Ryan Brosnahan Economics B.A. Candidate 9 September 2009

Why has minimum wage increased so much in the last few years?

On September 1, 1997 the minimum hourly wage was set to $5.15. On July 24, 2009 the minimum wage raised to its current level of $7.25. This paper discusses the reasons for the government mandated change and the implications predicted and observed.

To understand why minimum wage was raised in recent years first we must understand why it exists at all. During the 20s and 30s the textile industry began to move from New England to the South. The cost of living was lower in the south but the textile products were similar in quality. Northern congressmen bluntly demanded that wages be raised so that their constituents could continue to operate with equal competition [1]. Southerners naturally disliked this proposition and postponed new legislation for some time. The southerners were right to fight mandated wage hikes; when both producers (northern and southern based textile companies) are producing the same good at the same marginal cost* but one has higher fixed costs then that business will fail in a free-market system. The southern textile companies were on their way to eliminating the competition using the natural forces of the market. In 1938 the issue finally hit congress. The south continued to argue “Congress couldn’t make a man worth a certain amount by simply making it illegal to pay him less” [1]. The northern congressmen needed a better argument than lost profitability in order to get a bill passed. They took a stance of social responsibility; working conditions for low wage jobs were not good. And considering that many of these workers were children, the congressmen had little trouble gaining support. The Fair Labor Standards Act of 1938 passed and by October it was in effect;

* Marginal Cost – The cost to produce an additional unit of a product.

establishing a minimum wage in the US of $0.25. In 1997 dollars it was the equivalent of $2.85 [2]. Despite low unemployment, in 2006 a majority of Americans were dissatisfied with the inequality of income distribution [3]. Raising the minimum wage was on the table again and again both sides gave their arguments. Those who were against the legislation made the economists’ argument of supply and demand; government intervention causes a surplus. Consider figure 1 below which illustrate this point. There is some level of employment and wage where the market for labor is in equilibrium as the free market forces would dictate. But when congress passes legislation to increase it, the quantity demanded of labor goes down because it costs firms more to keep workers. The higher wage also gives incentive for more workers to enter the labor force. The result is increased unemployment [5].

Figure 1. Standard model of how a surplus in labor is created when government raises minimum wage above equilibrium.

Proponents of raising the minimum wage made equally valid arguments. Some economists believed that the wealthier business owners were undervaluing the cheapest workers by only charging minimum wage despite it staying the same for nearly a decade [3]. Gary Fields, Professor of Labor Economics at Cornell argued the industries that hire low wage workers have a monopsony in demand for labor and through subtle acts of collusion the cost of labor is inherently undervalued in our economy [4]. Both sides had outlined logical arguments using facts of economics to solidify their claims. So once again the argument was made that raising minimum wage should be done with social consequences as the key decider because there is no way to prove which economic school of though is more likely to happen. In 2006 it was determined that the minimum wage set in 1997 was no longer sufficient to live on. Real Minimum Wage in 1997 Dollars

Hourly Minimum Wage (1997 dollars)

$5.6 $5.4 $5.2 $5.0 $4.8 $4.6 $4.4 $4.2 $4.0 1996

1998

2000

2002

2004

2006

2008

2010

Year

Figure 2. Real minimum wage by year using 1997 base. When the minimum wage was set in 1997 it is reasonable to think that it was done with the intent to support the income of the cheap laborers, most of whom were 16-24 years old [2]. The legislation in 1997 did not, however, consider the change in the value of that minimum and

by 2006, 20% of the original minimum wage value was lost. It was apparent that these workers could no longer afford a lifestyle that most consider the minimum an American deserves. The issue of whether to raise it was answered; the issue of how much and when became the new debate. It had been 11 years since the last increase and most businesses had only accounted for a certain amount of labor cost. Because of this congress decided that the legislation should provide for a gradual increase in the minimum wage over several years with a final minimum wage close to that of 1997 in real dollars. When a bill was drawn economists could only guess at what inflation would be. On May 25, 2007 President Bush signed the Fair Minimum Wage Act into law. The results can be seen in figure 2; minimum wage is currently worth $5.40 1997 dollars, much like 1997. This excursion in exploring why minimum wage exists and changes has brought new insight in the world of labor economics and politics alike. Some market aspects cannot be answered with supply and demand curves but, rather, a sense of social duty. In every minimum wage increase from its establishment this has been the case and as our current laws stand, in a few years we will have the debate all over again to increase it back to the proper real wage.

References 1. Folsom, Burton W. PhD. Minimum Wage Causes Maximum Pain. June 1998. http://www.mackinac.org/article.aspx?ID=356 2. Bureau of Labor Statistics. http://www.bls.gov/ 3. Greenspan, Allen. The Age of Turbulence 2007. pp. 392 4. Gary Fields, "The Unemployment Effects of Minimum Wages," International Journal of Manpower, Vol. 15, issue 2 (1994), pp. 74-81 th

5. Schiller, Bradley R. Essentials of Economics 7 ed. Pp. 182