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How we are getting minimum wage wrong locally and nationally

Maryland Gov. Martin O'Malley, right, at a rally to raise the state's minimum wage. He recently signed legislation that will increase the wage to $10.10 per hour by 2018. Credit: Maryland Governor's Office

Politicians love to play power politics but are their games good for our city, state and nation? In Washington D.C., Republicans who control the U.S. House of Representatives blocked a bill to increase the federal minimum wage above $7.25 per hour. Meanwhile in Washington state, Democrats on the Seattle City Council decided to increase the minimum wage to $15 per hour in stages.

Is there a reasonable explanation why $15 per hour is good for Seattle while $7.25 is good enough for Boise? Is there a reason why $15 an hour is the right number and not $13 of $17 or even $20? The simple answer is: No, it’s all just politics.

Is one party right and the other wrong?

Let's examine some of the nuances of this partisan discussion. Democrats claim that increasing the minimum wage will reduce poverty and increase prosperity with little or no cost to anyone. Republicans claim that small businesses will go bankrupt in droves and millions of jobs will be lost in the process. There is some truth and some fiction to both claims, so let’s evaluate both the rationale and the evidence for the conflicting claims.   

Let’s start by looking at the historical value of the federal minimum wage. Between 1956 and 1984, the inflation adjusted minimum wage varied between a low of $7.67 and a high of $10.86, in today's dollars. During this period, income disparity remained relatively constant with the top 1% of Americans earning a little less than 10% of total income.

Since 1981, the inflation adjusted minimum wage has declined, varying between $5.87 and $7.99. During that period, income disparity more than doubled. For the first time in history, the richest 10% of Americans are now earning more than the remaining 90%. As a result, it becomes increasingly difficult for the next generation of great American entrepreneurs to get an education, raise capital and bring inventions to market.

Meanwhile a billionaire earns $50 million a year by simply hiring an investment counselor to make investments that return only 5% a year. America has prospered by allowing its people to realize their potential. Without a reasonable wage, more and more Americans opt out and act as a drag on the economy rather than work to drive it and spend to sustain it. A wage increase to $10.10 seems consistent with historical norms and would likely benefit the economy at large.

Now, let’s look at the minimum wage from a small-business person’s perspective. If a small business has 10 full-time employees working at the minimum wage, then the $5 Seattle increase will reduce profits by over $100,000. If the business is only making $50,000, then the minimum wage increase will definitely jeopardize the viability of the business. Some businesses will indeed go bankrupt, leaving their business owners broke and their employees out of work. More prosperous companies will look for ways to automate their operations and reduce headcount. The result could be, for instance, half the workers earning $15 per hour and the other half on unemployment. Automation becomes increasingly viable as the cost of labor increases. 

A danger for a municipality like Seattle is how easy it is for competitors outside the city limits to underprice their city rivals because of the labor cost advantage an inflated minimum wage provides. In some cases a competitor across the street may suddenly enjoy a huge cost advantage. Many service jobs are protected because they are tied to the location the service is provided, thereby limiting competition from outside city limits. Manufacturing operations are more vulnerable however. Most manufacturers ship their products to remote locations. If a Seattle manufacturer competes with one in Boise, or even one in Bellingham, the playing field will be tilted dramatically in favor of the lower-cost location. A $15 minimum wage may therefore be expected to do significant harm to Seattle’s manufacturing sector. 

Even some things that we don’t think of as being manufactured products may be impacted. It is natural to assume that some industries such as restaurants may be unaffected by outside competition. A $5 per hour wage differential creates a strong incentive to find ways to reduce the amount of worker hours subject to the wage. Seattle restaurants, may find they can reduce staffing and save money by buying their deserts from vendors outside the city. Similarly fast-food franchises are already outsourcing drive-through order-taking to other states or even overseas.

So does a minimum wage increase make sense or doesn’t it? Raising the minimum wage at the federal level would reduce poverty, minimize wage variations and related regional job losses, and allow businesses to compete on a level playing field. Increasing the minimum wage in Seattle will widen the variations and result in a number of bankruptcies and job losses in many business sectors. It seems like the Democrats had it right in Washington, D.C. and the Republicans had it right in Seattle.

Unfortunately for Americans, power politics assured that we got it wrong in both places.

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