Dear Clients and Friends,
For this weekend’s reading, we will be discussing one of the most hotly debated topics in economic theory and policy: the minimum wage. The national minimum wage was first introduced under the Fair Labor Standards Act (FLSA) of 1938 at $0.25 per hour ($4.60 per hour in today’s dollars). At the time, the country’s economy was recovering from the worst depression that it had ever experienced, and the nation’s workers toiled away under extremely harsh working conditions. The focus of the FLSA was to improve working conditions and create a minimum standard of living for those workers who possessed the least bargaining power.
The scope of the minimum wage has expanded over the years to cover virtually all the nation’s workers, with the exception of certain tipped workers, part timers, and unionized workers. As of January 2020, 29 states have a minimum wage that is higher than the federal minimum wage. More than twenty states have increased their minimum wage rate over the course of 2021.
The minimum wage has been $7.50 per hour since 2009. The following chart shows the inflation-adjusted level of the federal minimum wage from 1950 to 2020 (in blue). The purchasing power of the federal minimum wage peaked at $1.60 per hour in 1968 ($11.91 in today’s dollars). As we can see, the inflation-adjusted level of the minimum wage has consistently dropped since peaking in 1968, and is currently sitting close to its lowest inflation-adjusted level since 1950.
Opponents of the minimum wage cite Neoclassical economics to argue that raising the federal minimum wage will put too much pressure on employers and lead to lower overall employment. Neoclassical economics assumes that all market participants act independently and with full access to information in order to maximize their own utility; in addition, prices (including the price of labor) are dictated by supply and demand. Their argument: if we artificially increase the price of labor, then supply and demand curves dictate that employers must hire fewer workers in order to be able to pay them more.
Opponents of neoclassical economics argue that market participants do not have full access to information; therefore, the assumption that they are acting efficiently is false. Furthermore, recent research has shown that market participants do not act rationally, which has led to numerous studies that aim to determine how all these factors play out in the real world. This leads us to the highlight of today’s article: David Card, one of this year’s winners of the Nobel Prize in Economics.
In 1994, David Card and Alan Krueger set out to study the real-world effect of minimum wage increases through a “Natural Experiment.” Rather than cite theoretical studies, they observed the effect of a minimum wage increase in a real-life setting. When New Jersey increased its minimum wage in 1992, it became the highest rate in the U.S. Neighboring state Pennsylvania did not increase their minimum wage. Card and Kreuger surveyed over 400 fast food restaurants on both sides of the border. This is a notable population to study because fast food restaurants typically face very tight margins, and often employ workers at the minimum wage. If any companies would feel the effects of a rise in minimum wage rates, it would be fast food restaurants. What Card and Krueger found was that there was no indication that the rise in the minimum wage cost any jobs. The OECD and the International Monetary Fund have recently come out in support of minimum wages, and this study has been cited in their decisions.
So, what does all this mean? Can we raise the minimum wage as high as we want without having an effect on employment rates? Well, we don’t know that for certain, but the answer is very likely to be “no.” What this does show us, however, is that the classical view that higher minimum wages automatically mean lower employment is flawed. Knowing this, we can further utilize “Natural Experiments” to determine just how far we can go to try to pull the nation’s lowest paid workers out of poverty without putting too much strain on employers.
We hope you found this weekend’s reading insightful and informative. Next time you hear someone falsely state that higher minimum wages directly lead to lower employment rates, you can be armed with the knowledge to know otherwise. With that, we wish you all a lovely weekend.
Daniel Levinson, CFP®
Financial Planning Associate
MOR Wealth Management, LLC
1801 Market Street, Suite 2435
Philadelphia, PA 19103
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