By Aniket Baksy,

Debates surrounding the Minimum Wage have been resurrected in the face of the 2016 US elections, where a host of historical datasets have been invoked (and in many cases, restored) to show that the gains to economic growth in the US since roughly the 1970s have benefited the upper classes alone[1]. Economic Conservatives maintain that a wage floor always depresses employment and is unjust, given that firms are effectively forced to pay wages exceeding productivity (See Image 1). Liberals maintain that a living wage is a moral necessity in an economy where inflation has cumulatively exceeded wage growth many times over the past 30-40 years, and that wage growth has been far slower than productivity growth since the 1970s (See Image 2)[2].

Given how heated the debate has become, maybe a review of the case for a wage floor is needed. This case is at best ambiguous – there are probably superior ways to achieve the same objectives that a Living Wage would, which are less distortionary.

There are two main arguments for a Living Income – first, that Private Labour Markets are developing entry barriers which future generations cannot surmount unless their families today earn a living wage, and second, in the absence of a Living Income, demand and consumption – led economic growth is likely to remain weak.

Today’s developed world labour markets have, by and large, solved the problems of matching workers to firms through institutional arrangements such as flexible hiring standards, campus placements and walk-in interviews[3]. However, the first argument above relies on two market failures which remain inherent in labour markets, with the effect of imposing entry barriers to the market. This, of course, makes the labour market an institution favouring intergenerational immobility, sharpening inequality and worsening the demand side of the entire economy.

Caption: The Simplistic Case against the minimum wage – it’s a price floor, which forces employers to pay employees more than their marginal product, and will lead to inflation and the rapid substitution of Capital for Labour.

Caption: The Simplistic Case against the minimum wage – it’s a price floor, which forces employers to pay employees more than their marginal product, and will lead to inflation and the rapid substitution of Capital for Labour.

The first factor is discrimination in hiring. Despite what many would suggest, racial discrimination in hiring and gender-based wage differentials are realities, even after controlling for qualifications, work effort, time spent in office, or even choices made in the workplace[4]. This implies the exclusion of otherwise talented individuals on grounds which sound economic prudence would not consider a factor in hiring, and furthers historical discrimination against these groups, which are usually already disadvantaged. The second factor is the rising cost of acquiring human capital. This is driven both by the rapidly rising costs of education[5] and healthcare, and also by the need for the average worker to accumulate, on average, an even higher level of human capital than his/her predecessors due to technical progress. In addition, asymmetric information problems in hiring for high-paying jobs (where firms have less information about a candidate’s aptitude than the candidate) mean that candidates are required to invest in signals of capability – typically, an education from a Top School – which makes them even more expensive, given an already inelastic demand for an Ivy League Education.

Both of these factors make access to the “privileged” labour market a bigger challenge than ever before. Workers on the current minimum wage, even after accounting for benefits and social security, still struggle to afford the basic necessities of modern life. Even typical American families struggle to send children to college. Among racial minorities and weaker sections, it’s even worse – even if the necessary entry barriers are crossed, idiosyncratic preferences in the marketplace tend to exclude them from entering the labour market, which lowers their capacity to allow the next generation access to the same Labour Market[6]. A Living Income is quite clearly necessary – earning a living wage will reduce the opportunity cost of education, and free up resources, allowing future generations to accumulate enough education to enter the market.

Second and less discussed but intuitively more recognised, the absence of a living wage has allowed stagnation in nominal wages, which has translated to the slow erosion of purchasing power among large parts of the American populace[7]. The result is a slowdown in consumer sentiment and a fall in the propensity to spend of the population overall, which theory suggests will reduce the pace of growth a given level of investment can sustain[8]. However, a growth slowdown will further reduce the availability of jobs. In a sense, a low initial wage rate can trap an economy in a cycle of rising inequality, where weak demand owing to low purchasing power causes persistent unemployment and therefore further depresses wages, purchasing power and demand. A hike in incomes to living income levels can be interpreted as a shock to this sub-optimal equilibrium, forcing the economy to a higher growth path eventually – this is probably what explains Australia’s vibrant labour market with high wages and (relatively) low unemployment but controlled inflation[9].

The above “Progressive” argument is logically correct. However, note that nothing in the above requires a rise in Wages to living income levels – all it requires is an expansion of the net income a household receives. The minimum wage debate is much more complex, owing to employment effects. The elasticity of labour demand fluctuates unpredictably with a number of other stochastic processes including technical progress, immigration policy and government policy fluctuations. It is true that American workers probably face a high elasticity – after all, unionisation is low relative to other major economies and if “improved” technologies begin displacing workers, there is a chance they will begin to unionise in the US.

In an economy where rapid technical change is a reality, the elasticity of labour demand is likely to rise even further, and faster, as technology achieves near-human competence in a number of occupations[10]. As a result, imposing an arbitrary wage floor could cause unprecedented unemployment. This means that a minimum wage increase will be accompanied, almost certainly, with a decline in private sector employment or at the very least, a lower rate of job growth.

In such an economy, alternatives to a minimum wage will need to be found to ensure a living income for all – fortunately, these aren’t hard to find. A wage subsidy paid to firms which pay their employees the living wage would not involve significant administrative or

monitoring hurdles a minimum wage would. A large expansion of the negative income tax created by the earned income tax credit system in the US would raise incomes without work disincentives or affecting costs to employers[11]. A program of subsidised tr

The Simplistic Case for a minimum wage – it’s morally reprehensible that the worker-CEO pay gap has increased so far and so fast, the current minimum wage doesn’t allow one to afford essentials of life or education, and because other nations enjoy a higher minimum wage and a lower rate of unemployment, the US would be better off with a living wage.

The Simplistic Case for a minimum wage – it’s morally reprehensible that the worker-CEO pay gap has increased so far and so fast, the current minimum wage doesn’t allow one to afford essentials of life or education, and because other nations enjoy a higher minimum wage and a lower rate of unemployment, the US would be better off with a living wage.

aining, or even a move to formalise and recognise free or cheap MOOC[12] qualifications as valid job market credentials would drastically lower entry barriers to the privileged labour market. A massive expansionary fiscal policy[13] mechanism based on temporary employment guarantees for the frictionally unemployed, in employment-intensive sectors – most crucially, public infrastructure[14] – could impose, without much distortion, an effective minimum bound on wages, helping in their rise. Evidence to this effect is available from the positive effects on rural labour wages the MGNREGA programme in India has had. Coupling such a programme with massive expansions of public health and education infrastructure – for example, by training the unemployed to work in schools while on the wait for jobs – can further reduce the cost of human capital accumulation for those at the bottom. If we accept the notion that private sector job loss can be made up, at least partially, through state employment initiatives – and this is eminently possible, given that major developing economies have functioning public job guarantees available – then virtually no objection can be raised to a living wage.

Overall, the case for a living income is clear-cut on positive grounds, as well as on normative and moral grounds. An entitled minority in the US, vocal on social media, insists that poverty is the result of “laziness” and that those who are poor should just “go to college and get a job.” This argument ignores the imperfections in the labour market we’ve discussed above, and shouldn’t be taken seriously – sufficient research suggests that initial circumstances, ranging from parental income to the neighbourhood where one was raised are strong determinants of future prospects. And yet, the liberal case for an excessively liberal minimum wage – one that exceeds 60% of the current median income in some cities in the US[15] – isn’t as clear as might be thought, especially when one considers the less distortionary measures one possesses to raise net incomes. Expanding fiscal policy in the US is always a matter of some concern – rarely does there exist bipartisan support for such moves, and yet few superior alternatives exist when trying to ensure an inclusive economy that lives up to the American dream.

The writer is pursuing BA Hons Economics, St Stephen’s College; Inlaks Scholar, Starting a MSc. Economics from LSE in September


[1] It is disputable exactly how the average “Middle Class” US citizen has been affected by the onset of neoliberalism – socioeconomic and technological changes since then mean that the median US household has shrunk in size and has enjoyed a significant improvement in the quality of products available, rendering traditional Consumer Price Index – based inflation correction meaningless. While sufficient evidence suggests that wages have stagnated (for example:, there’s also evidence that correcting for product quality and household size tells the opposite story.


[2] Complete arguments to this end are available on populist websites, such as the following:

Case Against a Hike:

Cases For a Hike:

A good summary of the arguments for and against the Minimum Wage is available from The Economist’s Topics Index Page on the Minimum Wage, at

[3] In underdeveloped economies, these institutions needn’t be central problems – rather, labour markets tend to be informal and plagued by multiple-equilibria problems related to nutrition, imperfect enforcement and contractibility, short-term contracts, the absence of institutions like insurance and the like. These are probably more severe in some sense than the problems discussed here.

[4] On the question of Racism, the classic Study remains Bertrand and Mullainathan’s 2003 work ( which sent virtually indistinguishable resumes differing only in the race suggested by the candidate’s name to firms in Boston and Chicago, and observed nearly 50% more call-backs for Whites than for Blacks. A similar study in India showed similar results for Caste discrimination (

[5] A consistent data series which chronicles rises in the cost of college in the US since 1974-5 is available from the CollegeBoard’s website here:

[6] Discussions of the difficulties ordinary Americans face in acquiring human capital are available in Joseph Stiglitz’s The Price of Inequality (2012) and Raghuram Rajan’s Fault Lines (2010).


[8] Additionally, the debt overhang of nearly a decade of debts accumulated at near negligible interest rates can no longer be refinanced by home equity, which implies that US households will now be required to spend within their means for prolonged periods to reduce this debt, which stood at USD 11.85 Trillion. Of this, about 10% is Student Loan Debt. This is likely to be a further cause for slow consumer spending growth.

[9] As of July 2015, Australian Unemployment was at 6.3%, while inflation was at 1.5% in Q2 2015. The Australian minimum wage (AUD 17.29) is equivalent to USD 12.75 at current exchange rates.

[10] A particular study doing the rounds of late argues that up to 47% of all jobs in the US could be replaced by computers by 2020. See However, the essence of this argument is also available in Piketty’s 2014 article on top income shares ( Piketty argues that technical progress will increase the elasticity of substitution between labour and capital, making it easier to substitute capital for labour.

[11] This is a solution Warren Buffet proposes (

[12] Massive Open Online Courses.

[13] If the Economy faces a recession, an easy way to escape this would be to generate a selectively lose monetary policy, wherein the State is able to monetise its deficit at artificially low interest rates.

[14] The Poor State of US Infrastructure is well-known (




Posted by The Indian Economist