Reflections on the minimum wage.

Author:Van Lear, William
Position:Response to Robert Prasch, Journal of Economic Issues, vol. 30, p. 391, 1996 - Includes reply

Robert E. Prasch [1996, 391-397] argues that there are three constructive outcomes from a minimum wage increase: (1) higher minimums can raise aggregate demand, and hence productivity, because of a higher propensity to consume by low-income workers; (2) higher minimums prod firms to improve technology and productivity, thereby increasing economic competitiveness; and (3) higher minimums increase labor's bargaining power and enable people to earn a better living [1996, 391].

Prasch's defense of a higher minimum wage is commendable, and his argument stands in sharp contrast to economic orthodoxy. Some additional points can be made to further strengthen his position. For example, research indicates that the wage elasticity of the labor demand is low; higher minimums increase aggregate income to low-income workers while employment loss, due to higher labor costs, is low [Wellington 1991, 27-46; Bartlett 1996, A14]. And higher minimums increase the wages of workers farther up the pay scale; that is, wages on the same wage contour tend to move together [Spriggs and Klein 1994].

Moreover, though higher wages raise costs, employment levels are primarily determined by how much business is producing and selling. Firms typically operate with minimal staffing, particularly small, competitive, non-bureaucratic firms. As long as companies are profitable and have a strong desire to stay in business, a higher minimum wage will reduce profits but not reduce jobs. With no change in sales, businesses will retain their employees.

Further, there is a lack of consistency in the argument of those who oppose higher minimum wages. Most economists are not against all policies that may cause job losses. For instance, tight monetary policy is advocated to curb inflation, yet the higher interest rates raise borrowing costs and reduce employment. Similarly, when higher input costs to some businesses slow investment and hiring by the affected firms, economists view this as a non-policy matter; the higher costs stem from market forces, not from some businesses imposing costs on other businesses and thereby affecting growth.

Two of Prasch's points deserve further attention. First, I question whether a falling real minimum wage had no positive effect on structural unemployment since 1980 [Prasch 1996, 392]. The minimum wage fell about $2 per hour in real terms from 1980 to 1996. Investment by entrepreneurial and small businesses in the service sector has...

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