The Minimum Wage and Income Inequality

Data coming out of Britain indicates that there is a correlation between an elevated minimum wage and diminished income inequality. This is exciting news.

The continually growing level of income inequality in the United States has become a fundamental challenge for our political and economic systems. At present, it is difficult to envisage a systemic approach that could rapidly reverse this phenomenon. One simple approach that seemed to hold promise was to significantly raise the minimum wage.

Usually, such a move is viewed in terms of keeping the lowest paid above the poverty line. However, it is possible that a significant increase could cause a restructuring of a broad section of the wage structure. The current federal minimum wage is set at $7.25 per hour. If it was raised to $10 then anyone currently making between $7.25 and $10 would see a raise, but they would also be expected to pressure their employers to recognize that their efforts should continue to earn a premium over the minimum. How far such a ripple effect might propagate is unknown. New auto workers have starting salaries of about twice the current minimum. Would the auto companies feel compelled—or actually be compelled—to increase the premium they pay over the minimum? It would certainly be interesting to find out.

Economists stick by the supply and demand curves they studied in school and have assumed that a raise in wages must be accompanied by a fall in employment. But if one considers the economic effects of a raise in pay, the situation is actually quite complex. An employer who is required to pay a higher wage suffers a drop in profit, but the increase in wages of the employees acts as an economic stimulus. How this balances out for the economy as a whole might depend on the size of the wage increase, what businesses are affected, and local economic conditions.

In The Effect of Raising the Minimum Wage: Is There a Market for Labor? we discussed a famous, but controversial, study that indicated raising the minimum wage did not have a discernible effect on the employment level. An article in The Economist discusses the same data and more recent findings and suggests that the conventional wisdom is now shifting in favor of a "reasonable" minimum wage being a good thing.

"Some of the newest studies suggest firms employ a variety of strategies to deal with a higher minimum wage, from modestly raising prices to saving money from lower turnover."

"Bastions of orthodoxy, such as the OECD, a rich-country think-tank, and the International Monetary Fund, now assert that a moderate minimum wage probably does not do much harm and may do some good. Their definition of moderate is 30-40% of the median wage. Britain’s experience suggests it might even be a bit higher."

While economists continue to argue over their numbers and conclusions, Britain has provided some additional evidence that seems to suggest the ripple effect on the wage distribution discussed above is real.

"The most striking impact of Britain’s minimum wage has been on the spread of wages. Not only has it pushed up pay for the bottom 5% of workers, but it also seems to have boosted earnings further up the income scale—and thus reduced wage inequality. Wage gaps in the bottom half of Britain’s pay scale have shrunk sharply since the late 1990s. A new study by a trio of British labour-market economists (including one at the Low Pay Commission) attributes much of that contraction to the minimum wage. Wage inequality fell more for women (a higher proportion of whom are on the minimum wage) than for men and the effect was most pronounced in low-wage parts of Britain."

So—raising the minimum wage might have little or no effect on employment, but will diminish income inequality. What then is a "reasonable" minimum wage? The article also provided this chart to further the discussion.

If the US raised its minimum wage to 46% of median like Britain, it would be $8.78. If we copied France and set it at 60%, it would rise to $11.44. Is that an outrageous number? Perhaps not. In Why Not Raise the Minimum Wage to $12 per Hour we discussed a study of Walmart (average wage $8-$9) that indicated the effect of raising the minimum wage for its employees to $12 could be accommodated by a mere 1.1% rise in the cost of its products. Other companies and industries would be affected more or less than Walmart, but the idea of a dramatic rise in the minimum wage is not outrageous.

A significant boost in the minimum wage may be the only leverage we can bring to bear on income inequality.