Econ homework: A higher minimum wage increases social surplus

The homework for the third week of the Econ MOOC I am taking via Coursera was to argue that an increase in the minimum wage could lead to a lower unemployment rate. I gave two answers. Here’s one:

President Obama recently proposed that the US Congress raise the minimum wage to $9/hr from its current level of $7.25/hr. Republican Speaker of the House John Boehner says that raising the price floor on labor will destroy jobs. He’s wrong. I think.

Low-wage workers tend to spend their paychecks quickly, and they spend a large portion of their wages on food and other day-to-day essentials. Walmart is busy in the hours after paychecks get direct-deposited into bank accounts. If those paychecks get a little bigger, then Walmart–which is both the country’s largest employer and a company that pays only a little more than minimum wage–will see greater demand for its products. If retailers like Walmart are doing more business, then they will hire more workers, decreasing unemployment.

In Prof. Vazquez-Cognet’s lectures, he demonstrated that raising the price floor for labor would increase the supply of labor while decreasing demand, thereby increasing unemployment and reducing total surplus. But there is no evidence that the current minimum wage is the equilibrium price for low-skilled labor. In fact, because so few workers actually earn the minimum wage (in 2011, about 5% of those workers who are paid by the hour), there is good evidence that it is below the actual equilibrium point. The percentage of workers earning the federal minimum wage has declined considerably over the past few decades, from 15% in the high-unemployment years of the early 1980s, to a low of 2% in 2006.

If the equilibrium point is the “going rate” for labor, then the equilibrium is almost certainly higher than $7.25/hr. And if that’s true, then raising the minimum wage will increase the total social surplus in dollar terms (even though it may decrease the surplus that some employers gain from their workers’ labor).

That’s the best argument I can muster, but to be honest, even I’m not completely convinced that raising the minimum wage will decrease unemployment.

I am, however, convinced that raising the minimum wage will improve the American economy and society. It will even increase the government’s tax revenue while decreasing its payouts to poverty-relief programs, helping to reduce the federal deficit.

Pres. Obama framed his argument for raising the minimum wage in moral terms: “a family with two kids that earns the minimum wage still lives below the poverty line. That’s wrong.” It’s hard to quantify the social utility of justice, but Pres. Obama thinks that we will have a better society if fewer working people are in poverty. I think he’s right. Raising the minimum wage to $9 will do a little bit to narrow the huge, and growing, earnings gap between the bottom 10% of earners and the median earner, not to mention the gap between the bottom 10% and the top 10%. Without broadly shared prosperity, we cannot call ourselves a good society.

Finally, even though Republicans like John Boehner oppose a higher price floor for labor, the increase could end up giving him his party’s greatest wish: greater federal revenue without tax increases, coupled with a reduction in federal aid programs.

That family earning minimum wage is eligible for tax credits and public assistance. If they are earning more, then they will depend less on government programs like food stamps and the Earned Income Tax Credit. Government will get more tax revenue and pay out less. Paradoxically, it may take the visible hand of government intervention, pushing employers to pay their lowest-paid workers a little more, to reduce those workers’ dependence on government assistance.