The outcry is loud when businesses like gas stations and restaurants raise their prices. But when it comes to one of their most important resources, these same businesses are being told to pay higher prices.
In a speech from Austin, Texas, last month, President Obama urged Congress to "strengthen the middle class" by raising the federal minimum wage to $9 an hour and spending more on worker-training programs. The hope here is that a higher price "floor" in the labor market will improve our standard of living. Economic theory and historical evidence suggest otherwise.
First, the theory.
Price floors are legal minimums on the price at which a good or service can be bought and sold in a market. Some agricultural products have such rules.
But the most common example for all of us is the minimum wage. Idaho currently sets its minimum wage rate at the federal level of $7.25, last raised in July 2009. Our neighbors in Washington have the highest minimum wage in the nation at $9.19 per hour.
As will be true in any market, when the price floor is set above what would be the natural equilibrium, the quantity supplied exceeds the quantity demanded. The resulting surplus means that buyers' demand for the good or service must be rationed in some way among sellers.
The market for labor looks very much like all other markets: The quantity demanded falls and the quantity supplied rises as prices increase. The equilibrium price, or wage, assures an equilibrium quantity of labor is hired. When the minimum wage is set above the equilibrium wage, a surplus of labor will develop. This is unemployment.
Minimum wage laws are only binding in markets where equilibrium wages are already low. Thus, economic theory predicts that minimum wages have big impacts on the market for teenagers and other low-skilled workers.
The most recent historical evidence bears this out. The national unemployment rate for workers age 20 and over is averaging 7 percent in 2013, down from 8.6 percent in 2009 when the federal minimum wage last went up. Meanwhile, 24 percent of workers ages 16 to 19 are unemployed today, the same average rate as in 2009, despite nearly 1.5 million new jobs since then.
Despite this theory and evidence, some employers are saying minimum wage laws are just one factor in their hiring decisions. Reporting for StateImpact Idaho, Jessica Robinson profiled the owner of McDonald's restaurant on the Washington side of the Idaho-Washington border that said higher wages were only one factor in the location decision. ("Why won't this McDonald's move 20 feet into Idaho?," Business Insider, May 21-27.) If given a choice, the owner said, he'd prefer to pay Idaho's minimum wage, but it wouldn't change his mind about doing business in the state of Washington. Although not mentioned, other factors like absence of corporate income taxes in Washington likely play a big part.
In the article, Robinson reviews economic research addressing this question of whether minimum wage laws affect hiring. Economists Arindrajit Dube, T. William "Bill" Lester and Michael Reich put together a database of several border towns with differing minimum wage laws. These researchers used county-level data to study restaurants and other low-wage industries. They determined that there are no employment effects of minimum-wage increases. However, the authors go on to say that "several factors warrant caution in applying these results."
For example, they say their results should not "be extrapolated to predict the impact of a minimum wage increase that is much larger than what we have experienced over the period under study." The period under study was 1990 to 2006. The federal rate was raised just a few times over that period, so the sample size is relatively small.
The authors also say they did not "test whether restaurants respond to minimum-wage increases by hiring more skilled workers and fewer less-skilled ones." Economic theory predicts just that.
When the price floor of minimum wage creates a surplus of workers, some rationing mechanism comes into play. In this case, the workers who do get hired have higher skills. Our slow-growth economy is causing too many high-skilled workers to take low-skilled jobs, such as those at McDonald's.
The Bureau of Labor Statistics reports that there are 6.6 million U.S. workers currently taking part-time jobs for economic reasons. The same report shows there are 10.7 million part-time workers seeking full-time work. Raising the minimum wage for these workers isn't going to change their condition.
We don't like it when any business raises prices: Mandated price floors are no answer to bad economic conditions.