Massachusetts is debating a bill that would increase the minimum wage from $8 to $11 by 2015, and then peg future increases to inflation.The increase would be a boon to low-income workers and help reinvigorate a stagnant economy.
Critics of minimum wage increases point to the neoliberal consensus ("textbook economics"): if you increase the price of something (in this case labor) demand for that product goes down and you get less employment. In a state of equilibrium and perfect competition, this analysis is absolutely correct, the problem is, the world isn't a textbook. Anyone who has ever worked a minimum wage job knows that markets are not as fluid as economists assume. Let's look at a few "real world" situations.
The most famous study on the minimum wage comes from economists David Card and Alan Krueger, currently chairman of the Council of Economic Advisers. They compared employment at fast food chains in New Jersey and Pennsylvania before and after New Jersey raised its minimum wage from $4.25 to $5.05 an hour. They also compared employment in fast food chains with relatively high wages before the change. Their finding directly contradicts standard assumptions: "Contrary to the central prediction of the textbook model of the minimum wage … we find no evidence that the rise in New Jersey's minimum wage reduced employment at fast-food restaurants in the state."
Paul Krugman, Nobel Laureate and New York Times columnist, writes that the study has "stood up very well to repeated challenges."
Why was the conventional wisdom wrong? First, it may not be: there is some evidence that increasing the minimum wage will increase unemployment, but only slightly. But the biggest reason is that labor markets aren't as fluid as textbooks report them to be. Wages should rise naturally as employers compete for workers, but often there isn't much competition; the "reserve army of unskilled labor" artificially pushes down on wages. Now, there is certainly a point where the minimum wage will start to really press hard on unemployment, but international comparisons (and the experience of other U.S. states) indicate that it's probably not $9.75.
Even if increasing the minimum wage did slightly increase unemployment, it may still be worth the cost: if the gains accruing to those who keep their jobs are greater than the losses to the few who lose them, then we've reached a Pareto efficiency, and the best way to go forward is to implement the policy and compensate those who lose (i.e. slight extension of jobless benefits and a worker retraining program).
The advantages to a higher minimum wage are two-fold. First, it decreases inequality by giving the working poor a leg up. In my state of Connecticut, a recent minimum wage hiked helped pull 250,000 workers from poverty. Keeping the minimum wage adjusted to inflation will help those workers stay above the poverty line in the future.
Second, it can stimulate demand and get the economy moving again. When a worker takes home another $10 a day, they can use that money to buy more food, toys and clothes, or they can use it to pay down debts. If they buy consumer goods that will lead to more employment for people who make and distribute food, toys and clothes, who then in turn spend more money (this is known as the "multiplier effect"). This increases employment and tax revenues. If they spend down their debts, that means future consumption can be higher and they are more financially secure. A plurality of economists recently polled agree that even given the risks, raising the minimum wage is a good idea. It's worth noting that the guardian of the neoliberal consensus, the Economist, has shifted toward favouring minimum wage hikes, noting that the experience of most developed countries empirically debunk the argument of free-market dogmatists. It's a win-win-win policy.