History and theory of the minimum wage

Dr. Fred McKinney | 2/5/2014, 11:25 a.m.

“All but the hopelessly reactionary will agree that to conserve our primary resources of man power, government must have some control over maximum hours, minimum wages, the evil of child labor and the exploitation of unorganized labor,” said Franklin Delano Roosevelt in an address to Congress in 1937 in support of the minimum wage legislation.

It is time to confront the reality that we need to increase the minimum wage significantly to a rate far exceeding those being discussed in Washington, D.C., or in state capitals around the country. The federal minimum wage under the 2013 minimum wage law was scheduled to increase in three steps from $7.25 per hour to $10.10 per hour by 2015. This change would be welcome. However, we really need a minimum wage that is even higher and takes effect sooner. Congress should be encouraged to pass Senate Bill 460 and the president should sign it as soon as possible after the affirmative vote.

FDR’s motivation in proposing and enacting the nation’s first minimum wage law was to increase the amount of income in the hands of millions of American workers. The minimum wage law was originally passed during the height of the Great Depression. At that time there was widespread criticism from traditional economists who were quick to point out that in accordance with economic theory, the impact of the minimum wage would be unequivocally negative. Opponents of raising the minimum wage still rely on discredited economic principles.

There are basically three schools of thought on the minimum wage. The first, based on economic principles of demand and supply, opposes an increase in the minimum wage. The second accepts the demand and supply economic analysis, but believes the benefits of increasing the minimum wage exceed the costs associated with the increase. And the third school of thought rejects the classical economic analysis and believes the cost is exaggerated and the benefits are underestimated.

According to classic economic theory, labor markets are like all other markets: demand and supply determine prices. The price in labor markets is the wage. Equilibrium in a particular labor market occurs when the demand for workers equals the supply of those workers. The demand for workers occurs when employers must hire employees when consumers want to buy the goods and services that their firms sell. This is why economists call the demand for labor a “derived demand.” That is, the demand for labor results from the demand for goods and services. However, an increase in wages would require an increase in the prices charged for those goods and services. Then sales would decline and cause a loss in jobs. Conversely, a decline in wages leads to greater sales from lower prices and an increased demand for labor services.

From the workers’ perspective, higher wages will attract more job applicants. Conversely, when wages are too low, leisure becomes increasingly more attractive and workers will choose to stay home.

That economic theory leads to the conclusion that an increase in the minimum wage is counterproductive. A minimum wage set above the equilibrium level will result in more workers willing to work at that wage, but the necessary increase in the cost of goods and services will reduce sales and the need for more workers. That gap is what we call unemployment. The solution to unemployment, they theorize, is to lower wages.