Minimum Wage Laws – Moral Imperative or Political Gambit?

The following guest blog is by John Swindell, retired Vice President and Managing Director of RR Donnelley Financial.

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Our current federal minimum wage of $7.25 per hour went into effect in July, 2009, and is not indexed to any measure of inflation.  President Obama and fellow Democrats are now proposing to increase the federal minimum wage to approximately $10 per hour in a couple of stages.  Early battle lines are being drawn along traditional ideology, with Democrats supporting the raise by citing the moral imperative to fight poverty and reduce income inequality and Republicans opposing the raise by repeating the long-held belief that the laws of economics negate the impact of minimum wage increases, repeating the old adage that you get less of what costs more – higher wages equals reduced employment.  Democrats counter that a plethora of studies have shown no ‘employment effect’ of increasing minimum wage.  A recent Glenn Hubbard Op Ed in The Washington Post disagrees, citing a book by David Neumark and William Wascher:  “a higher wage almost surely reduces employment.”  A recent editorial in Investor’s Business Daily argues that the studies frequently cited by minimum wage supporters did not include wage increases of the magnitude now being contemplated and, further, that the periods studied were relatively short and failed to account for longer-term impacts.

Supporters also make a claim of macroeconomic benefit based on the concept that the less affluent spend a higher percentage of their income on direct consumption goods, so an additional dollar in their hands translates into a significant impact on our economy by increasing the demand for goods.  Taking the point further, this increased demand should then motivate employers to increase employment opportunities.  Supporters also suggest that raising wages paid to employees translates into increased potential for those employees to purchase their employers’ goods or services.  Henry Ford is often quoted to the effect that he instituted a high wage policy so that, in part, his own employees could afford to buy his cars.  Those opposed argue that these supposed benefits are low-impact derivative effects whereas the high-impact direct effect would be that employers faced with mandated wage increases would likely seek to reduce headcount, reduce hours worked, and potentially displace workers with technology solutions ranging from fulfillment warehouses replacing pickers with robots to fast food restaurants replacing order-takers with kiosks on which orders may be placed via computer screen (think airport kiosks used for boarding pass printing and luggage check-in).

Many business owners argue that the minimum wage is a ‘starting wage’ for untrained workers who can and will earn higher wages in future based on the workers becoming more valuable to the enterprise.  Forcing the employer to pay a higher starting wage could reduce funds available for training and for future pay raises.  Business owners further argue that raising the minimum wage increases the labor component of the cost of doing business and, in order to preserve profit margins (many times very thin in the retail trades where the minimum wage applies), prices would be increased and that would impact the very people meant to be helped by the wage increase.  Supporters of the raise counter that Wal-Mart, for example, pays such low overall wages (not just starting wages) that in many states Wal-Mart employees constitute the largest single group of Medicaid recipients.  Fast food chains are in similar straits, not because starting wages are low but because average wages are low.

The political aspects of this subject cannot be ignored either, with Democrats feeling they have a winning populist case which is poll-tested and provides the bonus opportunity to demagogue Republicans. In addition, according to a New York Times article late last year, Democrats are working toward placing minimum wage increases on ballots in conservative-leaning states as a means to fire-up Democratic constituencies to help Senate candidates who have been put on the defensive by the difficulties associated with the Affordable Care Act.

Meanwhile, Republicans may be of two camps, with the libertarian/tea party faction holding fast to the laws of economics (as they interpret those laws) and the more moderate faction urging caution about the potential for being flogged as unfeeling plutocrats if they resist, pointing to polls showing that even Republicans (57% in a November, 2013 poll) favor increasing the minimum wage.

Confusing stuff for a thoughtful RINO…but there’s more.

Tectonic Shifts in the Economy

The US economy has changed drastically since the advent of the minimum wage and some economists suggest that its very purpose at the time of enactment has become obsolete over the years.  James Surowiecki noted last year in a column in The New Yorker, that 40 years ago, fast food or discount retail jobs did not constitute a significant input to the overall economy and, accordingly, were not expected to provide a living wage.  Today, low wage workers provide 46% of family income and the minimum wage would appear to be much more important to a higher proportion of the nation’s workforce.  Surowiecki further noted that in 1960 General Motors was the nation’s largest employer and was also its most profitable employer.  GM, representative of a large cohort of similar industrial corporations, enjoyed high profit margins, real pricing power and paid most of its workers union wages.  Today, our largest employers are retail and fast food chains that have much thinner profit margins and low pricing power and so have low cost business models, featuring low wages and offshore sourcing.  In fact, according to Surowiecki, the major supermarkets, retailers and fast food chains in the Fortune 500 together employ some 5.6 million workers but their combined profits are smaller than the profit earned by Apple alone, which employs some 76,000 workers.

Is the Minimum Wage a Living Wage?

In arguments in favor of raising the minimum wage, supporters sometimes conflate the term ‘minimum’ wage with the more nebulous concept of ‘living’ wage – a number that moves about depending on assumptions of family size and location, but most would agree is considerably in excess of $10/hr.  Achieving a living wage level for the vast majority of American workers who are currently subject to the minimum wage would require a significant change in the business models of untold numbers of employers and a simultaneous shift whereby consumers accept higher prices for much of what they buy.  A tall order, but not impossible if we look to retailers like Costco and Trader Joe’s, among others, which have successfully demonstrated enterprise success while paying wages far higher than the minimum wage.  In a 2006 article in Harvard Business Review titled “The High Cost of Low Wages,” author Wayne F. Cascio cited findings that Costco paid average wages and benefits at a rate 70% higher than Wal-Mart (and by association Sam’s Club), Costco employees participated in retirement plans at double the rate of Wal-Mart, and Costco contributed double the plan contribution.

How can Costco succeed with such comparatively expensive labor practices?  It turns out that there are offsets, particularly in terms of employee productivity, sales per sq. ft. and, most impressively, in employee turnover.  Costco’s turnover clocks in at 17% per year overall and just 6% after one year’s employment.  In contrast, Wal-Mart workers depart at the rate of 44% per year, in line with industry averages.  Cascio calculated that turnover alone cost Costco some $244 million per year while Sam’s Club turnover costs came to $612 million per year.  In terms of productivity, Costco generated $21,805 in US operating profit (fiscal year not mentioned) per hourly employee compared with $11,615 at Sam’s Club.  Some business writers suggest Costco’s business model is unique – low employee count due to no requirement to stock shelves and high unit value products sold to affluent customers – valid points.  Plus, we cannot ignore the membership fees which separate Costco from run-of-the-mill discount retailers, although not from Sam’s Club which also has a membership fee structure.

So, let’s construct a living wage case study using McDonald’s as a low cost model and do the math.  If we assume, for the sake of this exercise, that McDonald’s labor component is 25% of revenue (actually very close to the 2012 Annual Report figures), that works out to $1.00 of labor per Big Mac priced at $4.00.  Next, we assume that today’s average McDonald’s wage is equal to the minimum wage of $7.25, and that a new McDonald’s wage policy is instituted whereby the average wage becomes the starting wage and that employees can achieve a higher salary capped at double the starting wage with 2 year’s service.  After taking into account employee turnover, the labor component of the Big Mac would increase about 50 cents, which would drive the retail price up to, maybe, $4.60 (preserving original profit margins).  Does a 60 cent increase in the price of a Big Mac over a two year period seem feasible in order to achieve the prospect of McDonald’s employees earning a living wage of $14.50/hr?

It seems that a reasonably strong argument could be made that higher labor rates can be beneficial to many businesses – a capitalist case for higher wages.  There are obviously many aspects of the typical business model that would need to change, including greater focus on employee training.  There would be implications, also, that hiring practices would need to change with greater focus on capacity to learn and to take independent action.  And, most important, customer buy-in would be critical.  If this capitalist case for higher wages could gain some traction it could begin to reverse the race to the bottom.

When Economics and Politics Mix

Last year, in a New York Times Op Ed, economist Christina Romer, former Chairwoman of President Obama’s Council of Economic Advisors made some notable observations with respect to the economics of the minimum wage.  Commenting on the proposal of President Obama to raise the minimum wage (to $9 at that point) she began by pointing out that “Raising the minimum wage, as President Obama proposed in his State of the Union address, tends to be more popular with the general public than with economists.”

Romer went on to explain that the classic progressive case is that government protection is the only way to insure decent wages, but basic economics tells us that competition between employers for workers can be very effective at policing business behavior.  In periods of high unemployment the workers’ leverage would be reduced, but in normal times competition would insure that workers would be paid commensurately with their contribution to employer profits.  We could call this a ‘competitive wage’.

In reality, most arguments (including President Obama’s) for instituting or raising minimum wage are founded on concepts of fairness and redistribution.  A market-driven competitive wage, especially in times of high unemployment, may not equal a living wage.  However, this moral issue is another one that can be informed by economics – how effective would a higher minimum wage be at reducing poverty?  Is income from rising minimum wages redistributed primarily to poor families?  Romer says that available data suggest that about half the workers likely to be affected by the minimum wage are in families earning less than $40,000 a year, a number roughly confirmed by current Obama Administration estimates.  Thus, a minimum wage increase would not be laser-focused on the poor.

Addressing the macroeconomic argument that minimum wage increases to the poor would increase overall consumer spending which could stimulate employment, Romer’s calculations imply the effects on the overall economy would actually be quite small – an additional $10 – $20 billion into a $15 trillion economy.

So, given that the redistributive effects of a minimum wage are so complex, diffuse and, ultimately have a relatively minor impact, most economists favor other ways to help low-income families.  Romer points out that the earned-income tax credit (EITC), for instance, already subsidizes work by the poor and is very well targeted only to poor families.  In lifting the reward for working this tax credit also might increase the supply of labor, providing the most valuable thing for a family trying to escape poverty – a job.  Ironically, this argument lies close to the heart of some current conservative positions.  In the end, Romer concluded that “The economics of the minimum wage are complicated, and it’s far from obvious what an increase would accomplish.”

The Way Forward

Is there solid ground where RINOs can stand given this confusion of facts, opinions and dueling studies?  It is evident that the minimum wage is a very poor redistributive tool which would not have much positive impact on poverty.  Further, the proposed increase would have a very minimal positive impact on the economy.  Other tools like the EITC could be more efficacious and are exactly the type of tools favored by Republicans, but populist politics can muddy the waters.  Democrats appear to have concluded that raising the minimum wage looks to be the winning populist position.  Republicans should grasp ASAP that debating the EITC vs. increased minimum wage is probably a losing proposition – the tax credit is a complex concept and for most citizens, dollars in hand weekly trump a tax refund.  The nail in the coffin of the EITC could be that taxpayers would be on the hook for the costs, whereas increasing the minimum wage would be a private-sector cost (i.e. free lunch to lawmakers).  In the end, this has all the markings of another one of those ‘don’t confuse me with the facts’ moments and Republicans would probably be best advised to either go along for the ride or, at best, try the RINO way and work toward a compromise combination of minimum wage plus EITC.  Increasing the minimum wage won’t achieve the outcomes touted by the Democrats, but it won’t cause as much damage as many Republicans claim either.  Republicans should avoid the trap being set by the Democrats and, absent this debate, the media would be free to re-focus on the trials of Obamacare and the job-killing impact of Obamanomics.

And we could hope that, over time, the aforementioned capitalist case for higher wages will find footing and the minimum wage can eventually be made largely redundant.

– John Swindell

John Swindell says his commitment to the Republican Party has passed through three phases. The first phase was based on respecting family tradition. The second phase, evolved during a 40-year business career primarily in New York City, created a more hard-edged fiscal pragmatism married to relative ambivalence toward social issues. Retirement introduced the third phase with more time for reading and introspection which has smoothed the edges of the fiscal pragmatism while enabling a more progressive view toward social issues. Alarmed that the influence of the hard right’s intrusive and overbearing social conservatism was ruining the Republican Party, he eventually saw the path and it led to RINOcracy.com.