My fellow Economy Lab contributor Armine Yalnizyan applauds a Barack Obama proposal to increase the minimum wage, as it would "bolster the economy" by providing economic stimulus. She concludes by proposing an increase to Ontario's minimum wage to $11.50 an hour from the current $10.25 – and indexing it to inflation thereafter. I believe the dual proposal of the minimum wage as economic stimulus and tying the minimum wage to inflation is contradictory; at least one of these ideas should be abandoned.
The "raise the minimum wage" argument made by Ms. Yalnizyan and Barack Obama is one of a short-term boost to the economy. Long-run economic growth requires an increase in productivity and there is no obvious link between minimum wages and productivity levels. Instead, the argument for increasing the minimum wage is one of Keynesian stimulus, of returning the economy to full employment after a recession. Moderating the business cycle is beneficial, so such a policy should not be dismissed out of hand because it does not increase long-run economic growth.
The minimum wage as stimulus argument requires two things. First, it requires that those receiving the minimum wage will be more likely to spend it (and spend it faster) than the company paying the minimum wage. It is true that poorer people spend a higher proportion of their income, but the minimum wage correlates poorly with poverty. It then also requires the consumption effect to be larger than the negative effect to employment caused by a minimum-wage hike. If this labour effect is large enough, a minimum-wage hike would cause an immediate reduction in economic activity.
If the minimum wage is going to be used as a tool to smooth out the business cycle, it should both rise during a recession and fall during an economic boom. If the Ontario minimum wage should be increased to $11.50 from $10.25 because our economy is slow, should it then not return to $10.25 when the economy fully recovers? If our economy overheats, are we prepared to cut the Ontario minimum wage to $9 an hour? If not, why not?
True Keynesian economics requires those tax, spending and employment policies to be altered, both upward and downward, as the state of the economy changes. This does not just apply to the minimum wage; those arguing for tax cuts on purely stimulative grounds need to be asked if they are prepared to have higher tax rates during economic booms. If they are not, then they are not asking for Keynesian stimulus, they are asking for a tax cut for other reasons.
Ms. Yalnizyan ends by suggesting that the minimum wage be tied to the rate of inflation. This is contradictory to the argument that the minimum wage be used as a form of Keynesian stimulus. The rate of inflation is procyclical – it typically rises in economic booms and falls in periods of economic weakness. Since the rate of inflation falls during a recession, so, too, would the rate of increase of the minimum wage – which is exactly the opposite of Keynesian stimulus.
Mike Moffatt is an assistant professor in the Business, Economics and Public Policy group at the Richard Ivey School of Business, University of Western Ontario.