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Pay hazard - raising the minimum wage
National Review, May 1, 1995 by Pete Du Pont
``MANY well-meaning people favor legal minimum wage rates in the mistaken belief that they help the poor,'' Nobel laureate Milton Friedman has observed. ``It has always been a mystery to me why a youngster is better off unemployed at $4.75 an hour than employed at $4.25.''
Pretty much everyone -- from Milton Friedman to the Congressional Budget Office to the 1987 editorial board of the New York Times -- agrees that raising the minimum wage increases unemployment. Under the headline, ``The Right Minimum Wage: $0.00,'' a New York Times editorial concluded that the minimum wage was ``an idea whose time has passed.'' The CBO estimates that President Clinton's proposal to increase the minimum wage from $4.25 to $5.15 would cost 500,000 jobs -- mostly the jobs of teenagers, minorities, and part-time workers.
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There is a nearly perfect correlation between minimum-wage hikes and both teenage and non-white unemployment (see chart). Poverty rates rise dramatically just after the minimum wage rises. And now there is fresh evidence that raising the minimum wage has also helped trigger recessions. This link has been brought to light by Richard Vedder and Lowell Gallaway, two economists at Ohio University. In a study for the National Center for Policy Analysis, Vedder and Gallaway document a connection between the 1974 - 75 and 1990 - 91 recessions and increases in the minimum wage. They say a good case can also be made that the 1979 - 80 economic downturn and the recession that began in 1981 were linked to minimum-wage increases. It is more difficult to isolate causes in those instances, because of the high inflation rate and other economic factors that could have played a part. But in the 1990 - 91 and 1974 - 75 recessions, minimum-wage increases appear to have been the straw that broke the camel's back.
Look at the start of our most recent recession. The minimum wage was raised by 45 cents (an increase of more than 13 per cent) on April 1, 1990. Hourly compensation, which had risen 3.5 per cent in 1989, rose at an 8.4 per cent annual rate for the next three months, far more than economic growth and increased productivity warranted. Unemployment jumped, too, from 5.3 per cent in April 1990 to nearly 6.5 per cent in April 1991. More than 800,000 civilian jobs had been created in the six months before April 1, 1990; more than 350,000 jobs were lost in the six months after April 1.
Usually, a year after a recession begins, market forces push the unemployment rate down. The stage was set for that to happen in early 1991; the annual growth rate of hourly compensation was back to 3 per cent. But there was another 45-cent hike in the minimum wage on April 1, 1991. Annual growth in hourly compensation jumped back to 4.6 per cent, and unemployment continued to rise, reaching 7 per cent by the end of 1991.
Much the same thing happened in the 1974 - 75 recession. After the minimum wage was increased by 25 per cent on April 1, 1974, hourly compensation grew at an annual rate of 12 per cent, compared to 7.3 per cent in the previous year, and unemployment rose from about 5 per cent to 7.2 per cent by the end of 1974. Nine months after the first increase, the minimum wage was bumped up another 5 per cent, and unemployment rose to 9 per cent by the spring of 1975. Vedder and Gallaway looked all the way back to the Great Depression and discovered that instituting a minimum wage made that bad situation even worse. In June 1933, Congress passed the National Industrial Recovery Act, which included a minimum wage. It was a high minimum: more than 90 per cent of the average hourly wage rate. The impact was immediate. The unemployment rate, which had fallen by 5 percentage points from March to July 1933, immediately flattened and stayed at around 22 to 23 per cent. When the NIRA was declared unconstitutional in 1935, ending the minimum-wage requirement, there was a dramatic improvement in employment. By 1937, the unemployment rate had fallen to about 12 per cent.
Despite this experience, the Clinton Administration is still pushing a 21 per cent increase in the minimum wage, relying on some studies by economists David Card, Lawrence Katz, and Alan Krueger. Card and Krueger compared fast-food employment in New Jersey, which raised the state minimum wage, and Pennsylvania, which didn't. They concluded that raising the minimum wage not only causes very little unemployment but may increase jobs. On March 29, Richard Berman of the Employment Policies Institute released a devastating analysis of Card and Krueger's study. Berman analyzed actual payroll data, instead of responses to a single telephone question, and found that Card and Krueger had got it wrong. In fact, Berman concludes, ``New Jersey's employment growth lagged Pennsylvania's by 5 percentage points.'' This study reaffirms what everyone already knows: when the price of a good (in this case, labor) is raised, demand for it falls. The Berman analysis even quantifies the effect: ``Every 10 per cent increase in the minimum wage decreased employment by 2.7 per cent.''
