A Review of the Economic Literature on U.S. Minimum Wage Laws

Congress instituted the first federal minimum wage laws in the United States in 1933, under the National Recovery Administration[1], and it has been steadily increasing wage minimums ever since. Today, all but five states have individual minimum wage laws and more than half of states dictate a minimum wage higher than the federal level.[2] Minimum wage has become a sacrament in America. While partisan squabbles arise from time to time over whether to raise the minimum wage (and, if so, by how much), the canard that minimum wage laws decrease poverty goes unchallenged in policy circles, and the assumption that the laws have no (or limited) negative affects on employment goes uncriticized.

This should not be the case. An examination of academic literature on U.S. minimum wage laws reveals that minimum wage laws exert downward pressure on employment levels and do little to alleviate poverty; in many cases the laws exacerbate it when businesses cannot afford to hire low-income workers who are willing to earn less than the "minimum wage." Even when some workers see their wages rise under a wage hike, this is vastly outweighed by the increase in unemployment.

In addition, minimum wage laws target the wrong demographics for fighting poverty. Most minimum wage workers are not poor but rather part-time workers, apprentices, or students. One telling statistic is that for each "full-time working poor person that exists, there are [seven] who either do not work or do so only part-time."[3]

Constitutional/Historical Analysis

The story of how minimum wage laws gained traction in the United States is one of factional interests-namely big business and big unions-exerting political pressure to advance their individual interests by neutralizing their competition. Unions support minimum wage laws because "by artificially increasing the wage rate of lower-skilled workers-who could substitute for union workers-the minimum wage increases the demand for union workers and hence their wage rates."[4] Similarly, businesses that pay their workers wages above minimum wage have an incentive to sabotage their competitors (who pay their workers less) by outlawing their competitors' business model of low wages. As Thomas Rustici points out, after the country's first attempt at a minimum wage law was declared unconstitutional by the Supreme Court in 1935, "businesses collaborated with unions in lobbying for a substitute."[5]

But both the original law, under the National Recovery Association, and the 1938 law their lobbying efforts produced, the Fair Labor Standards Act,[6] stand in woeful opposition to the letter and intent of the U.S. Constitution. Article 1 of the Constitution dictates that no states shall pass any "law impairing the obligation of contracts."[7] The Supreme Court has also found a right to "liberty of contract" in the due process clauses of the Fifth Amendment and the Fourteenth Amendment.

In the 1905 case Lochner vs. New York, the Supreme Court sided with Joseph Lochner in overturning the Bakeshop Act, which limited working hours in bakeries to ten per day or 60 per week. Rufus Peckham, writing for the majority, explained the Court's rationale concisely: "The general right to make a contract in relation to his business is part of the liberty protected by the Fourteenth Amendment, and this includes the right to purchase and sell labor, except as controlled by the State in the legitimate exercise of its police power." This decision established the Lochner Era, a golden period in the Court's and the country's history, in which arbitrary restrictions on wages were decried as unconstitutional.

In 1923, the U.S. Supreme Court decided on the case of "Adkins vs. Children's Hospital," in which the District of Columbia Minimum Wage Board, represented by Adkins, set a minimum wage for female employees of the D.C. Children's Hospital. The Supreme Court, in a 5-3 decision, ruled with the Children's Hospital that a minimum wage law is unconstitutional. Justice George Sutherland, writing for the majority, explained that a minimum wage law "authorizes an unconstitutional interference with the freedom of contract included within the guaranties of the due process clause of the Fifth Amendment."[8] Noting that there is no "absolute freedom of contract," Sutherland said that "freedom of contract is, nevertheless, the general rule and restraint the exception, and the exercise of legislative authority to abridge it can be justified only by the existence of exceptional circumstances."[9]

Adkins vs. Children's Hospital was overturned in West Coast Hotel Co. v. Parrish in 1937 (which also indirectly overturned Lochner),[10] but the fundamental constitutional logic of their reasoning remains.

Economic Analysis

The basic view of minimum wage is so simple and elegant that it is taught in all economics textbooks. The model's simplicity does not detract from its explanatory power. In the labor market for low-wage labor, where supply of labor (workers) must be balanced with demand for labor (employers), a minimum wage serves as a price floor above the equilibrium price of labor (wage). This causes a shortage of labor (unemployment) as the supply of labor exceeds the demand for it. The critics of the textbook theory of labor markets have a sundry arsenal of arguments, but all the arguments rely on some sort of belief in a monopsony in the labor market[11]-that employers in a plethora of industries have colluded or utilized economies of scale in order to fix the wages artificially low for a large cross-section of low-wage workers. This argument is not borne out by statistics or common sense.

But increased unemployment caused by immediate labor shortages is just the beginning of the negative economic ramifications of minimum wage laws. The laws can also reduce workers' ability to choose their preferred compensation package in much the same way that increased mandatory safety regulations diminish choice. If a worker prefers "fringe benefits and conditions of work" to straight wages, this choice is taken away from them as their employer is forced to cut nonmonetary benefits regardless of worker preference.[12] Also, the brunt of the pain of unemployment is borne by workers with the lowest skills. Because "labor competes against labor, not against management," the workers with the lowest skills will lose their jobs under a minimum wage law while workers with higher skills will benefit-as Rustici notes, this side effect of a minimum wage restriction is "exactly the opposite of its alleged purpose." [13] In some cases, "when the minimum wage raises the cost of employing low-skill workers" above the cost of an automated substitute for that worker, minimum wage can hasten the replacement of human jobs with mechanized ones.[14] Minimum wage also functions as a sort of educational discrimination against the least advantaged. For these disadvantaged, young workers, a low-wage job can serve as an apprenticeship where they learn skills that can foster higher future wages while only receiving the compensation equivalent to their inchoate talents.[15] Minimum wage laws eliminate this form of paid apprenticeship.

Literature Review

1) "A blunt instrument; the minimum wage." The Economist. October 28, 2006.

In its 2006 examination of the economic literature on minimum wage, The Economist concludes, "a higher minimum wage may not kill many jobs, but [it] won't help many poor people." The article cites a petition organized by the Economic Policy Institute ("a left-wing think-tank," according to the article) and signed by more than 650 economists that argued that raising the minimum wage would be effective at reducing poverty. However, the magazine argues, this does not "reflect a consensus among the dismal scientists," who, on the whole, believe that lifting the minimum wage is "at best a blunt instrument for fighting poverty." Debate has shifted toward the affect of minimum wage hikes on employment, where economists have reached the nugatory conclusion that "raising minimum wages has minor effects at worst." (Lawrence Katz, one of the signers of EPI letter, agreed that "most reasonably well-done estimates show small negative effects on employment.")

But the larger consensus among economists that the article highlights is the inability of fixed wages to reduce poverty. Some economists have found that minimum wage hikes increase poverty levels. The article explains this as being the result of three phenomenons. First, the unemployed do not benefit from wage hikes as they do not work regardless of wage levels. Second, poor consumers pay for the wage hikes through increased prices for goods and services. Third, and most importantly, "many minimum-wage workers are not poor"; almost a third of the 5 percent of the workforce who stand to benefit from higher minimum wages are "teenagers, many from families that are not poor."

2) Card, David E. and Alan B. Krueger. "A Reanalysis of the Effect of the New Jersey Minimum Wage Increase on the Fast-Food Industry with Representative Payroll Data." National Bureau of Economic Research. January 1998.

In 1994, David Card of the University of California, Berkeley and Alan Krueger of Princeton University released a study on minimum wage that stood in a diametric juxtaposition to previous economic research and the conventional economic theory of employment.[16] Card and Krueger's paper examined fast food businesses on both sides of the border of New Jersey and eastern Pennsylvania in the time before and after New Jersey's 1992 institution of an 18 percent minimum wage hike. They gathered their initial data in two rounds-before and after the hike-by contacting fast food restaurant managers directly and questioning them on the number of full-time employees in their employ. They concluded, improbably, that the increase in the minimum wage actually raised employment for the New Jersey businesses and, consequently, that minimum wage hikes have positive employment effects. Economists widely disputed these findings.

In their 1998 paper, Card and Krueger engage their critics, specifically David Neumark and William Wascher. Card and Krueger seek to disprove Neumark and Wascher's findings of data-set inaccuracies and analyze "employment trends using a comprehensive new data set derived from the Bureau of Labor Statistics." This data set, they explained, includes intensive "administrative employment data" between 1992 and 1993 as well as periodic data between 1991 and 1996. Card and Krueger claim that this new data set means that their findings are "free of the kinds of survey errors that may have affected [their] earlier results" and, by extending the time period researched to 1996, allows them a less myopic view of the wage hike's effects on New Jersey employment levels than their first paper-published just two years after the wage hike. After dissecting this new data set, they find that their original findings were correct and that there is "slightly faster employment growth in New Jersey than in the Pennsylvania border counties over the time period [they] initially examined."

Card and Krueger then "conduct a preliminary analysis of the effect of the 1996 increase in the federal minimum wage, which was binding in Pennsylvania but not in New Jersey." This serves as a supplementary study meant to determine whether any environmental factors skewed the results of their 1994 study. They find that Pennsylvania's employment did not diverge much from New Jersey's after the 1996 federal wage hike, and they conclude that "modest changes in the minimum wage have little systematic effect on employment."

Finally, Card and Krueger return to the 1992 New Jersey wage hike and attempt to reconcile the divergence between the findings of their study and the findings of Neumark and Wascher. They find "three main conclusions": 1) There was a different sample for the Pennsylvania data-set-Pennsylvania employment increased in Neumark and Wascher's data-set after the hike, but in Card and Krueger's it did not; 2) Neumark and Wascher nonrandomly selected as their sample "restaurants owned by one Burger King franchisee," which Card and Krueger say is too small a sample; and 3) They collected data on "patterns of employment changes" with inconsistent reporting periods-sometimes weekly, sometimes biweekly, sometimes monthly, etc.-which skewed the data as "seasonal factors" and "imperfect scaling of hours" caused these discrepancies to become significant. For the final factor, Card and Krueger found that "once this peculiar feature was taken into account, [Neumark, Wascher, and Berman's] data indicate virtually identical hours of growth in New Jersey and eastern Pennsylvania."

3) Gallaway, Lowell E. and Richard K. Vedder. "Does the Minimum Wage Reduce Poverty?" Employment Policies Institute. June 2001.

In this study, Lowell Gallaway and Richard Vedder of Ohio University look at minimum wage through a micro lens (individual states) and a macro one (the nation as a whole) and determine that, in the United States, minimum wages at both levels of government have failed to fulfill their putative aim, reducing poverty. Their view is a historical one, and they examine federal minimum wage laws through "an econometric examination of data on minimum wages, poverty, and other variables for the period since 1953 (or later) through 1998." (Information was unavailable between 1938, when the United States instituted minimum wage, and 1953.) Gallaway and Vedder examine their data according to the Consumer Price Index as well as to an adjusted CPI, which countered deficiencies in the original CPI, and they look at the affect of the minimum wage hike on a wide cross section of Americans, those with differing ages, races, gender, and geographical location. They find, in every subgroup they examine, that minimum wage does not have a reductive effect on poverty. Poverty, they write, "occurs mainly among nonworkers," and they note that "for every full-time working poor person that exists, there are at least seven poor people who either do not work or do so only part-time."

They also explore whether states with "minimum wages above the national level" have less poverty. They find that there is no "statistically significant poverty-reducing effect of the higher state minimum wages."

4) Neumark, David, Mark Schweitzer, and William Wascher. "The Effects of Minimum Wages on the Distribution of Family Incomes: A Nonparametric Analysis" Journal of Human Resources. Spring 2005. Pp. 425-450.

In their 2004 study for the Journal of Human Resouces, David Neumark, a senior fellow at the Public Policy Institute of California, Mark Schweitzer of the Federal Reserve, and William Wascher, the assistant director in the division of research and statistics at the Board of Governors of the Federal Reserve System, analyze the affect that minimum wage has on families near the poverty line and find that "while minimum wages do increase the incomes of some poor families, the evidence indicates that their net effect is, if anything, to increase the proportions of families with incomes below or near the poverty line."

In order to determine whether the "redistributive effects of minimum wage" are "potentially positive," they focus on two main criterion: 1) Do the "wage gains received by employed workers" exceed the lost wages of "those who lose or cannot find jobs"? and 2) Does the benefit to minimum wage workers "in poor families" counterweight the benefit to minimum wage workers in different (richer) "parts of the family income distribution." This is an analysis that does not seek to make qualitative claims on the value of a redistributive minimum wage but simply attempts to verify minimum wage proponents' argument that a minimum wage shifts wealth downward. That is, when Neumark, Schweitzer, and Wascher write about "potentially positive redistributive effects," they meant "positive" in a, well, positive rather than nominative sense.

In order to evaluate the above criterion, they decide to use "non-parametric difference-in difference estimates" of data from the March demographic files of the Current Population Survey between 1986 and 1995. The analysis was non-parametric in that it did not have a specific set of benchmarks for defining poverty that were settled on before the start of the study. Non-parametric models are praised by economists for making few assumptions and for being robust, which means that their predictions hold better than parametric models when the real world differs from the model.

The experimental set-up centers on comparing the treatment group, "states in which the minimum wage rose between years 1 and 2," with the control group, "families in states in which the minimum wage remained constant between years 1 and 2." They look at the "the amount and composition of family income, family size, and the family's state of residence" during those years. This type of analysis is known as difference-in-difference analysis; it attempts to eliminate alternative causes for changes to family income besides the minimum wage hike. If country-wide financial troubles caused rising unemployment, for example, this would be reflected in the data for both the states with minimum wage hikes and the states without the hikes and would be factored out of the data.

Neumark, Schweitzer, and Wascher's analysis lead them to conclude that "reductions in poverty or near-poverty should not be counted among the potential benefits of minimum wages," which means that "the efficiency and equity effects of minimum wages point in the same negative direction." They reach this conclusion because their data show that minimum wage hikes do not fulfill their proponents' predictions. While wage hikes do "raise the incomes of some poor families," overall they do not garnish the wages of employed workers to a greater degree than they diminish the wages of unemployed and underemployed workers, and they do not disproportionately benefit minimum wage workers in families with incomes hovering around the poverty line.

Conclusion

After careful examination of the relevant arguments, it is clear that the minimum wage is an idea conceived out of individualized rent seeking and socialized through the political system to afflict both its modern day detractors and proponents. It is, as Rustici said, "a law whose consequences its own designers would officially declare to be 'bad' on all counts" and a situation in which "the alleged beneficiaries turn out to be the law's major victims."[17] As such, the most prudent course would be for the United States to abolish both federal and state minimum wage laws immediately and restore a Constitutional foundation to its labor markets.

This is admittedly an unlikely scenario. As minimum wage hikes have been misconstrued by the public, they have become red meat for many Americans. Advocating minimum wage increases is a populist policy favored by many liberal politicians. In the 2006 mid-term elections, Nancy Pelosi, now the Speaker of the House, promised to raise the federal minimum wage by a shocking 40 percent, from $5.15 an hour to $7.25, if the Democrats won a majority in the House of Representatives.[18] When the measure reached the floor of the House after the Democratic victory, 82 members of the "conservative" Republican Party joined all 233 Democrats in raising the minimum wage.[19] Even among the measure's opponents, advocacy for the abolishment of minimum wage laws was scarce. These close-minded views that emphasize populist rhetoric over economically rigorous policy must change, and it will have to start with widespread understanding of the economic realities of the boondoggle that is the minimum wage.

[1] Rustici, Thomas. "A Public Choice View of the Minimum Wage." Cato Journal. Vol. 5, No. 1. Spring/Summer 1985.

[2] "Minimum Wage Laws in the States." United States Department of Labor: Employment Standards Division." January 1, 2009. Accessed http://www.dol.gov/esa/minwage/america.htm#content.

[3] Gallaway, Lowell E. and Richard K. Vedder. "Does the Minimum Wage Reduce Poverty?" Employment Policies Institute. June 2001.

[4] Rustici, op. cit., p. 117.

[5] Ibid, p. 120.

[6] Quigley, William P. "'A Fair Day's Pay For A Fair Day's Work': Time to Raise and Index the Minimum Wage," St. Mary's L. J. 1996.

[7] U.S. Constitution, Art. 1, Sec. 10.

[8]Adkins v. Children's Hospital, 261 U.S. 525 (1923)

[9] Ibid.

[10]West Coast Hotel Co. v. Parrish, 300 U.S. 379 (1937).

[11] Gwartney, James D. and Richard L. Stroup. "Economics: Private and Public Choice." New York: Harcourt Brace Jovanovich. 2005. pp. 559-562.

[12] McKenzie, Richard. "The Labor Market Effects of Minimum Wage Laws: A New Perspective." Journal of Labor Research. Fall 1980. p. 258.

[13] Rustici, op. cit., p. 113.

[14] Ibid, p. 113.

[15] Feldstein, Martin. "The Economics of the New Unemployment." The Public Interest. Fall 1973.

[16] David Card and Alan B. Krueger, "Minimum Wages and Employment: A Case Study of the Fast-Food Industry in New Jersey and Pennsylvania," American Economic Review, Volume 84, no. 4 .September 1994.

[17] Rustici, op. cit., p. 117

[18] "A blunt instrument; the minimum wage." The Economist. October 28, 2006.[19] Hulse, Carl. "House, by a wide margin, backs minimum-wage rise." The New York Times. January 11, 2007.