By Adam Nowakowski
One of the main arguments against raising the minimum wage is that it might cause the price of goods and services to increase. If the minimum wage is increased, will every dollar you earn buy less?
Let’s start with the relationship between wage inflation and price inflation. The Federal Reserve Bank of Cleveland published an often cited paper in the year 2000, here is what they found:
“It turns out that the vast majority of the published evidence suggests that there is little reason to believe that wage inflation causes price inflation. In fact, it is more often found that price inflation causes wage inflation. Our recent research, which updates and expands on the current literature, also provides little support for the view that wage gains cause inflation."
Why is this the case? Here is an explanation from the same paper:
“First, if a wage increase is brought about by increased labor productivity, it will not create inflationary pressure. Second, a wage increase will not create inflationary pressure if it leads to a squeeze in profits because a firm cannot pass along cost increases. No firm inherits the right to simply “mark-up” the prices of its output as a constant proportion above its costs; competitive market pressures strongly influence the pricing decisions of firms. Finally, causation could work in the opposite direction: An increase in aggregate demand may permit firms to raise the price of their products, and the resulting increase in profits would lead workers to demand higher wages in future negotiations.”
The emphasis is mine. In general, we can say that wage inflation has a minimal impact on price inflation, but we are interested in a slightly different question. A minimum wage is a government intervention into the labor market that increases the cost of labor. The question is, will the resulting across-the-board increase in labor costs be passed on to customers via price increases? In 2013, Sara Lemos did a study that looked at current research on the price effects of minimum wage increases. Here is what she found:
"Despite the different methodologies, data periods and data sources, most studies reviewed above found that a 10% US minimum wage increase raises food prices by no more than 4% and overall prices by no more than 0.4%"
Lemos’ results are consistent with other analyses of the price effects. As John Schmitt noted in his 2013 paper on the employment effects of minimum wage laws (see my summary here), David Neumark and William Washer’s assessment found similar results:
"Both because of the relatively small share of production costs accounted for by minimum wage labor and because of the limited spillovers from a minimum wage increase to wages of other workers, the effect of a minimum wage increase on the overall price level is likely to be small."
Also from Schmitt’s paper:
“Other recent research by Daniel Aaronson, Eric French, and James MacDonald on restaurant pricing, a sector with a high share of low-wage workers suggests that the price effects are likely to be lower than the upper bounds suggested by Lemos. Aaronson, French, and MacDonald "find that a 10 percent increase in the minimum wage increases prices by roughly 0.7 percent."
The evidence shows that an increase in the minimum wage will have some impact on price inflation, but it will be minimal. Sara Lemos' conclusion:
"[t]he main policy recommendation deriving from such findings is that policy makers can use the minimum wage to increase the wages of the poor, without destroying too many jobs or causing too much inflation."
Let’s start with the relationship between wage inflation and price inflation. The Federal Reserve Bank of Cleveland published an often cited paper in the year 2000, here is what they found:
“It turns out that the vast majority of the published evidence suggests that there is little reason to believe that wage inflation causes price inflation. In fact, it is more often found that price inflation causes wage inflation. Our recent research, which updates and expands on the current literature, also provides little support for the view that wage gains cause inflation."
Why is this the case? Here is an explanation from the same paper:
“First, if a wage increase is brought about by increased labor productivity, it will not create inflationary pressure. Second, a wage increase will not create inflationary pressure if it leads to a squeeze in profits because a firm cannot pass along cost increases. No firm inherits the right to simply “mark-up” the prices of its output as a constant proportion above its costs; competitive market pressures strongly influence the pricing decisions of firms. Finally, causation could work in the opposite direction: An increase in aggregate demand may permit firms to raise the price of their products, and the resulting increase in profits would lead workers to demand higher wages in future negotiations.”
The emphasis is mine. In general, we can say that wage inflation has a minimal impact on price inflation, but we are interested in a slightly different question. A minimum wage is a government intervention into the labor market that increases the cost of labor. The question is, will the resulting across-the-board increase in labor costs be passed on to customers via price increases? In 2013, Sara Lemos did a study that looked at current research on the price effects of minimum wage increases. Here is what she found:
"Despite the different methodologies, data periods and data sources, most studies reviewed above found that a 10% US minimum wage increase raises food prices by no more than 4% and overall prices by no more than 0.4%"
Lemos’ results are consistent with other analyses of the price effects. As John Schmitt noted in his 2013 paper on the employment effects of minimum wage laws (see my summary here), David Neumark and William Washer’s assessment found similar results:
"Both because of the relatively small share of production costs accounted for by minimum wage labor and because of the limited spillovers from a minimum wage increase to wages of other workers, the effect of a minimum wage increase on the overall price level is likely to be small."
Also from Schmitt’s paper:
“Other recent research by Daniel Aaronson, Eric French, and James MacDonald on restaurant pricing, a sector with a high share of low-wage workers suggests that the price effects are likely to be lower than the upper bounds suggested by Lemos. Aaronson, French, and MacDonald "find that a 10 percent increase in the minimum wage increases prices by roughly 0.7 percent."
The evidence shows that an increase in the minimum wage will have some impact on price inflation, but it will be minimal. Sara Lemos' conclusion:
"[t]he main policy recommendation deriving from such findings is that policy makers can use the minimum wage to increase the wages of the poor, without destroying too many jobs or causing too much inflation."