In the State of the Union address last week, President Barack Obama proposed increasing the minimum wage from $7.25 an hour to $9 an hour. This is a good idea that would raise the standard of living for millions of Americans and help minimize loan debt taken on by college students.
Perhaps an even more important piece of Obama’s proposal is the overlooked idea of indexing the minimum wage to inflation so it annually adjusts to account for changes in the cost of living.
Allowing the minimum wage to automatically adjust makes much more sense than the United States’ traditional policy of increasing the minimum wage whenever the governing party feels like it.
Obviously, the current approach is unpredictable and creates a huge amount of uncertainty—the bane of businesses everywhere. Employers are good at reacting to cost increases when they see them coming and can prepare for them. Every economist would agree that firms are most efficient when they possess the information to act rationally.
Our nation’s haphazard system of adjusting the minimum wage paralyzes companies with uncertainty and forces them to guess about the future cost of labor.
Of course, college students stand to benefit from an increase in the minimum wage. As most working college students are paid hourly at a rate close to minimum wage, the policy would direct more money into the pockets of college students. This would lower the amount of debt that students would have to take out to cover the rapidly increasing cost of tuition. Unfortunately, even if the minimum wage is indexed to inflation, it likely won’t keep pace with tuition, which has been rising in price much faster than nearly every other good in the economy.
But the jump from $7.25 an hour to $9 an hour is not insignificant. Minimum-wage workers putting in 40 hours a week would make nearly $4,000 extra per year. Even college students only working 10 hours a week would make close to an extra $1,000 per year.
And because the floor wage would be higher, employers currently paying a few dollars above the minimum wage would feel pressure to raise wages. You’d likely see your income rise even if you’re paid more than the minimum wage.
So why would anyone oppose raising the minimum wage?
Detractors of the president’s proposal claim that raising the minimum wage would increase unemployment. Many offer as evidence the classic model of supply and demand taught in Econ 101 that says the market automatically chooses the wage that minimizes unemployment.
But labor economics is not that simple. The truth is that the jury is still out on how the minimum wage influences the labor market.
A frequently cited study by David Card of UC-Berkeley and Alan Krueger of Princeton suggests little correlation between increases in the minimum wage and unemployment.
The White House also cites research suggesting that workers earning higher wages are more productive.
It seems unlikely that increasing the minimum wage would have a strong negative effect on unemployment. But we do know that it would significantly increase the income of millions of people and slow the growing inequality in wealth that we’ve witnessed since the Reagan era.
Further, indexing the minimum wage to inflation would promote stability in wages allowing workers to no longer see their real wages erode against inflation and allowing employers to plan for increases in the cost of labor.
Considering the costs and benefits of the President’s proposal, I recommend that Congress take action to increase the minimum wage.
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