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The Impact of Minimum Wage Increases on the Economy and Labor Market

In 2022, more than half of the states in the U.S. plan to increase their minimum wage, and many employers are planning to raise their pay floor on their own. Recruiters and hiring managers are already experiencing a tight labor market propelled by competition for professional, highly skilled workers as well as entry-level employees. The question is, will widespread increases in the minimum wage make hiring easier, and at what cost to the overall economy?

Minimum wage statistics

Over a million workers in America still earn the federal minimum wage—last raised in 2009—of $7.25 or less. Inflation is now at its highest level in 40 years. And even though many employers have increased pay rates to combat labor shortages (Costco raised its minimum wage to $17.00 in October of 2021 and T-Mobile is paying its workforce at least $20.00 an hour), inflation-adjusted average hourly earnings still fell by 2.4 percent in December 2021. If the minimum wage kept pace with the growth of the U.S. economy over the last 50 years, it would be nearly $26.00 an hour today—or more than $50,000.00 a year in annual income.

Minimum wage increases took effect in 20 states on January 1, 2022, four increases go into effect on July 1, 2022, and one on September 30, 2022. New York increased their minimum wage on December 31, 2021. The increases range from $0.22 in Michigan to $1.50 in Virginia. The two states with the lowest minimum wage—Georgia and Wyoming at $5.15/hour—require employers who are subject to the Fair Labor Standards Act to pay their workers the federal minimum wage of $7.25/hour. For all the specifics, check out the Ballotpedia News annual analysis.

Implications of minimum wage increases on the economy and labor market

There are conflicting views on the implications of raising the minimum wage. Some economists and lawmakers argue that when minimum wage increases it creates imbalances in the labor market and leads to inflation. Others argue that when the minimum wage has risen, historically, inflation did not follow. Below are a few of the pros and cons of raising the minimum wage.

Pros of a minimum wage increase

  • Improved standard of living: Higher earnings will improve the overall standard of living for minimum wage workers by providing them with a more appropriate income level and the ability to handle the cost of living
  • Reduced government expenditures: If workers earn more, the number of individuals classified as poor and low-income will decrease. This results in a projected reduction in the need for federal and state government expenditures on financial assistance. According to a Congressional Budget Office report, raising the federal minimum wage to $15.00 an hour would lift 900,000 people out of poverty, presumably reducing government assistance costs.
  • Stimulated economic growth: When wages rise an economic growth boost typically follows where we see an increase in consumer spending. A higher minimum wage provides workers with more discretionary income to spend which bolsters retailers and other businesses.
  • Higher job growth: Studies have found that states with a higher and more equitable minimum wage experienced a faster pandemic recovery and added more jobs in 2021 than states with lower minimum and subminimum wages. Many businesses—especially in the leisure and hospitality industry—have found it easier to attract workers after improving working conditions and increasing wages.  
  • Increased consumer satisfaction: Research from the Cornell SC Johnson College of Business found that in the restaurant industry, consumers benefit from an increase in the minimum wage. Their research found that higher wages positively impacted customer service which led to a reduction in negative customer reviews about workers’ friendliness and courtesy.

Cons of a minimum wage increase

  • Increased prices: To offset elevated business operating expenses resulting from higher labor costs, companies may need to increase the prices of their products and services. When businesses raise prices, the cost of living increases may negate any advantage gained by workers having more money in their pocket. This could then fuel inflation which is already at record levels and negatively impact the ability of companies to attract and retain talent.

Related: The Effects of Inflation on Attracting and Retaining Talent

Loss of jobs and/or hours: Labor is a major operating cost of doing business. A raise in pay may require businesses to cut jobs to maintain profitability. According to a Congressional Budget Office report, raising the federal minimum wage to $15.00 an hour would cost 1.4 million jobs over the next four years. Employers may also elect to cut hours across the board which will create an even worse situation for some workers.

  • Salary compression: When lower-paid employees receive a federally mandated pay increase, the pay scale for an entire company can become misaligned and pay levels may converge over time. This can cause salary compression—which can result in lost productivity, high turnover, and recruiting challenges.

Related: What Is Salary Compression and How Can It Be Addressed?

  • Fewer jobs for younger, less experienced workers: A minimum wage increase may cause a larger number of experienced job applicants to accept minimum wage positions. These low-paying jobs have historically been filled by younger, less experienced workers who will now face additional hurdles in finding work and gaining the experience they need to move forward in their careers. Studies have shown that a 10% increase in the minimum wage results in a 1 to 3 percent decrease in teenage employment. This challenge can be offset by having an exception to the minimum wage for younger workers who are working part-time. Another option is to pay a different minimum wage based on the categories and age classifications of workers. In the United Kingdom, the minimum wage is broken into four brackets—with under 18 and apprentices receiving the lowest pay—and incrementally increases up to age 23.
  • Loss of benefits: Workers understand that when they receive a substantial raise, there can be negative consequences. A minimum wage increase can result in a loss of benefits—like child tax credits and insurance coverage—causing workers to not earn enough to break even—which can take years to recoup. Rand Corporation has found that for every $1.00 increase in the minimum wage, low-wage workers and their families became 1 percentage point less likely to have job-based insurance coverage.

Summary

This blog was written by Broadleaf’s CEO, Lynne Marie Finn.