On March 11th 2021, President Joe Biden signed the nearly $2 trillion American Rescue Plan. It included $1.9 trillion in stimulus checks, vaccine distribution and assistance to small businesses. It did not, however, include raising the minimum wage to $15 per hour, leaving many of the progressive Democrats disappointed. The debate around minimum wage laws has been a provocative subject between both politicians and economists alike for decades now.
New Zealand was the first country to implement a minimum wage in 1894 with a simple concept of setting a base rate for hourly wages. At the time, most economists believed a minimum wage could erode jobs. How so? If there is one lesson everyone should take away from economics, it’s the law of supply and demand.
Supply refers to the production of a good or service, whereas demand is about how much people want that good or service. Theoretically, the market prices at an equilibrium where quantity supplied is equal to quantity demanded. For instance, there is high demand for diamonds, as well as a short supply. Diamonds are thus expensive. This principal elucidates why businesses can’t go around charging $100 for ordinary pencils; although there is a steady demand for pencils, the supply of pencils is abundant; hence they’re cheap.
But if a business does decide to charge $100 for pencils, it will be pricing itself beyond the market equilibrium. There are so few buyers for ordinary pencils at that price, that the business will be forced to drop prices, and return to the price where quantity demand equals quantity supply.
Applying that to the labor market, there is a steady demand for cashiers, yet nearly everyone can become a cashier and plenty of people are willing to work as one. Compared to more technical jobs such as a surgeon, there is a large supply of cashiers. As a result, they don’t get paid much, being the equilibrium wage as determined by the market.
But suppose the government says that no matter what the market price is, cashiers must get paid $15 per hour, which in our example is double what they were previously paid. The price of labour thus goes up, and quantity demanded goes down. Demand for workers decrease. Employers hire fewer cashiers.
In 1938, Franklin D. Roosevelt set the US federal minimum wage at 25 cents per hour. But that wage was not adjusted with inflation, so it lost value over time and stagnated, giving the opportunity for states and counties to set their own local minimum wages. With polities setting their own minimum wage laws, economists were able to conduct experiments and measure the impacts of the policies.
In 1992, a pair of Princeton economists analyzed minimum wage effects on fast food employment. They compared data in New Jersey, where the minimum wage increased, and Pennsylvania, where the wage remained constant. The results were the opposite of what you’d expect - New Jersey, despite its increase in minimum wage, experienced more employment relative to Pennsylvania.
This was the first substantial piece of evidence suggesting that the traditional supply and demand framework may not rigorously explain the labor market. The research was cited by minimum wage supporters but dismissed by opposers. Needless to say, the study’s methodology and the relevance of the findings are still bitterly debated amongst economists.
What meaning do we give to the number of jobs, as opposed to workers? Do we look at the entire labor market or just one sector? What timeframe is sensible to assess the impact of policy on unemployment? The study posed all of these and more questions, further intensifying the debate. To this day, critics of minimum wages defend the “price goes up, demand goes down” theory and say the labor market is no exception, whereas proponents assert the need for a minimum wage to prevent workers from being underpaid.
Even though he didn’t include it in the stimulus package, Joe Biden has promised to raise the federal minimum wage to $15 per hour from $7.25, the doubling in effect taking America’s economy into uncharted territory. There’s no question that getting it past the Senate will be tough and even if he does manage to do so, economists will likely be debating the impact for years to come.