One of the many divides between moderate, establishment Democrats and the party’s progressive wing is the minimum wage. By and large, moderates favor raising the minimum wage, but only to $10-$12; progressives, on the other hand, have rallied around a $15 minimum wage. Economic literature finds that a slight increase in the minimum wage does not have an adverse (or dramatically adverse) effect on the economy. However, literature is sparse on the effects of doubling the baseline wage. As such, neither side can proclaim to be “right,” but economic theory does favor one over the other.
At risk of substantially over-simplifying economics, there are three cost components business must take into account: capital, land, and labor. It is the latter two whose importance arises when considering minimum wage increases.
To understand the impact of each on a business, let’s consider two cafes, one in San Francisco and the other in Oklahoma City.
The capital inputs of a cafe include ovens, stoves, etc (basically all the physical goods used in the production of food). These costs are more or less equivalent in the two cities. An oven does not cost more – or significantly more – in San Francisco than in Oklahoma City (if such a discrepancy existed, entrepreneurs would establish a business to buy tables in Oklahoma City and sell them San Francisco. Doing so would increase table demand in OKC, raising prices, and increase supply in SF, lowering prices, thus eliminating the gap). Capital costs, then, are largely the same within industries, regardless of geographic location, and are about the same in absolute dollar amounts in both cafes. These costs do not amount to a significant portion of overall business cost.
Land, on the other hand, differs greatly in value between the two cities. Rent, as everyone knows, is remarkably high in SF – much higher on a square-foot basis than in OKC. Should our San Francisco cafe wish to be the same size as our cafe in Oklahoma City, it must pay more for rent than our OKC cafe. We’ll assume both opt for a location the same size. Because rent in SF is so expensive, it represents a very large percentage of total costs for the SF cafe; for OKC, on the hand, low rent means that the cost of land does not represent a large amount of total cost.
For sake of simplicity, we’ll assume labor costs the same in each city (San Francisco recently adopted new laws to raise the minimum wage, which makes labor more expensive in SF than in OKC). Each cafe pays its workers the federal minimum wage – $7.25/hour. The relative burden of this wage, however, is not the same in the two cafes. Labor is not a large proportion of total costs for the SF cafe because rent is so expensive. In other words, since rent costs so much, the SF cafe is relatively flexible to wage levels: it can raise wages without increasing costs by a large percentage (cost increases are transmitted to consumers through higher prices). Our OKC cafe, on the other hand, experiences a (much) higher percentage of costs related to labor than other inputs. Therefore, increasing the price of labor by any amount substantially impacts overall costs and translates to increased prices.
Raising the minimum wage, then, impacts the two cafes differently. The SF cafe can withstand higher labor costs without increasing its prices because increasing labor does not greatly impact overall costs. In OKC, an increase in the price of labor causes overall costs to rise by a significant amount, thus forcing the cafe to raise its prices.
This demonstrates the problem of a high federal minimum wage. The cost of living varies greatly over the country, there is no one-size-fits-all solution – what works in New York City likely won’t in Jackson, Mississippi. Costs may not increase in NYC, but they will in Jackson.
In the worst case scenario, businesses in Jackson or other low-cost areas (like our OKC cafe) simply won’t hire workers at a higher wage rate because they won’t be able to offset costs – there’s only so much a company can raises prices before consumer demand falls tapers.
While this relies on theory, it seems a logical reason to disfavor a high national wage. The best policy, seemingly, is to have a lowest-common-denominator federal minimum wage and then urge states and counties to raise their minimum wages as necessary. This would minimize cost-related price increases or layoffs while allowing for local flexibility in policymaking.
Unfortunately, Democrats like Bernie Sanders and Martin O’Malley tend to eschew market realities when advocating for a $15 minimum wage. If the Democratic Party were to follow suit, Republican claims that the Democrats are clueless about the economy would actually carry weight.