working Americans make to what the average person does. For purposes of the graph, I've assumed a 40 hour work week, 52 weeks per year. Our minimum wage as a percentage of per capita GDP is as follows:
In 1938, when the minimum wage was instituted, a fulltime minimum wage job would give you 80% of the per capita GDP -- that is, minimum wage earners were a mere 20% poorer than the average American. This trend largely continued until the mid 1960s, when the value of the minimum wage started to fall. It fell to 70% by 1967, then to 60% by by 1974, to 50% by 1982, to 40% by 1985, then to 30% by 2002.

Even with the hikes of the last two years and the one coming in July, minimum wage will still stand at only 32% of per capita GDP, an all time low.

Another interesting comparison is how the U.S. compares with other large world economies. I researched the 10 largest economies in the world. Of them, there are 8 first world powers (the United Kingdom, France, Canada, the United States, Germany, Japan, Spain and Italy) and 2 developing economies (Brazil and China.) Of these 10 countries, 3 do not have minimum wage laws per say. Germany and Italy rely on collective bargaining agreements by industry to set wages -- those wages tend to be relatively high compared to minimum wages. China has no minimum wage at all -- wages in China tend to be relatively low. Of the 7 that do have laws, the percentage of per capita GDP is below. Note that Canada has varying provincial laws that range from $8 / hour to $10 / hour -- I've used the lower number for their comparison, just as I've used the federal number for the U.S. versus the sometimes higher state laws.

So in terms of their economic wealth, Japan and Spain set a lower minimum wage than the U.S., but Canada, France, Brazil and the U.K. set higher wages, often significantly higher.

Also worth noting (as I stated above) are state minimum wage laws. According to the Department of Labor, the folowing state laws are on the books:

States where the minimum wage is equal to the federal minimum wage (there is either no law or it does not call for a higher wage):
New Hampshire*
New Jersey*
New York*
North Carolina
North Dakota
South Carolina
South Dakota
West Virginia*

* These states have minimum wage laws higher than $6.55/hour but lower or equal to $7.25/hour, meaning that their wage laws are currently higher than the federal law, but will not be when the July increase takes effect.

States with Higher Minimum Wages:
California ($8.00 / hour)
Colorado ($7.28 / hour)
Connecticut ($8.00 / hour)
District of Columbia ($7.55/hour)
Illinois ($8.00/hour)
Massachussets ($8.00/hour)
Michigan ($7.40/hour)
New Mexico ($7.50/hour)
Ohio ($7.30/hour)
Oregon ($8.40/hour)
Rhode Island ($7.40/hour)
Vermont ($8.06/hour)
Washington ($8.55/hour)

Note: For states with higher minimum wages, the rate effective as of July 2009 was used to be comparable to the July 2009 Federal Rate of $7.25 / hour.

So, you can see that a lot of states have taken matters into their own hands in advance of federal law. As of July, 12 states plus the District of Columbia will have higher minimum wages than federally required. An additional 14 have laws that are currently higher than $6.55/hour, meaning they are higher than the federal minimum wage, but will not be in July.

All of this gets us to two key questions:
(1) By what standard should we set our minimum wage laws?
(2) Is it better left to the federal government or to state governments to set the wages?

For question number 1, let's consider the two extremes:
The extreme conservative position would be that there should be no minimum wage. Minimum wages by definition are an interference in the free market and conservatives would argue that wages, as with the price for anything, should be set by the market and the natural balance of supply and demand.

Extreme liberals (socialists) would argue that the minimum wage should be equal to the per capita GDP, that all in a society should have an equal share of the wealth.

As with most things, I believe the truth lies somewhere in the middle. I don't think brutal free markets are the way to go -- you'd literally have workers on the lowest income rung starving to death and I don't think that is right in a society as rich as ours. I also do believe that capitalism promotes a rising pool of wealth, however, so I don't think setting all wages equal would serve us well. The goal should be a minimum wage that assures coverage of the basic necessities for all working people, does not overly disrupt the markets and leaves out the incentives that produce innovation and hard work to advance.

There are no hard and fast rules to this, but I look to two things: the US poverty level and historical evidence of the impact of minimum wage. I think it would be hard to argue that in the 1960s that the minimum wage was a huge weight on the economy. The economy rapidly expanded in the 1960s and I've seen no study that would indicate that it would have been better with a lower minimum wage. Therefore, I think that a minimum wage of up to 70% of per capita GDP would be attainable without major disruptions to the economy.

The U.S. poverty level guidelines for 2008 (the last year I could find), are as follows:
1 person household -- $10,400 / year
2 person household -- $14,000 / year
3 person household -- $17,600 / year
4 person household -- $21,200 / year

For my rough purposes, I'll assume a 3-person household with 1 income -- that is a parent that works, a parent that stays home with a single child. You could question this assumption -- should be in poverty be having children? But the reality is that many, many people in poverty do have children and the children are often the victims of being below the poverty level.

My rough calculations would imply a minimum wage of $8.50 / year, or an additional $1.25 / hour beyond what is going into effect in July. This would put the minimum wage at 38% of per capita GDP, still historically low, but sufficient for my theoretical family to cover the basic necessities.

But, to question 2, wouldn't it be an issue better left to the states?

There is certainly an argument to be made that with different economic circumstances and vastly different costs of living that different states should have different minimum wages. And evidence does suggest that states eventually take minimum wage laws into their own hands, as demonstrated by the 26 states that were out in front of the federal increase.

The counter agrument to this is that states are often wary of setting minimum wages that are very far out of line with the national minimum wage. States compete for jobs all the time and companies will tend to locate to areas with lower minimum wages. Why do you think BMW is in South Carolina and Honda in Ohio rather than in California or New York? Also, state level minimum wages reinforce existing wage disparities -- Mississippi is in no position to increase its minimum wage above Alabama's, for instance.

The only effective way to pull working people out of poverty is at the federal level. Therefore, I would propose, at a minimum, raising the federal minimum wage to $8.50 / hour and creating future inflation-adjusted increases. This could be phased in over two additional years -- say taking it to $7.85/hour in 2010 and $8.50/hour in 2011, in line with the size increases that we have had over the past few years.

I think this would be a very popular position and one that Democrats in congress and the Obama administration could champion fairly easily.

I hope they do.

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