Do Current Wages Disprove the Econ 101 Case Against Minimum Wage?

By Jon Murphy.

"Over the past year, we have seen wages rise considerably, especially in low-skilled jobs.  According to the Bureau of Labor Statistics, the average wage for a non-management employee of a limited-service (e.g., fast-food) restaurant has risen by $1.22 per hour over the past 12 months from $12.04/hr. to $13.26/hr.  That is an increase of 10.1%!  Many places are even higher.  In my current little slice of Heaven (Cape Cod, Massachusetts), the local Five Guys Burgers and Fries offers $16/hr.

During the past few years, as minimum wage activists have been advocating for a $15 minimum wage, many economists (myself included) argued that such a wage increase would cause a substantial loss of jobs.  Yet, even at wages above $16, many firms struggle to find workers.  These data present us with a conundrum: how can we explain an increase in wages without decreasing employment?  Were minimum wage activists right all along that increasing the minimum wage would not lead to unemployment and that firms were simply choosing to underpay workers?

 

Let’s see what the Economic Way of Thinking has to say.

The problem with drawing the conclusion that minimum wage hikes wouldn’t have an effect is reasoning from a price change.  Prices, including the price of labor (wage), are not arbitrarily determined.  In the case of wages, wages are determined by the marginal revenue product of labor.  In other words, the wage is equal to the contribution that the marginal employee makes to the company’s revenue on the margin.  Thus, wages can increase in two ways: 1) increasing the productivity of labor (i.e., increasing the amount one worker can produce) or 2) increasing the revenue earned by selling one more unit.

So, what is going on in the current market?  Partly, we have a shift in the supply of labor, as extended and increased unemployment insurance has kept some workers out of the labor force.  Employers have had to offer higher wages to lure workers from their alternative options.  But, to make these wages possible, employers also need to have more productive workers (quantity supplied must align with quantity demanded).

For employers, the current source of increase in the marginal revenue product of labor is from price increases.  Over the same period (the past 12 months), we have seen general inflation.  In fact, fast-food prices have risen by nearly the same amount as wages: 9.1%, according to the Bureau of Labor Statistics (CPI calculation).  So, employees are more productive because they can now produce more revenue for the firm; the demand curve has shifted out.  Thus, their higher wages are achievable without the need for layoffs.

But wages cannot rise infinitely.  If the marginal revenue product per worker is less than the wage, then the worker will not be hired (or fired, as the case may be).  And, likewise, firms cannot simply pass 100% of price increases onto customers.  So, we are seeing a situation as we have now: firms remain understaffed despite unusually high wages.  So, firms find other margins to adjust along to bring quantity supplied back into alignment with quantity demanded.  These margins include: operating reduced hours, increased automation, reduced offerings, etc.  The Law of Demand remains in effect.

So, the answer to the fallacy expressed above (that firms always could have paid a $15 wage) is that the situation has changed.  Ceteris is never paribus; we must be cautious before overturning a scientific law."