The Downside of the Minimum-Wage Fad

Worth the price?

Photographer: Michael Nagle/Bloomberg

Raising wages by government fiat seems to be catching on. The lowest-paid workers in Britain and California -- two of the world's largest economies -- are only the latest beneficiaries of plans to lift the minimum wage.

The goal in every case is commendable, but the method is far from ideal. On Friday, Britain's minimum wage will increase to 7.20 pounds ($10.36) an hour for workers age 25 and older, rising each year until it is expected to be above 9 pounds by 2020. California has agreed to set a $15 minimum wage by 2022. New York Governor Andrew Cuomo wants to do the same in his state.

QuickTake Minimum Wages

At least 25 U.S. cities have raised their minimum wage since 2014. Germany did so last year, and more increases are planned. Japanese Prime Minister Shinzo Abe has called for a 3 percent increase in the minimum wage each year.

It's hard to quarrel with the goal of a "higher wage, lower welfare, lower tax" society, as the U.K.'s government puts it. But the minimum wage is a two-edged instrument, because it raises the cost of hiring unskilled labor. Any increase, therefore, runs the risk of raising unemployment -- and the bigger the increase, the bigger the risk. In addition, governments aren't being honest about who bears the costs. At least some of the increase in employers' costs will be passed along as higher prices to consumers.

It's hard to say exactly what the effects of this minimum-wage activism will be. The economic literature on the subject is voluminous -- but inconclusive. A 2014 Congressional Budget Office study concluded that a $10.10 minimum wage in the U.S. would lift 900,000 out of poverty but result in the loss of 500,000 low-wage jobs. Other studies say the employment effects would be smaller. There's little experience as yet with minimums as high as $15.

Another problem, especially with national minimums, is that labor-market conditions vary a lot from place to place. Britain's minimum applies equally to London, where the wage floor by 2020 will be 47 percent of local median income, and Sheffield, where it will be 71 percent. The one-size-fits-all approach is going to cause problems for Germany as it tries to absorb an enormous influx of unskilled immigrants.

If governments overdo it and push the minimum too high, correcting the error might not be easy. Lowering the minimum will arouse political resistance. The California proposal includes "off ramps" that would allow the government to pause the annual increases, but it couldn't lower the floor -- and current rates of inflation would take a long while to do that without assistance.

A safer and more honest way to support the wages of the low-paid is with a subsidy, using programs such as the U.S.'s earned income tax credit. Rather than reducing the demand for unskilled labor, a subsidy increases it. The drawback is political rather than economic -- the cost to taxpayers is explicit. This approach, therefore, calls for brave leadership, which is not always in supply.

The best way to raise low wages is to raise productivity by helping workers to acquire skills and by ensuring that new entrants to the workforce are well educated. Reform along these lines requires not just political courage but also patience, because the benefits might not be apparent for years.

In the short term, raising the minimum wage -- modestly, and with sufficient flexibility to allow for local market conditions -- might do more good than harm. Relieving poverty in work deserves to be a high priority. But smarter ways of doing it shouldn't be sidelined, and caution should be the watchword.

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