Raising incomes by mandating higher wages.

• Author: Neumark, David
• Position: Research Summaries

A number of policy proposals and initiatives have been used in the United States in an attempt to reduce poverty, or more generally to assist low-income families, by increasing the incomes of families at the bottom end of the income distribution. My research over the recent past has focused on studying the effectiveness of two such policies that mandate higher wages for low-wage workers: minimum wages and living wages. (1)

Minimum wages first were established on a national level with the Fair Labor Standards Act of 1938. While initial coverage was originally quite restrictive, cover age is now nearly universal. The federal minimum currently stands at $5.15. Numerous states have at times imposed higher minimum wages, typically for the same workers covered by the federal minimum, but with some exceptions. The highest state minimum wages currently are in California and Massachusetts ($6.75) and Washington ($6.90).

Living wage ordinances are a much more recent innovation. Baltimore was the first city to pass such legislation, in 1994, and approximately 50 cities and a number of other jurisdictions have followed suit. Living wage laws have three central features. First, they impose a wage floor that is higher--and often much higher--than traditional federal and state minimum wages. Second, living wage levels are often explicitly pegged to the wage level needed for a family to reach the federal poverty line. Third, coverage by living wage ordinances is highly restricted. Frequently, cities impose wage floors only on companies under contract (generally including non-profits) with the city. Other cities also impose the wage floor on companies receiving business assistance from the city, in almost every case in addition to coverage of city contractors. Finally, a still smaller number of cities also impose the requirement on themselves and pay city employees a legislated living wage.

It is fair to say that the goal of both minimum wages and living wages is to raise incomes of low-wage workers so as to reduce poverty. Senator Edward Kennedy, a perennial sponsor of legislation to increase the minimum wage, has been quoted as saying "The minimum wage was one of the first--and is still one of the best--antipoverty programs we have." (2) Similarly, the Economic Policy Institute, while noting that other anti-poverty tools are needed, argues that "the living wage is a crucial tool in the effort to end poverty." (3) Thus, while there is generally no single measure with which the distributional effects of a policy can be assessed unambiguously, and while overall welfare effects are much more complicated, evaluating the impact of mandated wage floors on poverty is quite relevant to the policy debate.

While mandating higher wages for low-wage workers would appear to a non-economist as a natural way to fight poverty, there are two reasons why it may not help to achieve this goal. First, standard economic theory predicts that a mandated wage floor will discourage the use of low-skilled labor, essentially operating as a tax on the use of such labor. Thus, whatever wage gains accrue to workers whose employment is not affected must be offset by the potential earnings losses for some other workers. Second, mandated wage floors may target low-income families ineffectively. Broadly speaking, low-wage workers in the United States belong to two groups. The first is very young workers who have not yet acquired labor market skills, but who are likely to escape low-wage work as skills are acquired. The second is low-skilled adults who are likely to remain mired in low-wage work, (4) and who--as adults--are much more likely to be in poor families. To the extent that the gains from mandated wage floors accrue to low-wage adults and the losses fall on low-wage, non-poor teenagers, mandated wage floors may well reduce poverty. But there is no theoretical reason to believe that this outcome is more likely than the reverse, with concomitant adverse outcomes for low-income families. The distributional effect of mandated wage floors is a purely empirical question.

Minimum Wages

Labor economists have written innumerable papers testing the prediction that minimum wages reduce employment. Earlier studies used aggregate time-series data for the United States to estimate the effects of changes in the national minimum wage. The consensus view from these "first generation" studies was that the elasticity of employment of low-skilled (young) workers with respect to minimum wages was most likely between -0.1 and -0.2; that is, for every ten-percent increase in the minimum wage, employment of low-skilled individuals falls by one to two percent. (5)

More recent studies have used panel data covering multiple states over time, exploiting differences across states in minimum wages. This approach permits researchers to abstract from aggregate economic changes that may coincide with changes in the national minimum wage and hence make difficult untangling the effects .of minimum wages in aggregate time-series data. (6) Evidence from these "second generation" studies has spurred considerable controversy regarding whether or not minimum wages reduce employment of low-skilled workers, with some researchers arguing that the predictions of the standard model are wrong, and that minimum wages do not reduce and may even increase employment. The most prominent and...