Analysis: Will a Minimum Wage Increase Cripple Small Businesses and Reduce Jobs Growth?

In yesterday’s local newspaper, local business owner Alzada Knickerbocker, citing a recent National Federation of Independent Business/California study on the impact of AB 10, which would increase California’s minimum wage to $9.25 per hour in the next three years, argued that the effect of raising minimum wage would be the loss of jobs and economic productivity in the state.

“It doesn’t make sense. Jobs are the need. Why is the state leading with a proposal that will kill jobs?” she writes.  “I own an independent bookstore – The Avid Reader, in downtown Davis. I’ve been here 26 years. I have eight employees – four full-time, four part-time. Half are long-term staff and half are recent hires. Because I need staff with knowledge and work experience, my new hires are compensated above the minimum wage.”

She argues, “But that’s not to say that my business isn’t affected by minimum wage levels. Minimum wage is out there and recognized by all as the base line. Candidates for work here know what that rate is and have an idea of what their wages should be relative to that rate. I must choose a rate of pay that comports with their skills above the basic minimum-wage rate.”

One the other hand, Assemblymember Luis Alejo, one of the sponsors of the legislation, noted the rising costs of gas, predicted to go up 13% this year, wheat to go up 67%, and corn to go up 60%.  The overall cost of food is predicted to go up 6%.

“For the average household, that’s about $328 per family more than what they spent last year.  That’s almost two weeks of take-home pay for a minimum wage workers… just to keep up with the increase,” Assemblymember Alejo said.

“AB 10 is about equity.  It is about ensuring that workers can maintain purchasing power year after year.  For three years, workers have struggled to get by in light of rising prices while their real wages declined 2.9%,” he said.  “The fact of the matter is that raising the minimum wage will help our economy by generating more consumer spending.  When minimum wage workers have more money to spend, they spend it.  They cannot afford to save it.”

From the perspective of Ms. Knickerbocker, “Minimum-wage jobs are meant as a beginning, not an end. They are intended for the entry-level employee. Minimum-wage earners learn valuable lessons of responsibility that come from doing a job and working with others. They benefit, and so do our state and society.”

“Raising the minimum wage might accomplish a short-term jolt to the economy, but it ultimately will result in constricting hiring and the raising the cost of products in most industries to pay for fewer workers,” she writes. “The net effect will be fewer filled jobs leading to fewer goods being purchased, and California’s economy deteriorating rather than improving.”

But the research on this is mixed, and heavily dependent on both the assumptions and the outcome that the researcher is looking at.

Ms. Knickerbocker cites an industry-sponsored study.  Assemblymember Alejo cites a study co-authored by economic professors at the University of California at Berkeley, the University of Massachusetts and the University of North Carolina, which finds that “raising the minimum wage does not eliminate low-paying jobs in either the short- or long-term.”

On the other side of the fence, Mark Wilson of Applied Economic Strategies, in a Cato Institute study argued, “The main finding of economic theory and empirical research over the past 70 years is that minimum wage increases tend to reduce employment.”

He argues that the Department of Labor found that the first minimum wage cost the jobs of 30,000 to 50,000 of the 300,000 workers who were covered.”

John Schmitt, a Senior Economist at the Center for Economic and Policy Research in Washington who has surveyed this issue since 2000, wrote, “The employment effect of the minimum wage is one of the most studied topics in all of economics.”

He says that the impact of the minimum-wage increase is counter-balanced by adjustment: “Reductions in labor turnover; improvements in organizational efficiency; reductions in wages of higher earners (‘wage compression’); and small price increases.”

He writes, “Given the relatively small cost to employers of modest increases in the minimum wage, these adjustment mechanisms appear to be more than sufficient to avoid employment losses, even for employers with a large share of low-wage workers.”

Likewise, a 2010 Study in the peer-reviewed The Review of Economics and Statistics, showed that traditional research approaches, ones “that do not account for local economic conditions tend to produce spurious negative effects due to spatial heterogeneities in employment trends that are unrelated to minimum wage policies.”

Their work focuses instead on “policy discontinuities at state borders” in order to “identify the effect of minimum wages on earnings and employment in restaurants and other low-wage sections.”

Their study finds “strong earnings effects and no employment effects of minimum wage increases.”

A recent study by Texas A&M Professor Jonathan Meer, an assistant professor of economics, and Jeremy West, an economics graduate student, finds that net job growth falls in response to an increase in the minimum wage, but that employee turnover is unaffected.

In a statement, Professor Meers said, “This makes intuitive sense: firing people is unpleasant and costly, so adjustment takes some time as employers reduce their hiring of new or replacement workers.”

What should we glean from the gluttony of contradictory findings?  First, be careful when using one study to assert an effect on something as complex as the impact of minimum wage on jobs.  The modeling to do a study like this properly is quite complex and small changes in methodology have huge impacts on the findings.

Second, Ms. Knickerbocker expresses a legitimate concern that business owners have.

As she points out, “Payroll is generally suggested within my industry to be 20 percent of the store’s income, the highest percentage in my budget after the cost of books at 60 percent. In that 20 percent figure is not just the employees’ pay but also health care, vacations, payroll tax and workers’ compensation. Add a cost like higher minimum wage, and I’m over that 20 percent figure.”

“How do I bring what I can pay back into line?” she asks.  “Realistically, it comes down to reducing staff hours or store hours, i.e., cutting back on current employee opportunities through my store. That’s the effect on my store as it exists.”

But how is that countered against Assemblymember Alejo’s point that, while minimum wage remains flat, the cost of living goes up?  That means two things.  First, over time, business owners like Ms. Knickerbocker perhaps unknowingly benefit when minimum wage is held constant, even as other costs, including probably the cost of books, rise.

Second, the impact on the wage receiver is less bang for their buck.  Holding minimum wage constant acts as a de facto wage reduction.

Free market advocates would suggest this is a reason to do away with minimum wage and allow the market to dictate wages.

But there is an alternative.  One of the problems that may drive some of this data is that minimum wage policy is a form of punctuated equilibrium.  It remains constant over a period of years, perhaps decades, and then suddenly the cost increases rather sharply.

If studies are sensitive to the immediate moment that minimum wage is increased 50 cents, then you probably will be measuring job losses.  But over time, that minimum wage increase should have diminished impact, as inflation effectively wipes it out.  So I am skeptical that they could find any long-term impact on job creation, given the spacing of the wage increases.

The easier way to deal with this is simply allow minimum wage to float with either inflation or the consumer price index.  Creating a small way to slowly ramp up minimum wage, so that you are not looking at large chunks at a time, seems like a better way to effect the policy.

—David M. Greenwald reporting