That old chestnut: revisiting the minimum wage

 While reading fellow ESSA contributor Joey Moloney’s article I came across the under-consumption paradox. This was something that I had grappled with before in trying to reconcile the microeconomic lessons about price floors and the minimum wage with macroeconomic lessons about aggregate income and expenditure and the Keynesian Cross. It seems many other people have observed this contradiction before, including Karl Marx.

The producer’s goal is to maximise profit and this goal can give rise to the incentive to reduce wage expenses. However, this would lead to lower income and therefore lower consumption. On a microeconomic level, it is rational for a firm to oppose minimum wages and attempt to reduce marginal costs. However, if every firm reduced their wages it would have disastrous macroeconomic effects. This contradiction is known as the under-consumption paradox.

Many 19th century economists posited that a lack of consumer demand relative to the amount of goods and services being produced was the primary cause of recessions and stagnation. These were often heterodox economists who rejected classical economics, the prevailing school of thought pre-Keynes. We now know that under-consumption will not necessarily cause a recession as investments, government purchases and exports may counteract the under-consumption. Nevertheless, the tension between microeconomics and macroeconomics that Marx’s under-consumption paradox reveals is intriguing.

The under-consumption paradox in the real world

This tension is pertinent to the enduring minimum wage debate and current pay dispute in the U.S between fast-food workers and their employers. The median hourly wage for frontline fast-food workers is $8.49, according to analysis conducted by the National Employment Law Project. The workers participating in the campaign are demanding an increase of over 75% to $15 per hour. Against this backdrop California has enacted a law raising the minimum wage to the highest in the U.S. This has sparked renewed debate about the minimum wage at a federal level.

Leaving aside the equity and fairness issues at play, the main economic argument advanced for a wage increase is that it will increase disposable income and spur economic growth. This seems like an economically valid argument. On the other hand, opponents argue that this will increase the costs of hiring and therefore have an adverse impact on employment. Given the sluggish state of the economy this adverse impact would only compound the existing unemployment problem. This also seems like an economically valid argument. It’s at this point I scratch my head and wonder who has the economics on their side? Let’s examine the arguments further and assess the evidence.

Does the minimum wage really result in lower employment?

Anybody who has studied introductory economics will be dubious about government intervention in markets, especially in the form of price controls. But if all price controls lead to a deadweight loss then why do many erudite and prominent economists support the minimum wage? Nobel laureates such as Joseph Stiglitz and Paul Krugman note that the preponderance of evidence points to the minimum wage having little to no discernable effect on the employment of lower income workers. In support of this claim are recent meta-studies on research conducted since the 1990s. While there is still some dissent the evidence rebuts the employment argument, although it prima facie seems theoretically sound.

This is not to say that raising the minimum wage to $30 would not have adverse impacts on employment – of course it would. However, nobody is proposing to do that. Most proposals are in the ballpark of a $2 increase to the federal minimum wage of $7.25 over the medium term and then indexing to inflation for the longer term.

Will increased wages spur economic growth?

This argument is also theoretically sound and is borne out by the data. Based on results from a Federal Reserve Study, it has been estimated that the $0.30 increase in the minimum wage in July 2009 boosted consumer spending by $5.5 billion the following year. However, there has been doubt cast on whether minimum wage hikes boost GDP in the long term.

A counter argument might be that the minimum wage merely redistributes money from corporate profits (which will be paid as dividends or reinvested in productive assets) to lower-income persons. It may be argued that this makes no difference economically as the money, if left as corporate profits, would have also made a contribution to GDP. However, this argument erroneously assumes that $1 in the hands of a wealthy person is the same as $1 in the hands of a poorer person in terms of the contribution it would make to GDP. Poorer people tend to have a higher marginal propensity to consume (MPC) than wealthier people. Joseph Stiglitz has remarked that the bottom 80% of income earners in the years prior to the recession had an MPC of 1.1, that is, they consumed at a level higher than their disposable income. It therefore makes sense to ensure that people can participate meaningfully in the economy by legally enshrining an adequate minimum wage that does not decline over time in real terms.


There are many other arguments around the minimum wage that have been omitted from this article such as arguments around productivity, tax receipts and more. This is not to mention some of the more preposterous arguments advanced by Fox News pundits stating that life as a low-income earner ought to be hard in order to create sufficient incentives for advancement. You can find these arguments lampooned by the Daily Show here. After trying to examine this debate through the lens of economics rather than ideology or morality, I have found the macroeconomic argument about increased disposable income and therefore spending more compelling than the microeconomic argument about decreased employment. This conclusion is based upon the lack of empirical evidence linking modest minimum wage increases to decreased employment.


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6 thoughts on “That old chestnut: revisiting the minimum wage”

  1. Hi Yannis. I enjoyed reading your well articulated analysis of this contentious issue. Also thanks for referencing the Daily Show link. Very funny and poignant. Glad to see you are a fan of the show. Cheers Owen

    • Cheers Owen. I did think the Daily Show link was funny and poignant – glad to see that you are a fan also. The argument that people will get ‘comfortable’ on a minimum wage that allows them to remain above the poverty line and participate meaningfully in the economy is ridiculous. I loved the satire of this argument this ‘removing the incentive for advancement’ argument: “if you raise the minimum wage people will never stop working in the fast food industry. They’ll get so comfortable in those hot kitchens and in their acrylic uniforms, relaxing in that grease fog, smelling like processed meat no matter how many showers they take.”

  2. Great article Yannis
    Only today was I discussing in class the overly-simplified view many people have on minimum wages (on both sides of the argument), and that people too commonly and quickly reject minimum wages due to the stylised demand-and-supply-graphs-with-price-floors-showing-a-glut-and-unemployment-and-dead-weight-loss, which must mean that price controls must be unambiguously bad. Would be great to see you take this topic further.

    • I agree completely Kim. Over-simplified views of any complex economic question always irk me. Those basic supply/demand models from introductory Micro certainly over-simplify the minimum wage issue and clearly don’t take into account the macroeconomic benefits of a minimum wage in raising consumption spending. Further, any serious economist doesn’t form an opinion on a complex economic question without looking at the empirical studies. This is because, often in academic fields such as economics, whilst something seems theoretically sound it may not bear out in the real world. Steven Levitt acknowledges this when he talks about how many policies “fail to account for the way real people respond to real-world incentives.” That is why Steven and most serious economists don’t just rely on models from introductory micro but conduct empirical studies. This is also why we learn statistics and econometrics at uni :)

    • Glad to see you are also a fan of the Daily show Kim. I previously stated that simplified economic arguments about complex economic issues irk me. However, what irks me even more are simplified ideological arguments about complex economic issues. At least those who use the basic micro supply/demand DWL analysis are arguing from an economic perspective. However, our good friends at Fox put forward even worse arguments which are lampooned extremely well by John Oliver and the team at the Daily Show. One of my favourite lines from the clip that satirises the ideological argument is “Who would’ve thought that the line between capitalism and communism in America is a double-digit minimum wage?!?”

      P.S. Also as you can probably see, a few things irritate me :P Maybe I could get a job ranting about what grinds my gears on talkback radio? Perhaps I could be the next Derryn Hinch?

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