The Los Angeles City Council voted 14-1 to increase the minimum wage in the city to $15 an hour by 2020 for all businesses with 25 employees or more. Smaller firms would get an extra year to make the adjustment. The measure must be voted on again before it can take effect, but that seems a foregone conclusion. LA joins Seattle and San Francisco in raising the wage to this level. The economic impact is likely to be positive.
Opponents of minimum wage increases, and of the idea of a minimum wage, argue that when the price of a thing, in this case labor, goes up, the consumption of it declines. This, they argue, means that raising the minimum wage reduces the number of jobs, which is exactly the outcome one wants to avoid.
Embedded in this simple and straightforward argument, however, is an assumption that makes the case anything but a slam dunk. It presumes that the demand for minimum wage labor is relatively elastic. That is, employers have the luxury of reducing the number of employees as wages rise. Virtually all economic studies of minimum wage laws and their effects on employment show that this assumption simply isn’t true. Demand for minimum wage labor is inelastic, and employers tend to pay what they must to adequately staff their operations.
Take the common example of a McDonald’s hamburger restaurant (if that isn’t too grand a term for the place). There is a minimum number of staff required to operate it at any one time. In theory, the franchise owner could make all the fries, assemble all the burgers, pour all the soft drinks and ring up all the orders, thereby opting out of paying for labor at all. However, that isn’t the business model. Someone makes fries while someone else puts the ketchup on the meat patties while someone else makes change. For the restaurant to operate at all, these people are required inputs. It makes no difference if the minimum wage is $7, $9 or $15 an hour. If they don’t do their jobs, the franchise earns no money.
More succintly, Jamie Dimon of Citibank will pay whatever the rate is to get the toilets in his office cleaned because as CEO it’s not a prudent use of his time to do it himself.
The alternate arguments against the minimum wage increase are: 1) that the increase in labor costs are passed onto the consumer, who then purchases less, and therefore, the economy as a whole slows down; and/or 2) the cost is born by those who provide the capital in the form of lowered profits to the business, resulting in less investment and less economic activity.
Ceteris paribus, higher wages must be paid for by higher prices and/or diminished profits. Rarely is ceteris ever paribus, however. One must remember that every worker is also a consumer. Study after study proves that giving cash and cash equivalents to the poorest results in higher consumption. Food stamps, for example, generate $1.73 in economic activity for every $1 in the program. Mark Zandi of Moody’s explains it “If someone who is literally living paycheck to paycheck gets an extra dollar, it’s very likely that they will spend that dollar immediately on whatever they need – groceries, to pay the telephone bill, to pay the electric bill.” In other words, a McDonald’s employee at $15 an hour is more likely to take the family out to eat than one earning $7.50, so revenue in the restaurant sector increases.
The other point, that profits are reduced by higher minimum wages, only applies if one presumes that consumption is constant, that it does not rise. But as the food stamp example suggests, if the minimum wage is higher, consumption rises. A 10% margin on $1 million in revenue is not as good at 8% on $2 million.
Of course, there is a level at which raising the minimum wage ceases to be a useful tool. The law of diminishing returns cannot be repealed. However, it is safe to say at increasing the minimum to $15 does not take Los Angeles there. If the minimum wage had been indexed to labor productivity back in 1960, the minimum wage would be around $22 an hour. There is still room to maneuver.