Testimony

The Maryland Minimum Wage

Maryland House Economic
Matters Committee

Chairman Davis, Delegate Parrott, and members of the Committee, thank you for the invitation to testify on the question of whether the state minimum wage should be increased from $7.25 an hour to $10.10 by 2016 and then indexed for inflation, as proposed by Governor Martin O’Malley (Maryland Minimum Wage Act of 2014), or whether Delegate Neil Parrott’s “County Choice Minimum Wage Bill” (HBO293) would be preferable. That Bill would allow individual counties to determine their own minimum wages based on differential costs of living and economic conditions, rather than be subject to a “one size fits all” state-mandated minimum.

The Importance of Economic Freedom
Of course, the law that would be most consistent with the “Free State” and economic freedom, which is the key to economic development, would be the “law of liberty”—that is, a rule of law consistent with constitutional principles, freedom of contract, and private property rights. Such a law would be conducive to economic development by expanding the range of choices open to individuals.

Legally enforced minimum wage laws—whether federal, state, or local—interfere with worker and employer freedom. They prevent workers from offering to work at less than the legal minimum if they cannot find a job (because their productivity is lower than the government-dictated minimum wage), and they prohibit employers from hiring workers who are willing to take entry-level jobs at less than the legal minimum wage. Consequently, trades that would be mutually beneficial and enable low-skilled workers to get job experience and move up the income ladder are outlawed by minimum wage laws intended to “do good.”

Minimum Wage Fallacies and Consequences
Governor O’Malley, in supporting a raise in the minimum wage, argues that “the more workers are able to earn, the more customers businesses have,” and “that’s what drives the economy.” The fallacy here is that he is putting the cart before the horse: employers don’t say, “I’ll first pay workers with low skills more and they will then produce more.” Rather, they say, “If a worker acquires more education and skills, or if the demand for my product goes up, then I will be willing to increase that worker’s wage rate and retain her. In truth, the only way to increase the number of jobs and increase wage rates is to first increase the productivity of labor.

Two laws in economics—the law of demand and Say’s law (that supply creates its own demand)—are ignored or downplayed in discussions of the minimum wage. No one has ever disproved the law of demand, which, in the case of the labor market for unskilled workers, says that when the price of labor (the hourly wage rate) increases, other things constant, there will be a decrease in the quantity of labor demanded (i.e., fewer jobs or fewer hours worked). That effect will be greater in the long run than in the short run, as employers shift to labor-saving technology and substitute higher-skilled workers for lower-skilled workers. Moreover, as more low-skilled workers search for employment as the minimum wage is increased, not all of them will be successful in finding a job if the minimum wage is greater than the value of the extra output they can produce. Those who can’t find a job will have a zero income, even if the government promises them $10.10 an hour.

Hence, in addition to decreasing employment for unskilled workers, a rise in the minimum wage (in excess of the prevailing market wage) would increase unemployment among young, inexperienced workers (especially minorities)—and this effect would be more pronounced in the long run. Workers who retain their jobs at the higher minimum wage rate are better off, but only at the expense of those who have lost their jobs or can’t find a job. Also employers are likely to increase the remaining workers’ workload and reduce their benefits. These negative impacts of the minimum wage have been well documented (see, e.g., J. A. Dorn, “The Minimum Wage Delusion, and the Death of Common Sense,” Forbes.com, May 7, 2013).

Say’s Law tells us that workers must first produce more if they are to be paid more and keep their jobs. The minimum wage is neither necessary nor sufficient for real economic growth. Earning a higher wage rate requires sacrifice and hard work, including getting a better education (either through formal schooling or on-the-job-training), and acquiring good work habits. For those workers who are priced out of the market by the minimum wage, their income (wage rate x hours worked) will be zero. The minimum wage helps some workers at the expense of others.

The idea that an increase in the minimum wage automatically makes all workers better off and that overall consumption (aggregate demand) will drive the economy is upside-down economics. Workers who can’t find a job at the higher minimum wage or those who lose their jobs will have less to spend, as will employers who have to pay the higher minimum. Even if firms can increase their prices to cover the higher minimum wage, consumers will have less to spend on other things, assuming the Federal Reserve does not accommodate the higher minimum wage by printing money. If more money was printed and inflation occurred, then real wages would go down. There is no free lunch.

The minimum wage redistributes a given economic pie, it doesn’t enlarge it. The only way to “drive the economy” is to raise productivity, not the minimum wage. Today, in anticipation of a higher minimum wage, employers are using tablets and other technology to replace entry-level workers. Indeed, if the federal minimum goes to $10.10 and is indexed, states will also have to pay at least that rate—and employers will take action now to protect their profits. International competition means that cost-cutting, not price increases, will be the chief weapon to remain competitive. Higher-skilled workers (including union workers) will benefit from a higher minimum wage, but those at the bottom will suffer.

Politicization of Labor Markets
The public supports higher minimum wages because they haven’t thought about the longer-run consequences of a minimum wage, and most polls simply ask, “Are you in favor of a higher minimum wage?” without saying anything about the loss of jobs and the unemployment that will occur. When those costs are taken into account, the poll results flip, with a majority saying they do not favor a higher minimum wage (see Emily Ekins, “Americans Will Only Support Obama’s Minimum Wage Increase If It Doesn’t Harm Jobs,” Reason.com, January 28, 2014).

The promise of politicians to increase wages for low-skilled workers politicizes labor markets and deludes workers into believing they can keep their jobs and get a higher wage—without any effort on their part. Indeed, workers think of the minimum wage as a “right” even though there is no corresponding responsibility.

An increase from $7.25 to $10.10 an hour is a 40 percent rise in the minimum wage. Coming out of a severe recession and still hindered by slow growth, the U.S. economy needs to be driven by private entrepreneurship, innovation, and education; not by government dictates for higher minimum wages under the illusion they can increase incomes and consumption without any serious negative effects.

Nina Smith, a spokesperson for Governor O’Malley, contends that raising the state minimum wage to $10.10 an hour would “restore much of the value of the minimum wage without imposing a hardship on Maryland businesses.”  Indeed, she notes that “increasing the minimum wage rewards work, provides opportunities for businesses to expand their customer base and strengthens our state’s economy.” If so, why not increase the minimum wage to $20 an hour? Also, what is important is not the real minimum wage (i.e., the purchasing power of the nominal minimum wage) but the difference between the nominal minimum wage and the prevailing market wage for unskilled labor. The larger the spread between them, the greater the negative effects of the minimum wage on jobs and unemployment for unskilled workers.

Unintended Consequences: Some Empirical Results
Tracing the impact of a rise in the minimum wage on employment is difficult because of “confounding factors”—that is, things that are assumed constant in the law of demand. In a recent study that controls for other factors and focuses on the relation between a higher price of labor and the number of jobs in the market for low-skilled workers, Joseph Sabia, Richard Burkhauser, and Benjamin Hansen found that when New York State increased the minimum wage by 31 percent—from $5.15 an hour to $6.75, in 2004–06—the number of jobs open to younger, less-educated workers decreased by more than 20 percent (“Are the Effects of Minimum Wage Increases Always Small? New Evidence from a Case Study of New York State,” Industrial and Labor Relations Review, April 2012). A 40 percent increase in Maryland’s minimum wage would no doubt have a similar impact, and that impact would be compounded by an increase in the minimum for tipped workers from 50 to 70 percent of the state’s base rate.

In a separate article, Sabia and Burkhauser found “no evidence that minimum wage increases between 2003 and 2007 lowered state poverty rates” (“Minimum Wages and Poverty,” Southern Economic Journal, January 2010). Most Americans earning the minimum wage do not live in poor households. Those most apt to lose their jobs are from low-income households; hence, an increase in the minimum wage can actually increase poverty. As David Neumark, Mark Schweitzer, and William Wascher note: “The net effect of higher minimum wages is … to increase the proportion of families that are poor and near-poor” (“The Effects of Minimum Wages on the Distribution of Family Incomes,” Journal of Human Resources, 2005).

A more recent study by Jonathan Meer and Jeremy West, economists at Texas A&M University, found that “the most prominent employment effect of minimum wage laws is a decline in the hiring of new employees” with less education and experience (“Effects of the Minimum Wage on Employment Dynamics,” NBER, August 2013). That effect is stronger in the long run, as employers introduce new technology and utilize their skilled workforce more efficiently.

The most rigorous recent study on the employment effects of the minimum wage is an NBER study by Neumark, Salas, and Wascher, “ Revisiting the Minimum Wage-Employment Debate: Throwing Out the Baby with the Bathwater?” (January 2013). The authors carefully examine new minimum wage studies that purport to show no negative effects on employment of low-skilled workers from a rise in the minimum wage. They find “serious problems” with those studies and conclude: “Evidence still shows that minimum wages pose a tradeoff of higher wages for some against job losses for others, and that policymakers need to bear this tradeoff in mind when making decisions about increasing the minimum wage.”

The Case for Choice
A more fundamental question is whether legislators should intervene in free labor markets to mandate a minimum wage above the market wage determined by demand and supply. Doing so deprives workers and employers of the freedom of contract that lies at the heart of a dynamic market economy. The wealth of a nation is not enhanced by prohibitions on free trade—whether in product, labor, or capital markets. The role of government in a free society is to prevent barriers to entry, not to create them. People should be free to choose and to improve. The work ethic and character development are the keys to success. But if low-skilled workers can’t find a job at the minimum wage, they will never have the opportunity to fully develop themselves and move up the income ladder.

Choice could be improved by adopting the “County Choice Minimum Wage Bill,” which would allow employers to pay a minimum wage determined by the counties they hire in rather than be subject to a single state-determined minimum wage. Of course, all counties will have to pay at least the federal minimum wage—so the negative effects on jobs will remain. However, suppose the Congress does not enact President Obama’s proposed hike in the federal minimum to $10.10 over the next three years. Under the County Choice Bill, Maryland counties could opt to remain at the federal minimum wage of $7.25 an hour. If productivity increases, entry-level wages would climb without any government intervention, and the nominal minimum wage would fall below the market wage. For all practical purposes, the minimum wage would be a dead letter.

Those counties that did increase their minimum wages would still suffer the adverse consequences. Workers who became unemployed would have an incentive to search for jobs in countries that froze the minimum at $7.25. Those areas would grow and prosper over the longer-run, and workers would end up being better off than if there were a single state-wide minimum wage. This outcome is similar to what has happened with non-union employment and wages—both rose—during the last several decades as workers moved to right-to-work states.

Conclusion
Maryland needs more economic freedom, not less. Hong Kong is the freest economy in the world and one of the most prosperous. During most of its long growth period it had no minimum wage. Maryland has the potential to become a dynamic growth state, but to do so it needs to cultivate a business-friendly climate with lower tax rates, a better K–12 education system, a reduction in crime, and a political environment that considers the long-run impact of economic legislation, not just the short-term benefits to special interests.

The Governor’s minimum wage proposal is the wrong medicine for an ailing economy. The County Choice Bill is preferable but would still not escape a higher federal minimum wage. However, if Congress does not increase the minimum wage, then adopting the County Choice Bill would give the free market a chance.