The Minimum Wage Debate: Do Higher Wages Boost Productivity or Destroy Jobs?

Few debates are more classic in economics than ones around raising the minimum wage.  A minimum wage requires employers to pay at least a certain amount per hour to any employee, and these were instituted during the Progressive Era in the United States by individual states.  In 1938, a federal minimum wage law was created that applied nationwide.  Cities and states can set higher minimum wages, but the federal minimum wage is a nationwide price floor for labor.

Arguments for Applying a Minimum Wage

Low wages were a very common complaint in the United States during the Gilded Age of the 1870s-1890s.  An increase in the supply of labor due to immigration drove down wages, and the fact that most available jobs were low-skill positions meant that virtually anyone could take the role.  Another era of low wages was the worldwide Great Depression, where wages decreased dramatically due to high unemployment.  These two eras of low wages created a conundrum: full-time workers did not have enough income to make ends meet.  Adult workers could also be replaced by child laborers, who could be paid significantly less than their adult coworkers.

Labor Force Protection

Low wages were often considered exploitation of labor, and thus applying a minimum wage had both a political and a humanitarian purpose.  However, giving workers a minimum wage could also protect the viability of the labor force as a whole by keeping workers engaged in the labor force.  If wages are too low, many workers may drop out of the labor force and try to exist on social welfare, family assistance, or even revenue from criminal activity.  A low labor force participation rate can harm society through an increase in unemployment-related crime or lack of production capacity when the need arises.  If there is a sudden crisis, such as a war, valuable time will be lost trying to restore labor force participation.

Wealth Redistribution

A minimum wage can serve as a wealth redistribution tool, similar to a tax on those with higher income.  However, it is more efficient than a taxation-and-welfare system because there is no means testing - anyone who has a job that sets its hourly wage rate at the minimum wage is benefiting.  To benefit, one must find a job, which is typically a goal of those opposed to social welfare in general.  Therefore, a nationwide minimum wage can be seen as an efficient and labor incentivizing tool of social welfare.

Preventing Unrest

Taken together, the first two arguments in favor of maintaining a healthy minimum wage combine to prevent labor unrest that can lead to high costs for all of society.  If masses of workers lose faith in the system, they may turn to violent protest and/or crime.  Famously, many French citizens lost faith in their economic system in the 1780s due to high taxes and high rates of poverty…which helped bring about the violent French Revolution.  Allowing workers to remain underpaid for too long can result in social movements that devolve into mass violence.

Increasing Productivity (Efficiency Wage Theory)

A more modern argument for maintaining a healthy minimum wage is boosting worker productivity.  While a strong social welfare system may prevent unrest from unemployment and poverty, society may suffer from an economic malaise if workers feel poorly compensated and underappreciated.  These workers, feeling disrespected and unvalued, will work only hard enough not to be punished.  Overall, this leads to reduced quantity and quality of output.  And, if the worker is in jeopardy of losing his or her job due to low output, is much income really at risk?  Workers may come to see low-wage jobs as interchangeable and simply try to move on to the next one. 

Additionally, if businesses are required to pay workers more, they may begin to treat them as investments and focus on skill-building, which increases productivity.  Businesses that can hire workers for extremely low wages may naturally undervalue them, resulting in little improvement in their skills over time.  Having to pay a substantial hourly wage to a worker may pay long-run dividends by creating stronger ties between the employer and the employee.  As the two value each other, they may work toward mutually beneficial goals.  For example, the well-paid worker will be a source of advertising and marketing for the firm, telling his or her friends and family that the company is great to buy from.

Arguments Against Applying a Minimum Wage

Many critics of minimum wage laws argue that forcing businesses to artificially pay workers more money than is needed to attain them (the equilibrium wage) violates free market principles and will lead to higher unemployment.  They also argue that sweeping minimum wage laws are too broad and do not account for unique employment conditions.  Others also argue that such laws deprive business owners of discretion in offering some workers more money for extraordinary effort or skill, reducing incentive for workers to improve their output.

High Unemployment (Classical Price Floor Theory)

The minimum wage is a frequent topic of conversation in economics not because they do not exist, but because they are not often effective minimum wages.  To be effective, a minimum wage must be higher than the equilibrium wage rate, which is the wage rate where all labor demanded by employers can be hired.  Any minimum wage higher than the equilibrium wage rate establishes a price floor for labor that leads to quantity supplied being greater than quantity demanded.  Basically, an effective minimum wage creates a surplus of available labor.

At the effective minimum wage, more people are willing to work than employers are willing to hire.  This can lead to labor unrest.  Opponents of this argument, however, would posit that most of the new additions to the labor market, suddenly lured in by the effective minimum wage, could simply go back to not being part of the labor market without fomenting unrest if they could not find employment.

Higher Costs of Production Harm Businesses

The classical price floor theory argues that employers will simply stop hiring as many workers if there is an effective minimum wage.  If this is not the case, however, the burden of an effective minimum wage falls on the employer, who now must pay more wages.  They will attempt to transfer these costs to consumers by raising their own prices.  If this occurs on a wide enough scale, it could cause inflation.  Then, critics argue, those receiving the new minimum wage are no better off; their real wage remains unchanged due to the inflation.

Minimum Wage is a Barrier to Entry That Hinders Entrepreneurship

Having to pay an effective minimum wage could be considered a barrier to entry for some small businesses.  Critics argue that some small businesses hire mainly teenagers or college students, who do not require an effective minimum wage to live (as they are typically subsidized by parents and/or scholarships), and will now be priced out of the labor market.  Some businesses that could have been formed and provided goods or services will not be formed due to entrepreneur resistance to the minimum wage.

An Imposed Minimum Wage Hinders Free Market Principles

A final argument against imposing an effective minimum wage is that it constitutes government intervention in the free market.  For better or worse, this removes some discretion from business owners and could drive some to quit the market due to political beliefs.  Critics of government overreach would protest the new minimum wage as unnecessary and harmful to small businesses that are less equipped to pay all employees a higher wage.  They would state that, in a free market, shouldn’t any voluntary labor agreement between job applicants and employers be honored?  If the minimum wage is $15.00 per hour, but a teenage employee is willing to work for $12.00 an hour, why should the state intervene?