Getting minimum wage right

PROPONENTS of a higher minimum wage are well-intentioned in their effort to help low-wage workers. But whether a higher minimum wage would help most workers is debatable. Though it would raise wages for some, it would leave total compensation for others the same and reduce to zero the wages of those who lose their jobs as a result.

US President Joe Biden has proposed phasing in a federal minimum wage of US$15 per hour, up from the current US$7.25 per hour, and Republicans have objected. The president's proposal would more than double the minimum wage over four years, whereupon it would then be indexed to increases in the cost of living (COL).

But there are foreseeable costs to such interventions. A higher minimum wage could finish off many small businesses that are already on shaky ground. It could prompt businesses to cut fringe benefits to offset some of the increase, thus reducing the purported gains to total worker compensation. And it could undercut the competitiveness of US industries in world markets.

Those who oppose a minimum wage increase worry especially about its likely effects on industries that are already struggling to survive. The hospitality industry, childcare, and other services that have been hit hard by the pandemic would struggle to absorb the additional wage costs. Employers in these industries could respond by passing those costs to consumers by raising prices, but this might reduce demand for their services. Moreover, when the minimum wage for unskilled labour increases, the skill premium declines, creating a temptation for employers to substitute skilled workers for unskilled, or for automation technologies.

Obviously, the level of the wage floor matters. A minimum wage could be set so high that it reduces employment substantially, or so low that it has no effect at all. The higher it is, the greater the risk that more workers who are unable to find jobs in the formal economy will turn to extralegal activities.

That is what has happened in Puerto Rico, which is subject to the US mainland minimum wage, and where a large share of the workforce is unskilled. Puerto Rico's official labour-force participation rate is 40 per cent - compared to a rate consistently above 60 per cent on the mainland - reflecting the fact that many of its residents work informally without paying taxes or receiving legally mandated employer benefits. Many developing countries have experienced the same problem. In India, for example, the labour laws protecting workers are so strict that only around 15 per cent of workers are employed in the formal economy.

In the United States, the Congressional Budget Office estimates that an increase to a US$15 hourly minimum wage over four years would raise the wages of 27 million workers but lead to a loss of 1.4 million jobs. One question, then, is whether the wage gains for the 27 million would more than offset the losses for the 1.4 million who lose their jobs.

But it is also unclear whether the minimum wage increase would actually raise the total compensation of workers receiving higher wages. Following a rise in the minimum wage, employers could become less generous with healthcare benefits, sick leave allowances, training programmes, on-site amenities, and other non-wage benefits. There is some evidence to suggest that companies will offset at least part of the impact of a wage increase by scaling back such benefits. If there is to be a sizeable increase in the minimum wage, the policy could be less costly if it included some other provisions, such as adjustments for COL differentials in different parts of the country and measures for young workers and apprenticeships.

On the COL index, Hawaii leads US states with a score of 192.9, followed by California at 151.7 and New York at 139.1 . At the other end of the spectrum, Mississippi scores 86.1, and nine other states are below 90. Given these disparities, it makes no sense to have the same minimum wage in Hawaii as in Mississippi. Not only would a single rate fail to provide the same "living wage" across every state; it would most likely reduce employment in low-COL states.


There is no reason to insist on a blanket policy. COL data from the Department of Labor could readily be used to reflect differences in living costs in the minimum wage. After all, state-level minimum wage laws already differ widely. Georgia's hourly minimum wage is US$5.15, while New York's is US$12.50. And several states, such as Minnesota, have a higher minimum wage for large employers than for small employers.

An analogous distinction should be considered for teenage and apprenticeship employment. Employers may be discouraged from providing training if they must pay the minimum wage to teenage summer workers, young people who are in school or working part-time, and apprentices.

A compromised minimum wage rate well above US$7.25, but well below US$15, combined with these exemptions and adjustments for COL differences among states could reduce the potential negative effects of a minimum-wage increase. It might even induce employers to provide more training for the unskilled, thus improving the functioning of the labour market overall. PROJECT SYNDICATE

  • The writer, a former World Bank chief economist and former first deputy managing director of the International Monetary Fund, is senior research professor of international economics at the Johns Hopkins University School of Advanced International Studies and senior fellow at the Center for International Development at Stanford University

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