Want Innovation? Try Raising Minimum Wages

When labor costs rise, innovators go to work.

Some automation might not be a bad thing.

Photographer: Andrey Rudakov/Bloomberg

I’ve spent some time talking about the downsides of minimum-wage laws. But there is a big possible upside that I haven’t mentioned, in part because it’s pretty speculative. It’s the idea that minimum wages improve productivity and innovation over the long run. 

Usually, it’s detractors of the minimum wage who talk about the long term. Minimum-wage hikes tend to have only small or negligible effects on employment levels, but critics of setting pay floors have said that they slow long-term employment growth. But I’m now thinking about the even longer term, and about the effect of minimum wages on productivity rather than employment. 

Minimum Wages

In the long term, productivity comes from technology. Economists often treat technology as if it just appears out of nowhere, but in fact it comes from the innovative efforts of companies and researchers. 

Why do companies innovate? You might think that companies invent any technology that will make them more productive, but this isn’t actually true, for a number of reasons. First of all, innovators don’t know ahead of time which things they will be able to create -- trying to innovate is risky, and companies are usually risk-averse. Second, companies may be focused on the short term, and may thus be unwilling to shell out cash for research and development that would only pay off years later. Finally, companies may simply get comfortable with what they have, and fail to engage in innovation unless they feel sufficiently intense pressure to do so. 

So what happens if a company suddenly finds that it has to pay higher wages? It might just take the hit to its profit margins and continue operating as before. It might decide to downsize, laying off workers and shrinking its operations. 

Or, it might decide to invest in labor-saving technology. 

Forbes writer Adam Ozimek pointed this out back in 2013, in an article entitled “Doubling McDonald’s Salaries A Great Way To Get Workers Replaced By Machines”:

We’re hearing more and more about machines replacing workers and there are some obvious contenders for replacement within a McDonald’s...[Automated payment kiosks are] just the most obvious way for machines to replace workers. One already working on robots to replace the cooks too...In the long-run such technological change makes us better off on average[.]

In the two years since then, Ozimek’s prediction has come true. McDonald’s is installing a line of automated kiosks where people can create their own burgers. 

Of course, Ozimek is a dogged minimum-wage opponent, and is trying to make workers worried that minimum wages will cost them their jobs. But I am not sure that workers should be so afraid of being replaced by this kind of technological improvement. Ultimately, it may make them more productive, and actually help them earn more. 

In the past, when companies implemented labor-saving technology -- whether assembly lines or computers -- their workers didn’t simply go on the unemployment rolls. They became more productive than before, and commanded higher wages. If they got laid off, they eventually found jobs at other companies -- and since the economy overall was more productive because of the innovation, more new companies were started. In the past, automation has always complemented human beings instead of making them irrelevant. That might change in the future, but so far the old pattern is still holding. 

For workers to become more productive in order to take advantage of new technologies, they often have to improve their skills. Workers have always been able to do this quite successfully. When the Industrial Revolution demanded that people learn to read, they learned to read. When the Information Revolution forced people to use computers, they learned how. Low-skilled workers might have skimped on education because they were focused on the short term; the pressures of a technologically advancing workplace may force them to think longer term and develop new skills. 

So minimum-wage laws, by forcing us to abandon low-skilled labor, might actually increase technological innovation. Some people even speculate that this effect might have started the Industrial Revolution itself! Economic historian Robert Allen has argued that the Industrial Revolution began in Europe, rather than in China, because European employers were forced to pay more for labor. Since labor was more expensive, companies invested in technology, which then raised productivity so much that it boosted wages even higher, forcing companies to invest more in technology, even as their increased incomes allowed them to make those investments. A 1987 theory by growth economics pioneer Paul Romer operated on a similar principle -- expensive labor causes an upward spiral of technological improvement. 

So in the very long term, minimum-wage laws might force companies to do what they otherwise wouldn’t do -- make risky bets on new technologies. And as workers raise their own skill levels, that new technology would raise their wages as well. The entire economy, including any workers who temporarily lost their low-wage jobs, would benefit in the long run. Of course, this theory is fairly speculative -- theories that play out over years or decades are hard to test with real-world data. But it’s a potential benefit of the minimum wage that is worth thinking about.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.