What Happens When the Minimum Wage Increases?
Despite what many people think, raising the minimum wage does not hurt small businesses that can pass higher costs on to consumers. In fact, a new study co-authored by UC Berkeley economist Michael Reich found that such firms can even thrive when the minimum wage rises.
A minimum wage increase boosts the income of low-wage workers who keep their jobs, which lifts some families out of poverty. But families whose workers lose employment would see their incomes fall.
Increased Labor Costs
In many industries, firms must balance worker productivity and labor costs. When minimum wages increase, that balance shifts.
In order to recoup the direct cost increase that comes with an increased wage, firms may adopt practices that negatively impact worker productivity. They might reduce training opportunities, offer fewer noncash benefits (like health insurance), or even replace workers with technology.
Ultimately, such tactics reduce employees’ motivation to work hard and their ability to develop skills on the job, which can hurt overall company productivity. And they can also reduce firm profits, which can lead to a loss of jobs and decreased income for low-wage workers.
To avoid these effects, policy makers should consider combining any increase in the minimum wage with additional policies that ensure consistent schedules and adequate hours for workers. For instance, some cities and states have passed “fair workweek” laws that require employers to offer part-time workers the opportunity to move into full-time positions.
While the conventional wisdom is that a minimum wage increase reduces jobs, a growing consensus finds that moderate increases do not affect overall employment. That’s because, at those levels, wages account for a small share of total firm costs and firms can absorb the change in many ways other than cutting staff or accepting lower profits.
For example, many of the goods and services that workers provide are not easily substituted—haircuts, restaurant meals, electricity and construction—and firms can raise prices to recoup some of their higher labor costs. Other strategies that firms can use include reducing nonwage benefits or investing in production technology. The latter could improve worker productivity and morale, but may also lead to job losses. In fact, Deserranno and Persico found that a $1 increase in the minimum wage led to better productivity in stores with high supervision but reduced productivity at stores with low supervisory oversight. In addition, store profits fell.
Increased Labor Market Competition
A common view is that a higher minimum wage reduces employment by forcing businesses to replace low-skilled workers with machines or automation. This, in turn, impedes young, less-experienced job-seekers from entering the workforce and advancing their careers.
A more serious projected impact is that higher wages will increase labor costs, prompting firms to raise the prices of their products and services in order to recoup the increased operating expenses. The resulting inflation will also negatively affect consumers by increasing the cost of living.
The COVID-19 pandemic has already prompted many small businesses to cut worker hours or close entirely, and a significant increase in the minimum wage could further strain these businesses. The good news is that extensive research by UC Berkeley economists and alumni has found that, at least in the short term, minimum wage increases have little to no effect on employment levels.
A minimum wage increase can cause families’ incomes to fall when prices rise, as they did during the Great Recession. Because a large share of low-income family budgets goes toward goods and services produced by minimum wage workers (like haircuts, restaurant meals, electricity and water), this can reduce their purchasing power.
Moreover, many small firms are forced to raise prices or cut worker hours after raising the minimum wage. This can also reduce demand for their products, leading to lower sales and profits.
Firms may also try to offset higher labor costs by reducing noncash benefits, such as health insurance or retirement plans. This can also reduce workers’ motivation, erode employees’ ability to develop skills on the job and lead to higher turnover, all of which can hurt productivity. This is why some firms prefer to hire part-time workers, who are cheaper than full-time ones. However, a growing number of cities and states have passed laws that require employers to offer their workers consistent schedules and adequate work hours.