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What Goes Down When Minimum Wages Go Up

August 1, 1998
Related Topics: Compensation Design and Communication, Wages and Hours, Featured Article
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October 1, 1996 was an eventful day. Not only did Teamsters chief Ron Carey file a $30 million libel suit against James P. Hoffa, but New Hampshire Natural Heritage Inventory scientists announced they’d found New England’s oldest living tree at 562 years old. And FedEx workers debated their newly styled uniforms.

But perhaps the most widely felt news event of the day for human resources and employment professionals was the federal wage increase which jumped from $4.25 to $4.75 -- the first wage jump in five years. Then, only 11 months later on September 1, 1997, federal law required employers to increase wages again 40 cents to $5.15 as the second of a two-part increase. The latest increase marked the 25th such augmentation since the minimum wage was instituted in 1938 at 25 cents an hour.

Obviously, the ten million employees who are paid minimum wages appreciated the raise. But in 1997, $5.15 was still half of the country’s average hourly wage according to the U.S. Labor Department. That’s why arguments abound among politicians, employers and employees nationwide about minimum wage not being a living wage. Yet, “if you look at the hearings up on Capitol Hill, the average employer or employer groups resist increases in minimum wage because they say they can’t afford to pay a higher rate,” says Douglas McCabe, a professor at Georgetown University School of Business in Washington, D.C. who specializes in human resources issues.

But what real effects, if any, has the recent two-step wage hike had on employers’ HR practices? A new framework puts a fresh perspective on the issue.

Study suggests four effects.
A new study by the Washington D.C.-based Economic Policy Institute (EPI) reveals several effects created by the minimum wage hikes. The EPI is a nonprofit, nonpartisan think tank that produces research on the economy. The organization was founded in 1986 by economic policy experts, including Lester Thurow and Robert Reich. According to their survey, “Making Work Pay: The Impact of the 1996-97 Minimum Wage Increase,” there are four usual effects on employers and HR practices when a mandated minimum wage increase comes down the pike.

Jared Bernstein, a labor economist with the EPI who co-authored the study with John Schmitt, says: “When the minimum wage increases, the impact typically has to be felt somewhere. Every action has a reaction in the labor market.”

Bernstein says the four most common effects on employers are: 1) changes in employment, such as cutting or adding jobs or changing the number of hours employees work; 2) changes in prices -- producers push price increases of products that are low-wage labor intensive; 3) absorption of the increase through production practices and operating more efficiently; 4) redistributing profits to wages so that profit margins fall at the expense of labor costs.

How the hikes have affected employment practices and prices.
The EPI’s research suggests that the first category -- cutting jobs or work hours -- is not the primary effect on U.S. employers. “You certainly can find cases like that,” says Bernstein, “just like you can find cases that go the other way.”

He emphasizes that EPI’s study averaged out many employer experiences, and incorporated a tremendous amount of research, including many experiments and analyses, and still found a zero effect on employment gains and losses. “Some employers had to cut back their workforces, but others had to add workers. It’s not a simple employment story, either in terms of jobs or hours,” he says. In fact, none of the company representatives interviewed for this story mentioned having to cut employees or hours.

However, several employers have had to raise their prices -- confirming the second point in EPI’s study findings. For example, John Mickle, who owns and operates two Baskin Robbins ice cream stores in Southern California, one in Costa Mesa and the other in La Mirada, says he didn’t raise prices after the recent federal wage increases in 1996 and 1997.

Yet there’s been a third hike for California employers on March 1 when the state-mandated minimum wage rose to $5.75. That means California’s minimum went from $4.25 to $5.75 in about a year and a half. “I took the hit completely the first [two] times, but this last time I raised prices,” says Mickle, who employs 11 people at minimum wage in one store and 16 in the other. “That’s how things work. If your costs go up, you’re going to have to pass some of that along to the customer. You don’t pass all of it along. But you have to pass some of it along -- that’s basically how I try to offset it.”

Confirms EPI’s Bernstein: “We saw some prices increase when the minimum was raised, but the increases tend to be small.” He points to the booming economy with its low inflation rate, even with the two last wage hikes. He adds that price increases were nil, even in markets that employ lots of low-wage workers.

One reason for the small impact is the minimum wage lags 30 percent behind its 1990 level in terms of its buying power. “So there’s room for the minimum wage to increase without putting price pressures on employers,” he explains. “It’s not that big a deal, especially in this economy, for an employer to pay $5.15 an hour. In many localities, many employers are already paying way above that.”

Ten states already had minimum wages higher than $4.75 before the federal law was changed. And the previous federal minimum wage of $4.25 had become almost irrelevant in metropolitan areas, where fast-food chains had long been paying a starting wage of $5 or more.

Other employers such as Miami-based Burger King Corp. whose workforce comprises primarily low-wage workers, aren’t affected directly by federal or state-mandated pay increases. “Basically, we pay the prevailing wage that’s competitive within the marketplace,” says Laura Parsons, director of field HR for all of Burger King’s U.S. locations. “That [wage] can vary across the country. In some markets, we have a starting paycheck of $7.00 an hour. In other markets, because of supply and demand, our wage might be lower -- it might even be minimum wage -- but in this economy, there are few places that are starting [people] at minimum wage.”

Because competition for workers in the lower wage bracket is so fierce, service-based companies like Seattle-based Starbucks Coffee Co. also starts workers at higher-than-minimum rates. In Oak Park, Illinois, for example, Starbucks workers start at $6.55 an hour.

Beyond employment changes and price increases, the other two factors that EPI’s study suggest do factor heavily into the HR arena when wages go up.

How the wage hike affected efficiency gains and redistribution of profits to wages.
Looking back to the EPI’s four-point model, efficiency gains are the third biggest effect employers experience with a minimum wage hike.

Bernstein explains that although a wage means operations are more costly, it forces employers to figure out ways to operate more efficiently and get a more productive hour of work -- for that extra 90 cents. And since the low-wage labor market is characterized by high turnover, high vacancy rates and other inefficiencies, the increased wage helps lower some of those inefficiency problems by lowering vacancy rates, turnover and training costs and seems to be one of the ways employers absorb this increase, according to EPI’s study.

And focusing on the study’s fourth point, employers often redistribute profits to pay for the hike in wages. Bernstein says this is usually a temporary shift. “It doesn’t last long because other factors kick in, particularly the efficiency gains, and also because the minimum wage is falling in real terms from the day it’s legislated,” he says.

The EPI’s findings aren’t much comfort to one employer who says the recent federal wage increase actually cost him his business. “I sold my business largely because profitability wasn’t going to be there,” says Rick “Mouse” Glenn, who owned a Lamppost Pizza parlor in Huntington Beach, California, until December. He sold it three months before the second wage hike went into effect.

Glenn says that when his payroll went up with the first federal wage hike, payroll increases came right out of profits. When your business has a close profit margin like his did, it makes for a tight race. “I would’ve needed another day of sales a month just to meet the jump in payroll costs -- and it wasn’t going to happen.”

While Glenn believes the minimum wage increase was a fair thing for workers, he maintains it was difficult for a smaller firm which had 30 workers, with 90 percent making minimum wage. “When you’re forced to give a 21 percent increase in 18 months, you’ll see a lot of small businesses fold,” he says.

On the other side of the minimum wage coin, some businesses have been relatively unaffected. “For us, the fiscal impact has been minimal,” says one human resources manager at a non-profit organization in Southern California, who wished not to be identified. Her organization employs 800 employees, and 300 to 500 temporary employees each month. Most of the temporary workers the organization employs are minimum wage earners.

However, other employers note another big effect of the minimum-wage hike -- a ripple effect on wages across the board. For example, because the lowest paid workers got a raise at Glenn’s pizza business, he had to give his higher-paid workers raises, also, to be equitable.

And while companies like Burger King already pay higher-than-minimum wages to most entry-level workers, federal or state-mandated increases cause prevailing wage rates to increase. Parsons explains: “Because if you have a minimum-wage increase to $5.50 an hour, for example, suddenly the competitive wage on the street goes up 50 cents an hour, too. So that prevailing wage goes up, which actually drives up our labor costs.” This scenario may happen again in the near future because of another proposed minimum-wage increase. But it may have global, not just national, implications.

Global profitability and competitiveness may be affected.
There’s currently talk of another hike to the federal minimum wage. Senator Ted Kennedy (D-Mass) now proposes raising the minimum wage again by more than 50 percent over the next five years, to $7.25 an hour. Many employers aren’t looking forward to giving more mandated raises, should the legislation pass. And it may even affect global competition.

“The [last] minimum wage raise didn’t affect HR practices at my organization too much, since we pay above the local average,” says Tony Bryant, HR associate at Irving Tanning Co., a producer of fine leather products based in Hartland, Maine. “However, if the minimum [wage] goes up again so soon after it was raised, I foresee problems.”

Bryant says his firm employs 600 people in a small town where it’s difficult to find applicants. Because Irving’s management team offers a higher wage, the company has an edge over other local employers. “If the minimum wage goes up a great deal, then our attractiveness goes down, and so does our ability to maintain employment levels,” adds Bryant. “We could try to maintain a relative distance from the new minimum rate, but it would make our efforts to keep benefits costs down close to impossible.” As a firm that competes globally, he also says increases in wages are costs it’s foreign competitors don’t have, putting Irving at a disadvantage.

He may be right. For example, an April 26 article in the Los Angeles Times about the apparel business says there’s been a sharp increase in the number of Southern California apparel businesses that are shifting production work to Mexico primarily because of the recent minimum wage hikes and other competitive pressures. By moving production to Mexico, firms say they can cut labor costs by at least half and save at least 35 percent in total production costs, even with the additional charges for freight, and insurance on shipments. Although many firms have scrambled to set up shops in other countries because of comparatively high American labor costs, they certainly face other barriers to profitability by doing so. But that’s a debate with no clear winners or losers.

The Economic Policy Institute’s study on the effects of the recent minimum wage hikes on HR practices seems to shed new light on an otherwise politically charged and complex issue. While some employers’ experiences may differ from the study, at least it provides a framework from which to consider the HR effects when the next minimum wage increase comes along. And it will come along. Be prepared with options.

Workforce, August 1998, Vol. 77, No. 8, pp. 54-59.

Recent Articles by Jennifer Koch

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