Minimum Wage - We Can Do Better

The Federal Minimum wage law was a partisan issue from the day it was enacted in 1938.  Democrats in favor, Republican's opposed.  Politics has shaped the minimum wage more often than problem solving.  Dealing realistically with the minimum wage laws would be a great way to begin a new era where the good policy for the entire country comes before partisanship.

That the minimum wage laws have made the country a stronger and fairer country is beyond question.  But the minimum wage is far from a perfect policy solution.  Republicans have long objected to the minimum wage on the basis it destroys jobs.  They are correct, it does destroy entry level jobs, particularly in economically depressed areas.  But Republicans ignore the bigger picture that the minimum wage also reduces income inequality and in the process creates a stronger consumption base that builds a stronger economy and makes the country more financially solvent.

The basic problem the minimum wage seeks to solve is an unregulated free market pushes business to drive wages as low as possible to survive.  If one business in a market exploits workers they drastically reduce their costs of production.  Every other business in the market will be undercut on price and end up either cutting what they pay workers, or getting out of the market.  As this dynamic plays out across all industries in an economy it undermines the consumption that supports and grows our economy.

The formula enacted in 1938 addressed that problem by setting a floor on wages.  Summarizing the current law, the US Department of Labor website states:

"The minimum wage law (the FLSA) applies to employees of enterprises that have annual gross volume of sales or business done of at least $500,000. It also applies to employees of smaller firms if the employees are engaged in interstate commerce or in the production of goods for commerce..."

The second part of the current law is the problem - virtually any business is arguably "engaged in interstate commerce..."  The distinction drawn by the first test of gross business income of over $500,000 is undermined by the interstate commerce test.  Small local businesses that generate little revenue provide a disproportionate number of the entry level jobs in this country.  A high minimum wage makes hiring too expensive for these small businesses.   

We should learn from history.  The US and many European nations have followed this model that disregards the impact of a single minimum wage standard on small business for decades.  They have always been plagued with high unemployment rates.  The burden of unemployment always falls on the folks who need the most help.  A mandatory minimum wage that works for dynamic urban areas crushes entrepreneurship in not so dynamic urban pockets and more rural areas, while no minimum wages fosters market driven exploitation.  We need a minimum wage law that draws careful distinctions - and distinctions based on "interstate commerce" have failed. 

Facts about the minimum wage:

1.  Unemployment falls disproportionately on folks under the age of 34, and over the age of 54.  In particular people under the age of 24 have consistently high unemployment rates.  Within those age parameters people of color are the most likely to be unemployed. 

2.  64% of the new jobs in the United States come from small business.   In the 81 years between the enactment of the minimum wage in 1939 and 2019 the country averaged an unemployment rate of  5.8% of the working population.  That 5.8% unemployment figure represents literally millions of people who cannot find a job.  But that 5.8% figure is misleadingly low about the true impact of minimum wage laws. Really low unemployment years bring the average down.  In the last 81 years really low unemployment rates have usually occurred during wars when a large part of the young male population were in the military - substantially reducing unemployment among the demographic most likely to be unemployed.  

In the 10 years from 1961 to 1970 the minimum wage was raised 4 times and we experienced a prolonged period of rapid economic growth (without a subsequent financial collapse).  Purchasing power of the minimum wage reached its historical peak in 1968 when the minimum wage was 52% of the average wage.  For that period the average unemployment rate was 4.6%. That is still a lot of unemployed folks but that figure is deceptively low.  Many millions of the young men at highest risk of being unemployed were not in the job market - they were "employed" in the military as we rotated half a million soldiers in and out of Vietnam while maintaining forces in Europe, Korea and other locations around the world.

In the 10 years from 1971 to 1980 the Vietnam war wound down and the military downsized.  The minimum wage was only raised once while the unemployment rate averaged 6.49%.   From 1981 to 2000 as we moved to an a smaller, all volunteer military unemployment averaged 6.1%.

Historically, adjusting for wars and recessions, rising purchasing power from the minimum wage correlates directly with higher unemployment.

How to improve the minimum wage law - A conceptually better way to address the problem of market driven exploitation would be to link how much the owners and managers get paid to how much their employee's get paid.  That will take exploitation out of the marketplace while also enable fledgling business where no one is making a lot of money to bring in help to grow the business for everyone.  The kind of business that provides most of the entry level jobs for young people.

How do we draw the necessary distinctions?  Some ideas include:

Develop Tax policies that make it advantageous in the marketplace to pay your employees well, by setting up tax penalties if the managers make some specified amount more the the lowest paid workers. 

A distinction based on the form of business ownership could also be simple partial solution.  Make the minimum wage law presumptively applicable to any business organized as a limited liability entity as a part of the price of limited liability.  But businesses that operate as a sole proprietorship or partnership, where the owners are directly liable for the business losses, could be exempt from the minimum wage subject to some yearly income test.  

We are a country built on the notion we offer everyone the opportunity to choose their own path.  A one size applies to all minimum wage can preclude entrepreneurial folks trying to create their own path from taking on entry level employees.  A small business without big profit margins that might employ low skill entry level workers to grow into a bigger business can't afford the same wage a big established organization can afford.  The result is some people who would like to be employed are not.  That should be unacceptable.

We can do better.

Problems in Government: Social Security and Pension Plans

 In 1935 the Federal government created the Social Security system to address a chronic problem in society - how to take care of people who cannot support themselves through age or disability.

The problem had been an issue long before 1935, so many local and state governments, and some businesses had begun seeking to address the problem by creating pensions systems for their workers.  The concept that dominated was a defined benefit plan - if you worked a certain number of years you would be entitled to a amount of money each month after you reached retirement age defined as a percentage of your final salary.  It relies on complex  formula's to project how much money has to be set aside each year to have a pot big enough to meet retirement obligations.

Social Security as created in 1935 was a work around to supplement defined benefit plans already in place.

In the century since the defined benefit plan became popular it's two glaring deficiencies have long been apparent.  

The first problem is the model relies on the managers correctly projecting how much per year they need to set aside to provide a big enough pot for retired employees.  Management who have other business priorities, like finding money for raises for themselves, are incentivized to err on the side of putting too little aside.  Rather than what would be prudent they assume the best case scenario.  Assuming a 7% annual return has been common even during recessionary times.  The result has been pension plans often verge on insolvency during stock market downturns.

The second problem is defined benefit plans usually contain "vesting" requirements - money set aside for each employee did not actually become the employee's money until the employee had worked a specified number of years.  This was a considerable benefit to the organizations.  It allowed them to dangle the carrot of a pension to entice potential employees, but they could rely on a certain number of the employees leaving before their retirement vested, so the contributions in the leaving employee's account went back in the pot and reduced the overall contributions the organization had to make - in effect long term employees were subsidized by of short term employees.

The result has been chronically underfunded pensions, and workers who often accumulate little or no pension as they move through life.  It also tended to keep people at jobs they no longer liked in order to become vested.  Finally it is a hurdle for potential entrepreneur's needing a little financial security before striking out on their own to create new business.

Congress recognized the problems decades ago and responded with regulations aimed at private business. Private business, in response, moved away from defined benefit plans to 401K's, employee investment programs created by Congress that effectively funnel money to Wall Street - not only a huge money maker for Wall Street but also a huge factor in the chronic overvaluation of stock markets.  

Government and church related non-profits are still unregulated and continue to imposed vesting requirements that may require years of working service before the worker is entitled to their money.

The Congressional solution to the insolvency issue was a program aimed at funding bankrupt retirement plans,  But with the National debt currently exceeding the national income the ability of the Federal government to bail out underfunded pensions is limited, particularly given that the reason many retirement funds currently appear solvent is because of a stock market chronically inflated by low interest rates.  A market crash could devastate retirement plans, which could crush consumption.  

It is time to start redesigning Social Security law around what's good for workers rather than relying on the poorly aligned incentives of private pensions and 401K's herding retirement money to Wall Street.  A big step forward would be to give workers the option of having retirement contributions directed into the social security system in their name, or rather than supplementing their social security account, use it to fund a business, buy an asset or otherwise take control of their retirement pot without a complex web of restrictions.