Minimum Wage: When More Is Less

Soon after Sen. John Kerry proposed raising the national minimum wage from $5.15 to $7 by 2007, that proposal received predictable cheers from some quarters and predictable boos from others. Yet both the supporters and critics of a higher minimum wage keep missing one critical point.

Take a careful look at the precise wording of a recent Bureau of Labor Statistics (BLS) report on this topic: “Slightly over half of workers earning $5.15 or less were under age 25, and about one-fourth were age 16-19. … About 2 percent of workers age 25 and over earned the minimum wage or less.”

The key phrase in that report — strangely ignored by both supporters and critics of a higher minimum wage — is “or less.” Among 73 million workers still paid by the hour in 2003 (40 percent of us are salaried), only 545,000 or 0.7 percent earned the minimum wage. Three times as many — 1.6 million or 2.2 percent — earned less than the minimum wage. That is a huge improvement over 1997, when 3 million earned less than the minimum wage. Contrary to a universal confusion between words and reality, those paid the official “minimum” wage are not the nation’s lowest-paid workers.

The federal minimum wage does not apply to those working on small farms or at seasonal amusement or recreational establishments. It does not apply to newspaper delivery people, companions for the elderly, outside salesmen, U.S. seamen on foreign-flag ships, switchboard operators or part-time babysitters.

Any employer with an annual income below half a million dollars is free to ignore the minimum wage, except in states with their own minimum for such small establishments (such as $2 an hour in Oklahoma, $2.80-$3.35 in Ohio and $4 in Montana). Such jobs offer a crude safety valve, preventing the full brunt of minimum wage hikes from taking the form of higher unemployment.

Not all the unskilled job applicants precluded from minimum wage jobs end up being added to the ranks of the unemployed, or (another neglected effect) to the ranks of discouraged labor force dropouts. Instead, many are just displaced into jobs exempt from the federal minimum wage.

Jobs paying less than the minimum wage, legally or otherwise, are typically more arduous and less secure than jobs in, say, chain stores or restaurants, where the minimum wage is more easily enforced. Jobs exempt from the minimum wage generally offer no pension or health benefits, and no effective regulation of overtime hours, sick pay or other working conditions. Employer payment of Social Security taxes is notoriously negligent, leaving affected workers ineligible for benefits.

Past experience shows that an increase in the minimum wage is not only likely to reduce the number of workers earning the minimum wage, but also to increase the number earning less than the minimum. The resulting increase in the supply of workers forced by a higher minimum wage to compete for sub-minimum wage jobs can be expected to push the lowest wages even lower.

The minimum wage was increased from $2.65 to $2.90 in January 1979 and to $3.15 in 1981. The percentage of hourly wage workers earning less than the minimum reached 5.6 percent by 1979 and 6.8 percent in 1981. The unchanged $3.35 minimum wage gradually became less burdensome as wages and prices rose during the strong 1983-89 expansion, so that by 1989 the percentage earning less than the minimum had fallen to 2.2 percent. But the minimum was then increased to $3.80 in April 1990 (and to $4.25 a year later) and the percentage earning less than the minimum jumped to 3.8 percent in 1991. The economy was in recession during part of 1981 and 1991, however, so we cannot be entirely certain the increased minimum wage was the main culprit.

The effect of the most recent rise in the minimum wage is harder to ignore (although Kerry nonetheless ignores it). The minimum wage was increased to $4.75 in October 1996 and to the current $5.15 a year later. What happened? The percentage of workers earning less than the minimum wage jumped from 2.5 percent (1.7 million) in 1995 to 4.2 percent (3 million) by 1997. The percentage of teens working for less than the minimum rose from 7.2 percent to 19.8 percent. The increased minimum wage is the only plausible explanation, because the job market was unusually strong. The unemployment rate dropped from 5.6 percent in April 1996 to 4.2 percent in April 1997, even as the number of workers earning less than the minimum wage nearly doubled.

Some cite the falling unemployment rate in 1996-97 as evidence the higher minimum wage did no harm. They are quite mistaken. Jobs paying the minimum wage currently account for only four-tenths of one percent of all U.S. jobs — far too tiny to have much effect on total unemployment. For those directly affected, however, the effect can be extremely nasty.

Critics of the minimum wage emphasize the negative effect of the minimum wage on employment, particularly among teens, new immigrants and other entry-level workers. This is correct as far as it goes. States with minimum wages in the vicinity of $7, for example, generally suffer above-average unemployment — 6.1 percent unemployment in Washington, 6.2 percent in California, 7.3 percent in Alaska. But unemployment is not the only possible effect. Those displaced from job opportunities by a higher minimum wage have another option: They often can and do work for less than the minimum wage. A higher minimum wage reduces the number of such jobs that are offered, leaving a larger number of low-wage job-seekers competing for jobs that pay less than the minimum wage. That, in turn, must push the lowest wages even lower.

Whenever the minimum wage is pushed up faster than the market would have moved it, the effect is to greatly increase the proportion of jobs paying less than the minimum. Employers offering less than the minimum, legally and otherwise, suddenly find themselves blessed with a flood of applicants whenever the minimum wage goes up. These people were displaced from dwindling job opportunities among the larger, more formal businesses that are uniquely affected by the federal law.

Cutting off the lowest rung on the ladder of opportunity may please some members of labor organizations who stand much higher on the ladder, because it reduces future competition for better jobs. But to describe an increased minimum wage as a compassionate gesture is the opposite of its most obvious effect. In reality, Kerry’s proposal to raise the minimum wage to $7 an hour would shove hundreds of thousand of young and unskilled American job seekers into dead end jobs that pay less than the minimum.