All Pay Raises Are Not Created Equal

All Pay Raises Are Not Created Equal

Protestors in over 100 U.S. cities gathered yesterday to call for a $15 federal minimum wage. Already this year, 14 states and several major cities, including Chicago, Oakland, San Diego, San Francisco, and Seattle, have increased their minimum wage. Meanwhile, a tighter labor market driven by stronger economic growth has led several companies, including Walmart and McDonald's, to promise wage increases for hundreds of thousands of employees.

On the surface, both scenarios look like a win for workers. But dig a little deeper and you'll find that not all pay raises are created equal. Rising wages driven by a growing economy mean more opportunity for both businesses and job seekers. But when politics is behind a pay increase, nobody wins unless someone else loses.

Some of the minimum-wage increases we have seen this year have been relatively small. For example, Washington indexes its minimum wage to a cost-of-living index, and so the minimum wage increased by only 1.6 percent. Because the increase is so small, it's unlikely to make a big difference to most workers, and it's unlikely to reduce employment much in the short term, since it may be more costly for businesses to substitute technology for labor than it is to just pay higher wages.

But not all of this year's minimum-wage increases were so mild. For example, when fully implemented, San Francisco will increase its minimum wage by $3.95, nearly a 36 percent increase. This dramatic increase has caused small businesses and local restaurants to either decrease their workforces, increase menu prices, or exit the market entirely. It's the outcome most economic research would predict: a large increase in the minimum wage reduces employment opportunities among the least skilled and reduces hiring rates.

The fact that smaller businesses have been disproportionately affected is predictable, as larger firms have the resources and flexibility to cope with a sudden increase in input costs. This also helps explain why many large businesses are vocal supporters of higher mandated minimum wages, since it eliminates their smaller competitors. Increasing inequality between small and large firms is probably not the effect minimum-wage proponents were aiming for.

Compare these cases of politically driven wage increases to what's happening with Walmart and McDonald's.

In February, Walmart announced it would increase its starting hourly wage to $9 an hour and raise the hourly wage of all current workers to $10 an hour by next year, affecting the wages of 500,000 workers. This action was voluntary and a result of real business needs. As the economy grows, competition for workers intensifies, which means Walmart must offer competitive wages or risk losing existing and potential employees to rivals. Even though Walmart has a market capitalization of $260 billion and is the largest private employer in the United States, it cannot escape competitive forces.

The same holds true for McDonald's, the nation's third-largest private employer. On April 1, McDonald's promised it would pay each of its 90,000 workers in company-owned restaurants at least $1 more than the locally mandated minimum wage. In recent years, McDonald's has struggled with low employee morale and customer dissatisfaction. Paying higher wages is one part of the company's attempt to retain and attract employees, improve service, and win back customers in the face of growing competitive threats from Chick-fil-a, Shake Shack, Chipotle, and others.

In a growing economy where market forces drive higher wages, both employers and job seekers can win. Employers see a chance to expand their business and offer higher wages to retain and attract the talent they need. As a result, opportunities for workers multiply, putting them in a position to negotiate better compensation. Unlike the acrimonious minimum-wage debates of recent years, there's no pitting business against labor. And there's none of the negative employment effects we see with the minimum wage.

For too long, the wage debate in the United States has been about taking from one side and giving to the other. That's what's bound to happen when an economy grows slowly, which has been the case in the United States for the better part of seven years. But pay is beginning to rise all over the country, not because of political pressure, but because businesses see opportunity. If our policymakers are really fans of higher wages, the best thing they can do is get out of the way.

Jared Pincin is an assistant professor of economics and Brian Brenberg is chair of the Business and Finance Program at the King's College in New York City. 

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