Giving America a Raise (in the Minimum Wage) Would Foster Inclusive Growth

Written By: Satyam Panday, Beth Ann Bovino, Robert E Schulz and Gabriel J Petek
Written by Satyam Panday, Beth Ann Bovino, Robert E Schulz and Gabriel J Petek

While a significant increase in the federal minimum wage could come at a cost to profit margins or employment levels in industries such as retail and restaurants, S&P Global Ratings believes that the economic benefits of a measured increase--to bring the U.S. in line with comparable countries around the world--at this time in the business cycle would outweigh the negative effects, especially among the demographic groups who suffered most during and after the Great Recession.

There is no disputing that a federal minimum wage of $7.25 an hour is comparatively quite low. At just 36% of the U.S. median wage (and trending lower), the current level is substantially below its peak of 55% of the median wage in 1968 and puts the U.S. dead last among the 35 countries in the Organisation for Economic Co-operation and Development (OECD). In fact, the U.S. minimum wage would be higher by more than one-third--at about $10--if it were at 55% of the prevailing median, and a little more than $12 if taken as a proportion of prevailing mean wage (1). If the minimum wage were indexed to inflation starting in 1968, it would currently be $11 (2). Simply put, the U.S. is an advanced economy with a midlevel federal minimum wage.

Much in the way regular maintenance of the country's transportation infrastructure bolsters economic productivity, we see raising the minimum wage--upkeep in the "human infrastructure" of the labor force--as ultimately beneficial to the economy. And international comparisons aside, if there has ever been a good time to give America a raise, it's now. Empirical evidence suggests that moderate increases in the minimum wage haven't typically caused significant job losses overall. There is also evidence that paying workers a better hourly wage improves their morale, boosts productivity, and, to some extent, addresses the rising income inequality problem (3). Moreover, associated job losses are more likely when the minimum wage is already high to begin with and labor markets are weak (4). As it stands, the U.S. minimum wage is neither high nor is the business cycle in the midst of a downturn (or early in the recovery, for that matter).

Overview

  • Disadvantaged workers--those with lower productivity or weak bargaining power--are in increasing danger of being left behind while the economic recovery continues to unfold. The minimum wage is failing to meet at least one of its goals: to augment purchasing power of low-wage workers.
  • From S&P Global Ratings' perspective, wage levels are an important credit consideration for many industries because the costs of higher wages can be significant. While a gradually higher minimum wage would be unlikely to have any immediate effects on the credit quality of these borrowers, their profitability could be hurt given that wages and employee benefits can account for upwards of one-third of their costs.
  • We think the conditions are favorable for a hike in the federal minimum wage, given its current low level and our view that the business cycle isn't in a downturn or the initial stages of a recovery, when businesses would have more difficulty digesting the extra cost.
  • There is also evidence that paying workers a better hourly wage improves their morale, boosts productivity, and, to some extent, addresses the rising income inequality problem.
  • Recent empirical evidence suggests that moderate increases in the minimum wage haven't typically caused significant job losses overall. States that peg their minimum wage to inflation also have the lowest wage disparity.

At any rate, disadvantaged workers--those with lower productivity or weak bargaining power--are generally paid less and are therefore most strongly affected by minimum-wage provisions. More specifically, any desired (or undesired) effects are felt most by women, the young, and groups such as lower-educated or temporary workers. As such, adjustments to the minimum wage must be done with caution, since a wage floor too low would lead to undesirably paltry wages for workers who are without representation in the wage-setting process and with a particularly weak bargaining power, while a floor too high leaves little room for rewarding employees in line with productivity, and may lead to job losses or reduced working hours for some (5). To be sure, minimum wage is not a panacea for all that ails the disadvantaged workers. To increase purchasing power of such workers and their families, there is a consensus that minimum wage works more effectively in tandem with income support policies, such as the Earned Income Tax Credit (EITC), for example (6).

Granted, it's difficult to pinpoint specific significant effects of a minimum wage increase on GDP. And it's clear that such a move would increase businesses' labor costs and output prices, potentially eat into firms' profitability, and cause adverse employment effects--each of which may curb economic expansion. However, a raise for low-skilled workers who keep their jobs could fuel growth, given that these workers generally have a higher marginal propensity to consume (they typically spend, rather than save, more of each additional dollar of household income) than wealthier Americans or low-skilled workers who lose their jobs.

And even as a higher minimum wage could increase compensation costs for employers, companies could reap the benefits of lower employee turnover rates and higher employee productivity, and, by extension, lower costs of hiring and training new workers, as well as increased demand for their goods and services among low-wage workers. Additionally, if a local low-wage labor market is not competitive--examples would be with one major employer (a so-called monopsony) or a case of few employers (oligopsony) with a degree of collusion in their wage-setting behavior--there is scope for minimum wage increases to actually boost employment, as counterintuitive as that may sound (7).

The state of the minimum wage debate is such that, if one accepts that the competitive model approximates the actual operation of labor markets and the adjustment channel of minimum-wage increase is limited to loss in employment, the more one is likely to oppose employment regulation such as a minimum wage law (8). The fact that wages and labor productivity seem to have less and less to do with each other suggests that the demand for labor isn't perfectly competitive. There is also substantial evidence that the most important channels of adjustment are price increases, reductions in labor turnover, improvements in organizational efficiency, and reductions in wages of higher earners ("wage compression") (9).

In Danger Of Being Left Behind As The Economy Recovers

A legal minimum wage is a government's (federal, state, or city) most direct policy lever for influencing pay levels, especially for workers in a weak bargaining position (chart 1). It also serves as a basic labor standard, alongside working-hours regulations and related provisions, such as overtime pay standards and the employment of minors (10).

Although U.S. economic output is now more than 10% above prerecession levels and unemployment has dropped below 5%, a significant wage gap persists, especially among disadvantaged groups. In fact, workers at the minimum wage are paid 10% less today, after adjusting for inflation, than they were the last time Congress raised the wage, in 2007.

The federal floor on wages was first established at 25 cents an hour in 1938 under President Franklin D. Roosevelt, with the goal of directly putting a stop to falling labor standards, and in the process, indirectly augmenting purchasing power of low-wage workers without derailing the recovery from the Great Depression (11). Since its inception, the nominal value of the federal minimum wage has increased sporadically, to today's $7.25 an hour (reaching the current level in three 70-cent increments over two years in 2006 and 2007) (12). By contrast, since the most recent increase, the average hourly earnings of production and nonsupervisory employees have risen 16% (cumulative), reviving the debate about the need for another increase in the minimum wage. The minimum wage is now just 36% of the median wage and trending lower, substantially lower than the 55% in 1968 (see chart 2) (13).

An aside: Another aspect of this debate, which we aren't addressing here, is the purpose of the minimum wage. Some think "minimum wage" means "living wage," while others view the minimum wage as a threshold for entry-level positions that are meant to be transitional (14). MIT's Living Wage Calculator explains the amount an individual must earn to support oneself and a family across all American states and counties, along with data on expenses, typical annual salaries, and local minimum wages. In New York County (Manhattan), for example, the living wage for an adult with one child is $28.24 per hour; the local minimum wage is currently $10.50. In Manhattan, Kansas, the living wage for an adult with one child is $21.41; there, the minimum wage is $7.25.

The difference between the minimum wage and many other federal benchmarks is that it's not indexed to, or consistently updated with, inflation. In fact, adjusted for inflation, the minimum wage topped out in 1968, when it was $11.22 (in today's dollar terms) (15). Since then, the purchasing power of the federal minimum wage has eroded 35% (see chart 3).

As it stands, the U.S. minimum wage is low compared with those in other advanced economies (16). In France and Ireland, for example, the base remuneration level is the equivalent of more than $11 an hour. Even in the U.K., a country seen as having a flexible, American-style labor market, it's close to $10 an hour. Granted, international comparisons aren't always apples-to-apples, given differences in the cost of living and median pay, but it's still fairly telling that the U.S. minimum wage is comparable to those in places like Greece, Spain, and Slovenia--countries where GDP per capita and labor productivity are markedly lower than in the U.S. (see chart 4).

Today's minimum wage translates to annual gross earnings of about $14,500 (based on 50 work weeks of 40 hours each). That's not very far above the poverty threshold for an individual of $11,880. If two providers in a household work, the minimum wage would give them just $29,000--far below the median U.S. household income of about $56,516 (as of 2015) and barely above the Federal poverty level threshold of $24,257 for a family of four (as defined by the Office of Management and Budget).

In this light, it's clear that those at the low end of the income ladder are in increasing danger of being left behind while the economic recovery continues to unfold. Thus, the minimum wage is failing to meet at least one of its goals: to augment purchasing power of low-wage workers.

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