The Reluctant Case for Indexing the Minimum Wage to Inflation

by Reihan Salam

Last February, Megan McArdle made a strong case against indexing the minimum wage to inflation:

Inflation allows you to lower the real value of peoples’ wages by just not giving them a raise, while not triggering the complex emotion response that a pay cut engenders.  

So what happens if you make the minimum wage rise in line with inflation?  

Well, you’ve taken away a key adjustment mechanism.  Now productivity losses have to be experienced as either shrinking profits, or unemployment.  But while corporate profits are up in general, fast food franchise owners are not generally sitting at home watching the checks roll in.  Margins for most franchise owners aren’t that great, though I believe that McDonalds franchises are still a license to print money . . . if one could print money by spending hours every day personally ensuring that the toilets are spotless and the rest dealing with misplaced purchase orders and sullen teenagers.

And this effect would probably percolate up the food chain somewhat.  Companies near the minimum wage may want to maintain the gap between their employees’ wages and the legal minimum, in order to ensure that they get better workers.  So as those wages increase, near-minimum wages will also have to.  

Would we see a sharp spike in the unemployment rate?  Unlikely.  Even if 10% of minimum wage workers were laid off, that would be a fraction of 1% of the overall job market.  

But I would expect to see higher unemployment among young and low-skilled workers during recessions, when employers are facing a lot of pressure on their margins.  If your sales fall by 30%, so does the output of each worker.  So that overall, monetary policy would become at least slightly less effective at managing the employment declines during recession.

Despite Megan’s argument, I suspect that the ineptitude of Republican lawmakers in combating the new push for an increase in the federal minimum wage has led us to the point where indexing the minimum wage to inflation is the least bad option. Yuval Levin has observed that had the last federal minimum wage increase (to $7.25) been indexed to inflation in 2009, when it went into effect, it would now be $7.85. Had it been indexed to inflation when it was enacted, in 2007, it would now be $8.15. As Megan suggests, this higher federal minimum wage would likely have meant somewhat higher unemployment in recent years among young and less-skilled workers, which is saying rather a lot. But if the alternative is that we have successive rounds during which Congress bids up the minimum wage higher and higher, with little rhyme or reason, indexing might be a feasible fallback position, particularly if carve-outs can be secured for the long-term unemployed and other groups that might otherwise be harmed.

In the first decades of Social Security, benefit adjustments were not automatic. Automatic benefit increases have only been in place since 1975, and President Nixon signed them into law in 1972. The first benefit adjustment, in 1950, proved as popular as you might expect, and Congress found the idea of passing these increases difficult to resist as the years passed. There is at least some reason to believe that automatic benefit increases might have actually helped Social Security benefits from growing at an even faster rate in deference to political imperatives. (A trusted friend recommends Kent Weaver’s 1988 book Automatic Government for a fuller account.) Perhaps something similar will prove true of the federal minimum wage.

And though Mitt Romney didn’t campaign on the minimum wage in 2012, it is worth noting that the former Massachusetts governor endorsed indexing the minimum wage to inflation.

The Agenda

NRO’s domestic-policy blog, by Reihan Salam.