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Raises and Rises

Q&A with Murat Tasci, senior research economist at the Cleveland Fed

As a poverty-reduction tool, raising the minimum wage isn’t without drawbacks.

As policymakers and economists across the country debate the merits and pitfalls of an increase, the federal minimum wage sits at $7.25 per hour for non-tipped workers and $2.13 for tipped workers. Ohio and West Virginia, two states within the Federal Reserve Bank of Cleveland’s Fourth District, which comprises Ohio, western Pennsylvania, the northern panhandle of West Virginia, and eastern Kentucky, have state minimum wages that exceed the federal minimum. Two others in the District, Pennsylvania and Kentucky, match it. As pressures to raise wages escalate across the nation, some major metropolitan areas such as San Francisco and Washington DC are taking matters into their own hands and effecting area-wide raises—for better or worse. Large companies, too, many in food service and retail industries, are feeling the pressure as calls come in from multiple corners to raise wages for their lowest-paid workers.

We wanted to know, to what extent might a rise in the minimum wage affect hiring and employment, and who would feel the pinch? We sat down with Murat Tasci, senior research economist at the Cleveland Fed, and asked him some tough questions.

Forefront: The federal minimum wage was last raised in 2009. What drives the current push for an increase?

Tasci: Since the US federal minimum wage is set nominally, over time it tends to decline in terms of its purchasing power. Changes since the 1980s coincide with a decline in the real hourly minimum wage to around $6 per/hour (normalized to 2015 levels). This time around, though, in real terms the minimum wage doesn’t seem to be exceptionally low relative to its high levels in the late 1970s. It’s hard to speculate, but I’m presuming the stagnant median household income over the past two decades has something to do with it. In 2007, median household income was $57,357, but fell substantially during the Great Recession. The most recent data for 2014 indicate that real median household income recovered, but only to $53,657.

Real minimum hourly wages are not substantially low relative to the high levels of the 1970s.

Forefront: One aspect of the current debate about raising the federal minimum wage is that doing so may cost jobs and increase unemployment. What are your thoughts?

Tasci: Evidence points to disemployment effects, meaning that a minimum wage increase reduces employment for the groups of workers in the intended population. The argument for raising the minimum wage is often not about the effects on employment numbers. Instead, the intention is to provide a higher living standard for lower-skilled workers. But if the additional labor cost incurred from a higher minimum wage leads employers to cut jobs, the policy will produce a substantial unintended consequence. While the estimated effects are small, much of the evidence suggests that the negative effects on employment in response to raising the minimum wage fall disproportionately on lower-skilled workers. An important note to the existing research is that it has largely relied on small changes in the minimum wage to identify effects. Many of the current proposals would be for larger changes, potentially making the employment effects estimates unreliable.

Forefront: What benefits and pitfalls are there to raising the minimum wage piecemeal by city or state rather than federally?

Tasci: One obvious benefit is the cost of living might be different by location. So if the motivation is to raise the living standard of low-wage earners, the right benchmark should be different in New York City than in, say, Youngstown, Ohio. On the other hand, if the locations are physically close, firms might relocate to avoid facing a minimum wage hike in one location, thereby shifting employment to another location without worker benefit.

Forefront: What effects would increasing the minimum wage have on employment, particularly in the current labor market in which large corporations have generally recovered from the recession but smaller businesses might still be struggling?

Tasci: An increase poses another challenge for the strength of the recovery. Not only is the labor market recovering from one of the deepest recessions in US history, but it also faces intensifying challenges from technological changes. Lower-skilled workers performing routine tasks are increasingly replaced with machines and software, thereby reducing demand for human labor. Assuming we’ll face similar results in line with empirical evidence, a substantial increase will reduce job creation. How much will depend on the magnitude of the change. Small businesses will be especially affected because they often lack other instruments to absorb cost increases.

Forefront: What effects would increasing the minimum wage have on family income?

Tasci: It depends on who we’re talking about. Undoubtedly, there are single parents who earn minimum wage working one or more part-time jobs, and most arguments in favor of an increase emphasize the positive income effects on such households. But minimum wage is not a function of household income, so it follows that raising it doesn’t necessarily target this type of household. Really, many of the people likely to benefit from an increase are teenage members of wealthier households. In the end, then, it’s not clear how an increase would unambiguously help with a poor household’s problem, especially if it increases the likelihood of losing a job. As a poverty-reduction tool, minimum wage is a very blunt one, and research suggests that its negative employment effects are amplified for exactly the groups needing targeted poverty measures.

Forefront: Is there a course of action that could help mitigate any unintended consequences of a federal minimum wage hike?

Tasci: When minimum wage has negative effects, it’s because it induces distortion into the marketplace. A society can decide whether it prefers to induce this distortion and raise incomes for a group of low-wage earners in spite of the risk of increasing the number of unemployed from the same group. But it might make more sense to devise a targeted poverty-reduction measure for the low-income households directly, such as with the Earned Income Tax Credit. This particular credit depends on household income, so it would benefit the single parent in the previous example. As long as the parent’s total income meets certain thresholds, his or her tax burden will be substantially alleviated, effectively raising the household’s income.

Forefront: What’s presently on the minds of those who study minimum wage and unemployment, something that may be obscure but significant?

Tasci: I think to understand the effects of the minimum wage, one must be aware of the characteristics of most minimum-wage earners. Plus, the fraction of workers who earn at or below the minimum wage is quite close to its lowest levels, around 3.9 percent of hourly paid workers in 2014, down from 15.1 percent in 1980. This substantial decline cannot be attributed to the changes in the real minimum wage, suggesting that the market for minimum wage jobs is probably disappearing.

Sum and substance: Raising the minimum wage won’t necessarily reduce poverty.

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Want to know more about minimum wage effects? See “Positive and Normative Effects of a Minimum Wage” for more information.

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