President Joe Biden has expressed support for raising the federal minimum wage for federal contractors and employees to $15 per hour. On Jan. 26, House and Senate Democrats took it a step further— introducing legislation to increase the federal minimum wage to $15 per hour by 2025, more than doubling the current minimum wage of $7.25 per hour set in 2009.
But Biden’s plan is too aggressive, according to Radhakrishnan Gopalan, professor of finance at Olin.
Gopalan, who has used big data on multiple impact studies on minimum wage increases, recommends delaying any increase until 2022 to allow the economy and unemployment rates to rebound.
He also recommends increasing it in increments of $1 to $1.50 and, going forward, having a clause to automatically index the minimum wage rate.
In a forthcoming paper in the Journal of Labor Economics, Gopalan and Barton Hamilton, the Robert Brookings Smith Distinguished Professor of Economics, Management and Entrepreneurship, found positive and negative effects for U.S. workers over a two-year period in six states that enacted minimum wage increases between 75 cents and $1.25 per hour in the 2010-15 period.
On the positive side, their study shows that minimum wage hikes not only increase the wages of those workers, but also create a positive “spillover” effect on the wages of other workers earning up to $2.50 above the minimum wage. Additionally, these workers continue to retain their jobs as they are no more likely to be fired.
‘Make the increase more gradual’
However, raising the minimum wage hurt new entrants into the labor market. Researchers found that businesses, especially those making tradeable goods — such as the manufacturing sector — reduce the rate of hiring new workers at low wages following an increase to minimum wage rates. Read more about this research here.
Given the fact that unemployment remains at 6.7%, according to the U.S. Bureau of Labor Statistics, Gopalan warned that increasing the minimum wage would likely make a bad situation worse.
“There are two broad effects of a minimum wage increase. One, it reduces firm’s incentives to hire more minimum wage workers. This effect would be all the more enhanced when firms are hurting from the pandemic,” Gopalan said.
“On the flipside, minimum wage increases put money in the hands of people who are most likely to spend it. Thus, a wage increase is likely to give a boost to consumer demand.
“Having said that, the multiple stimulus packages have put a lot of money in people’s hands, so one is talking about demand in the economy possibly outstripping supply once the pandemic is brought under control. Some are already cautioning about the economy overheating.”
Going slow on the minimum wage increase is the best option, Gopalan said. “Not only is it better to wait for the pandemic to be brought under control, but it is also good to make the increase more gradual and not drastic from $7.25 to $15 in one fell swoop.
“Currently, small businesses are especially hurting from the pandemic. The restaurant sector, which employs a significant number of minimum wage workers, and the retail sector are struggling. Raising the minimum wage now would spell a death knell for many small restaurants.”