Why a Higher Minimum Wage Is Bad Economic Policy

If you want to know why the Democrats keep treading water in spite of an unpopular president and the feckless pork-barrel leadership of congressional Republicans, look no further than the minimum wage.

Resident Scholar Kevin A. Hassett
Resident Scholar Kevin A. Hassett
In a recent move that was about as surprising as a low-scoring soccer game, Democrats made it clear they will make the minimum wage a central part of their election strategy next fall.

They certainly took to the pulpits in recent weeks. Howard Dean, chairman of the Democratic National Committee, opined to a church group that "it is a moral principle to raise the minimum wage. It is nothing but economist mumbo jumbo to say raising it will hurt jobs." Massachusetts Senator Edward Kennedy issued a report under the title: "When Work Doesn't Pay: Minimum Wage Families in America."

The minimum wage began in 1938 with the Fair Labor Standards Act, which enacted a 25-cent hourly wage. Over time, the rate has increased, and the act has been repeatedly amended, resulting in today's $5.15 per-hour wage. The rate hasn't been increased since 1997.

A higher minimum wage is terrible economic policy and Americans know it. State-level Democrats have been pushing the issue this year and have been on the losing side of the debate. While eight states have enacted legislation to increase the minimum wage this year, 18 have seen such legislation defeated, according to the National Restaurant Association. Several states have minimum wage legislation pending, including California, Massachusetts, North Carolina and Pennsylvania, but so far the record on the minimum wage stands at a resounding 18-8 against.

Bad Politics

Politically, you couldn't hope for a better opponent than one who thinks that something that has lost more often than not should be the centerpiece of an election strategy.

As an economist, I would like to believe that the minimum wage doesn't work politically because voters, unlike Howard Dean, understand the economics. There is an abundance of research on the minimum wage, and literature reviews regularly report that raising it induces firms to hire fewer workers, and to cut back on hours.

The effects are not huge, but they are significant. It is hardly rocket science. If you raise the price of apples, people buy fewer apples. If you raise the price of labor, firms buy less of it. And if you look at what happens to those whose lives are disrupted by higher minimum wages, the policy seems less and less just.

Negative Effects

In a recent study, economists David Neumark and Olena Nizalova documented the long-run negative consequences of following the Democrats' favorite policy. They began with the insight that minimum wages are particularly tough on young adult workers; the literature shows that lengthy unemployment can have a "scarring effect" on them, the economists noted. That is, young adults unemployed for a long period have significantly more negative labor-market experiences well into adulthood.

This effect has often resulted in an increased propensity to engage in criminal activity, among other things. Neumark and Nizalova reasoned that the negative employment effects of high minimum wages may increase this "scarring" and therefore continue to harm the victims as they grow older.

To evaluate this hypothesis, they compared outcomes for older workers who grew up in a state that had relatively high minimum wages with outcomes for those who faced low minimum wages when young. They found strong evidence that the negative effects of high minimum wages last into adulthood. A 29-year-old worker who grew up in a state with higher minimum wages has a significantly lower wage on average than a similar individual from a state with a lower minimum wage. This effect was especially strong for black workers.

Superior Options

It is true that those folks who are on the minimum wage and don't lose their job have higher earnings. But the trade-off is morally ambiguous at best. Should we enact a policy that gives 10 people an extra $40 a week, but whacks the 11th guy? Shouldn't the terrible disruption to the lives of those who are fired be more of a concern to us than the extra money for those who are not? Is it right to redistribute from the worse-off poor to the better-off poor?

It's especially wrong when there are superior options. The earned income tax credit gets money to working poor folks without creating the disincentives that go with higher minimum wages. Columbia University economist Ned Phelps has also suggested a tax subsidy for firms that hire low-wage workers. That, too, would be preferable.

Republicans trying to hold on to their political power are probably rejoicing that Democrats are resorting to their same old bag of tricks. Poor workers of America better hope the Democrats don't win.

Kevin A. Hassett is a resident scholar and director of economic policy studies at AEI.

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