The Consequences of Indexing the Minimum Wage to Average Wages in the U.S. Economy


Two consistent themes have echoed throughout the current debate over the future of the minimum wage: minimum-wage workers today have been left behind by the overall growth in wages; and, mandated wage increases are desirable because most minimum wage workers are adults and have families to support. Both of these assertions are based on simplistic views of the workforce. Neither stands up to close scrutiny, as this paper by David Macpherson and William Even demonstrates.

Have Minimum Wage Workers Been Left Behind?
In 1974 the minimum wage stood at $2.00 and equaled 45 percent of average wages in the economy. By 1993 the minimum wage had increased to $4.25 but had fallen to 35 percent of average wages. This erosion in the relative economic status of minimum wage workers has propelled the debate over minimum wages and even led to demands that the minimum be explicitly linked to other wages, rising whenever economy-wide wages increase. What this simple analysis neglects, however, are the massive changes that have taken place in the American workforce.

Over the last 20 years the baby boom generation has aged out of the entry-level workforce and moved into its prime earnings years (working to raise average wages, since age and earnings are positively associated). At the same time, American women have entered the workforce in greater numbers than ever before (working to lower average wages, since women earn less on average than men). Accounting for both of these effects is complicated by the increase in the fraction of the population with higher education (working to raise average wages) -- those with college degrees now represent 24 percent of the workforce, compared to only 15 percent twenty years ago.

This concentration of more experienced and better educated workers in their peak earnings years has skewed measurement of average wages. Since workers' earnings rise with labor force experience, especially when they have college degrees, the effect has been to raise average wages. This effect is so strong that measured average wages would have risen even if each and every wage classification in the economy had remained unchanged over the last twenty years.

Consequently, had we in 1974 linked the minimum wage to the average wage, we would have seriously over-indexed the minimum wage by 1994. This strict indexing would require a minimum wage of $5.51 today, $1.26 over its current level. Controlling for just the three factors identified above -- age, gender and education changes -- demonstrates that we would have over-indexed the minimum wage by at least 120 percent.

As attractive as indexing the minimum wage to other wages appears, this report demonstrates that simplistic comparisons between wage levels in different segments of the economy ignore not only important economic effects -- notably changes in supply and demand conditions-but that such comparisons suffer serious flaws from a failure to account for the massive changes in the characteristics of the workforce. The post-war baby boom-arguably the most significant demographic event of the 20th century-must rank first among these omissions.

Who Benefits from a Higher Minimum Wage?
Discussion of the distributional effects of the minimum wage have most often taken place in the context of the age of the workers. Recently, however, the debate has shifted to the family status of the workers. This paper provides the distribution of higher earnings from an increased minimum on these lines.

Almost one third of the added earnings from a $5.15 minimum wage would flow to workers (teen and other workers) living with their parents. Single parents would receive less than 5 percent. In contrast, single individuals without children living at home (not including those living with their parents) would receive more than 20 percent of the increased income. For every dollar of higher earnings that this minimum wage increase would bestow on single parents, $4.50 would go to single individuals and $6.80 would go to children and other workers living in their parents' home. In fact, children and other workers living with their parents would receive more than twice as much extra income as would all families dependent on a single minimum wage worker.

As Macpherson and Even show in this paper, simple comparisons between the minimum wage and other wages in the economy suffer by virtue of their simplicity. Any such comparisons must take into account the vast changes in the American workforce. We must adjust for changes in the composition of the workforce in much that same manner as we adjust for inflation. A policy which blindly indexed the minimum wage to other wages in the economy over the last two decades would have markedly over-indexed that wage.

The same data set that made it possible to understand the compositional changes in the workforce also provides the framework in which to analyze the distribution of benefits from a higher minimum wage. Although it has become fashionable to portray the minimum wage as a means of helping family heads, it is clear that few of the benefits flow to these parents, and even fewer flow to families dependent on the earnings of a single minimum wage worker.

About the Data
The data for this study are drawn from the 1974 through 1978 May Current Population Survey (CPS) and the 180 monthly CPS Outgoing Rotation Group (ORG) files for January 1979 through December 1993. An important advantage of the data sources are the large sample sizes. The approximate annual sample sizes are 40,000 for the May CPS and 180,000 for the CPS ORG files.