Written by Ryan Erickson
One proposed element of the American Rescue Plan Act from March 2021 was raising the federal minimum wage from $7.25 to $15 per hour by 2025. The provision ultimately was not allowed in the reconciliation process used to pass the act. Notably, Republican senators Mitt Romney and Tom Cotton countered the $15 proposal with one aiming to raise the minimum wage to $10 by 2025, combined with required use of E-Verify that screens the legality of employees (The Hill, 2021). Thus, while the two proposals differed, this effort showed bipartisan support to raise the federal minimum from $7.25. For context, most Americans already have a minimum wage greater than $7.25 because they live in one of the 30 states with an elevated state minimum wage (U.S. Department of Labor, 2021). Raising the federal minimum would most affect states in the Deep South and the Great Plains, whose minimum wage remains at the federal level of $7.25.
Jimmy Hefter wrote an overall critique of a $15 federal minimum wage in a previous MJE article. He mentions “every state would have to match this price [the federal level]” (Hefter, 2020). He then remarks that employment would go down significantly, hurting the people the policy intends to help, and businesses may also increase prices to absorb these costs (Hefter, 2020). The model used in Hefter’s article for the labor market is supply-and-demand. Although this is the most simplistic one, its use involves many assumptions: crucially, the labor market is a competitive market with many buyers and sellers and free mobility of workers.
But what if this isn’t the case? Barriers could prevent employees from easily finding a new job. As a result, the employer would have leverage over their workers. Employers having market power over their workers, allowing them to lower wages, describes a monopsony, or single buyer, in the labor market. Anna Sokolova and Todd Sorensen recently published a large meta-analysis of over 53 studies on this subject, examining reported estimates of the labor supply elasticity facing firms. A lower elasticity, or a steeper labor supply curve, suggests monopsony. While they found noticeable discrepancies among estimates and evidence of bias against reporting of negative elasticity estimates, the “best-practice estimates” yielded a relatively low elasticity estimate of 7.1 (Sokolova and Sorensen, 2021). They found “Overall, the best-practice estimates provide strong evidence of firms possessing monopsony power”(Sokolova and Sorensen, 2021).
So how would a monopsony affect the minimum wage’s impact? The most important difference to understand is that employee vacancies can occur when firms have monopsony power—a departure from supply-and-demand. Since these monopsonistic firms face an upward labor supply curve, hiring more workers requires paying a higher wage not only for the new workers but for all existing ones. This makes the marginal cost of labor higher than the wage and inefficiently employs too few workers (Bhaskar, Manning, and To, 2002). This effect would depend on how uniform a firm’s wage is across its workers: a larger wage distribution would lessen the effect. In reality, this is somewhere in between a single wage and paying workers their individual contribution.
Assuming this reasoning holds, the government implementing a minimum wage higher than the market wage would fill these vacancies and could increase employment overall (Bhaskar, Manning, and To, 2002). Here the marginal cost of labor for firms is now the minimum wage up to the quantity of labor on the firm’s labor supply curve associated with the minimum wage. But there is a catch here. As Hefter focused on in his article, this is an increased cost for businesses and, all other things being equal, would cut into their profits.
Businesses can offset this by raising their prices. In April, Chipotle CFO Jack Hartung described a “2% to 3% price increase” from adopting a $15 minimum wage as “very manageable” (Business Insider, 2021). But he went on to remark that Chipotle was better positioned to do this than “other companies out there” (Business Insider, 2021). For some businesses, especially those earning low profits, the costs from a higher minimum wage can be prohibitive and drive them out of the market. This effect is seen in a 2019 paper about the reallocation of workers in Germany from a minimum wage. Following the introduction of a minimum wage, workers reallocate to “larger, higher paying ones [firms]” with these firms being better able to adjust for the minimum wage (Dustmann et al. 2019).
Therefore, with the two opposing effects of filling vacancies and exiting firms on employment, it is likely that the federal minimum wage can be raised to $15 with little downside.
References
Bhaskar, V., Manning, A., & To, T. (2002). Oligopsony and monopsonistic competition in labor markets. Journal of Economic Perspectives, 16(2), 155-174.
Dustmann, C., Lindner, A., Schönberg, U., Umkehrer, M., & Vom Berge, P. (2019). Reallocation effects of the minimum wage: Evidence from Germany. Unpublished manuscript. http://sarkoups.free.fr/dustmann719.pdf
Elis, N. (2021, February 23). Romney, Cotton propose $10 minimum wage plan. The Hill. https://thehill.com/policy/finance/540051-romney-cotton-propose-10-minimum-wage-plan
Hefter, J. (2020, November 14). How a $15 Minimum Wage Unintentionally Hurts the Workers It Intends to Help. Michigan Journal of Economics. https://sites.lsa.umich.edu/mje-new/2020/11/14/how-a-15-minimum-wage-unintentionally-hurts-the- works-it-intends-to-help/
Kay, G. (2021, April 22). Chipotle will raise prices if a $15 minimum wage passes. Here’s how much more a burrito could cost. Business Insider. https://www.businessinsider.com/chipotle-will-raise-burrito-prices-if-a-15-minimum-wage-passe s-2021-4
Sokolova, A., & Sorensen, T. (2021). Monopsony in labor markets: A meta-analysis. ILR Review, 74(1), 27-55.
U.S. Department of Labor. (2021, September 30). State Minimum Wage Laws. Wage and Hour Division. https://www.dol.gov/agencies/whd/minimum-wage/state