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Obama’s pledge to raise the minimum wage is good policy

President Obama has proposed raising the minimum wage from $7.25 to $9, reigniting the debate about the effect of a wage hike on unemployment. flickr\brianwallace

In his State of the Union address, US President Barack Obama reignited a perennial debate in his proposal to increase the minimum wage from its current level of $7.25 an hour to $9.00 an hour. Advocating for the move, Obama argued that “this single step would raise the incomes of millions of working families. It could mean the difference between groceries or the food bank; rent or eviction; scraping by or finally getting ahead. For businesses across the country, it would mean customers with more money in their pockets.” To Obama, the case for the minimum wage is rooted not simply in compassion, but also in its consequences for demand: more money in people’s pockets will lead to increased spending, aggregate demand, and – eventually – profits.

However, critics of the move have subsequently countered that an increase in the minimum wage might be bad for not only business, but also for employment and the standing of low-wage Americans. For example, Keith Hall, a George Mason University economist, suggested it could increase unemployment among the less fortunate: “If you force employers to pay more than they want, they are less likely to hire teens and low-skilled folks and, instead, will cut workers hours and benefits.” Similarly, Moody Analytics Chief Economist Mark Zandi warns that a higher minimum wage “would also likely mean lower profits for businesses employing minimum wage workers and higher prices as businesses try to pass through their higher labour costs.” In this framing, ostensibly hard-headed economists take issue with soft-hearted politicians who fail to recognise the unintended consequences of their attempts at compassion.

Taking these perspectives together, one can again see the enduring nature of a Classical-Keynesian debate that has shaped economic deliberations for nearly a century. From the former vantage, Hill and Zandi – like many of their professional brethren – assume that economic outcomes are shaped by “backwards-looking” concerns for productivity. From this vantage, where firms allocate a fixed sum to labour costs, any government mandate to spend more on wages will have one of two consequences. As Hill stresses, they may reduce their workforce to pay a smaller number of employees a higher wage. Or, as Zandi argues, they will keep the workforce the same but raise prices, passing on the cost of higher minimum wages to the public.

In contrast, from the latter vantage, Keynesian economists concede that higher wages may temporarily result in higher costs at the microlevel for individual firms. However, at the macro level of the aggregate economy, increased incomes may lead to higher spending, revenues and profits. From this “forward-looking” vantage, firms are more likely to keep workers on payroll where they expect that demand will increase, and can keep prices low if higher wages result in worker retention and increased productivity.

Over time, in the US context, a higher real minimum wage has been associated with lower unemployment, as John Cassidy has shown in tracing US trends from 1938 to 2012. In this light, it may be that what is ethical — and what is efficient — prove mutually reinforcing!

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