Minimum Wage Laws and Pricing: Are They Connected?

President Obama has been pushing to increase the federal minimum wage by about 39% (from $7.25 to $10.10/hour), but this has yet to come to fruition, and states are taking action on their own.  On 1 January 2014, 12 states raised their minimum wages, making 21 states in total that have a minimum wage above the federal rate.  Proponents of a wage increase say that it will be good for the economy, as it won’t cause minimum wage workers to lose their jobs, but instead these workers will now have more money to spend on essential items.  Most workers earning minimum wage are living paycheck to paycheck and it can be assumed that the extra income they receive will not be saved but rather spent on goods and services in their local economies.  For this article, I will put politics aside as the main focus here is the effect of this increase in minimum wage rates on pricing.

Could Minimum Wage Increases Lead to Inflation?

The nonpartisan Economic Policy Institute predicts that the new state-level minimum wage increases will lead to an added $619 million dollars in new economic activity and create around 4,600 new full-time jobs¹.  Could this new money and job creation cause inflation?

As displayed in the Short-Run Philips Curve, as unemployment falls, inflation rises.  We observe this inverse relationship between inflation and unemployment because as more people find work, more money is going to be circulating throughout the economy.  More money in the economy leads us to inflation—read: higher prices.  In the case of increasing the minimum wage law, the logic is the same: more money being spent results in higher prices in the short run.  The workers earning minimum wage will likely spend all of their new income, as low-wage earners typically do have to live paycheck to paycheck.  These people will most likely be using their extra wages to buy more groceries and clothing, more necessities.

However, the increases that go into effect this month are rather small (none so large as the hike proposed by President Obama), and it doesn’t seem likely that this extra income will have a serious impact on the inflation rate.

Will the Increased Cost of Labor Be Passed on to Consumers?

Opponents of increasing the minimum wage law have pointed out that in order to compensate for increased wages, employers will raise the prices of their goods and services.  Not all employers can lay off workers or cut back on employee hours, and therefore could need to make up the cost difference through increased pricing.  We could potentially see higher prices in industries that traditionally hire a lot of minimum-wage employees, such as fast food and retail.  These employers do not want their business to suffer by offering less customer service, so instead they will keep their employees hours consistent and use a price hike to pass these new costs on to consumers.

Roughly 5% of the U.S. workforce earns the minimum wage or lower, and therefore these hourly pay rate increases are not actually going to have an impact on the majority of workers in the states implementing new wage laws in 2014.

How much will the new wages really cost employers and will it be enough to lead to price increases?  That is hard to say, but seeing as the workers most impacted by these higher wages will likely be spending their new earnings in the type of business in which they are employed, food and retail, the employers paying out more might actually gain from this new economic activity.

Could the 2014 Minimum Wage Increases Have a Significant Impact on Prices?

I highly doubt it.  The workers impacted the most by these new laws will yes, most likely be spending all of the extra income they earn as a result of higher wages, but the wage increases are so small that this new spending doesn’t seem like enough to cause any significant price increases.

As an undergrad, I worked a retail position and earned minimum wage.  During my employment with this retail company, the state minimum wage was raised from $5.15 to $7.25, this was a pretty significant increase, as I had been working about 20 hours per week at the $5.15 rate, I was looking at around a 40% increase in my paychecks.  Unfortunately, to cover the new labor costs, I started getting scheduled less hours so my paychecks were roughly the same as they had been before the minimum wage was raised.  I cannot say that all companies will do this but it seems like a feasible option if the new wage rates end up costing employers too much.