×

Wage growth highest since Great Recession — the minimum wage factor

It's not just the least-paid workers who will be seeing higher incomes after the latest round of minimum wage hikes.

More than a dozen cities and states raised wages this year, and those higher pay floors should also cause a ripple of extra earnings for people making as much as 20 percent more than the minimum, according to economists. For states like New York and California, which will increase wages to $15 an hour over the next few years, those benefits will extend to people making $18 an hour, according to some estimates.

Indeed, in the June jobs report released Friday, wage growth hit 2.6 percent for the past year, the highest level since the Great Recession. What's more, the data showed that 287,000 jobs were added in June, far exceeding analysts' expectations. Even if future job growth should slow, some believe that is still good for wages.

Wage increases above the minimum wage are believed to be a response to what economists call "wage compression," which occurs when more senior employees are no longer better compensated than less senior employees.

Say you worked at a fast food restaurant in Washington, D.C., at the old local minimum of $10.50. On July 1, your hourly wage increased to $11.50. That's great news for you, but the shift manager getting paid $12 an hour may not be overjoyed about your sudden good fortune.

In the old economic models, the workers don't care what the employees next to them are making, said John Schmitt, research director at the Washington Center for Equitable Growth. But in reality, we compare our pay to the pay of the people around us.

"We know, however, from extensive experience and reflection on our own lives that if somebody who just finished high school and has no experience is making the same amount as someone with more experience, you have a real-world problem recruiting and retaining people and motivating them to work," he said.

Compressing lower wages

To avoid serious morale and hiring problems, companies will often adjust their compensation structure relative to the new minimum, giving raises to employees who earn just above the new minimum. Of course, those raises may not be proportional, and the effect seems to die off somewhere in the lower half of wage earners.

"The thing about the ripple effect raises is that we are talking about raises that are discretionary for the employer," said Jeannette Wicks-Lim, a researcher at the Political Economy Research Institute at the University of Massachusetts Amherst. "I was surprised that the effect didn't extend further than it did, because there was a lot of talk about how employers need to preserve the wage hierarchy, but they appeared to have a lot of flexibility."

Wicks-Lim found that the average ripple effect for wage increases from 1983 to 2002 only made it up to 23 percent above the minimum wage prior to the increase. Later, she calculated that if the federal minimum wage jumped to $15, the ripple effect would extend to at least $17.50 an hour — 17 percent over the new minimum. Another study found that the 1998-2001 San Francisco wage increase affected airport workers at 40 percent over the new minimum.

According to other recent estimates, the effect falls off as we move up the wage scale, and tends to fade out around the 25th percentile.

Overall, only about 3 percent of workers are paid minimum wage, according to an analysis by the Brookings Institute. But nearly 30 percent of workers make less than 1.5 times the minimum wage. By that rough calculation, about 35 million workers could see raises if the minimum increased.

The minimum wage does more than simply shift the wage distribution toward higher pay — it effectively compresses the lowest wages. The end result is a reduction in wage inequality below the median wage — a little under $30,000 for individuals.

Higher earners and companies keep earning

When interviewed by economists, employers often say that a wage hike would cause them to "delay or limit pay raises/bonuses for more experienced employees." But in practice economic data generally show little impact on the wages of the highest-paid employees.

"I think it's reasonable to assume there will be some level of spillover for low-wage workers, less so for middle-wage workers and no spillover at all for high-wage workers," said Schmitt.

Yet the higher wages will put a bigger burden on employers. According to Wicks-Lim's calculations, the combination of mandated wage hikes and the ripple effect would cost about $31 billion in additional wages each year for the fast food industry alone, or 14 percent of industry revenue. Overall, ripple effects more than double the wage costs for employers across all industries.

If wages are going up for millions of workers, the money has to come from somewhere. Economists debate the extent to which companies respond by cutting jobs, but research suggests that many employers find other ways to defray those costs.

"The basic law of demand in economics is clear that raising the price of anything will reduce demand for that thing, all else equal," Wicks-Lim and her co-author wrote in a recent paper. "Since nobody has proposed repealing this basic law of demand, it follows that, for an increase in the minimum wage to not generate employment losses for low-wage workers, it is necessary that the 'all else equal' provision of the law has to be relaxed through some possible set of channels."

It is possible that employers adjust by taking advantage of higher productivity and less turnover. A 2013 study found that for every 10 percent increase in the minimum wage, turnover rates for fast food workers decline by more than 2 percent.

A wage hike reduces inequality in the short term, but it can also help set the tone for how the United States views its wage distribution overall, said Schmitt.

"Wage differentials are not set in stone," he said. "The gap between high-, middle- and low-wage workers has been a lot lower than it is now, and the economy worked just fine. Social standards and expectations evolve over time, and raising the minimum wage might change people's expectations about what's a reasonable differential."