Increasing the minimum wage on a sporadic basis isn’t the right way to help low-income workers or the economy.
Support for a minimum wage increase is running high. What’s more is that there is strong support to tie the minimum wage to inflation, which is good news. Inflation has slowly chipped away at the value of the minimum wage since the late 1960s, so tying the minimum wage to inflation will ensure that its real value is kept constant.
Tying the minimum wage to inflation has another advantage. Currently, the minimum wage is increased sporadically and rarely, resulting in larger increases that are more harmful to employment. By tying the minimum wage to inflation, increases are smaller, regular, and predictable, and therefore less harmful.
However, tying the minimum wage directly to inflation is a bit crude. It means the minimum wage will increase every year by at least 1-2% (approximately the same rate as inflation). There are at least two situations where this could be problematic. The first is that during a recession, businesses would have to deal not only with decreasing demand and poor economic conditions, but also a rising wage. A minimum wage increase along with a recession would hurt employment above and beyond that of just a recession. On the other hand, during good times the minimum wage would still only increase by 1-2%, whereas the economy may very well be able to absorb a larger increase.
How can we design the minimum wage so that inflation doesn’t chip away at its value over time, while still giving it enough flexibility in increases to accommodate current economic conditions? The best way would be to tie the minimum wage to inflation over the business cycle instead of on an annual basis. The idea is that the minimum wage would increase during booms and would stay constant or may even decrease during busts. Over the course of a business cycle, the increases would offset the decreases enough so that the minimum wage would keep up with total inflation during that cycle. A good example of a similarly designed policy is Sweden’s balanced budget rule, which requires the government to run a budget surplus over the course of a business cycle. This allows the Swedish government to spend more than tax revenue during busts, but forces it to spend less than tax revenue during booms, so that the net result is a budget surplus.
Yet having flexibility in choosing an annual minimum wage means someone will need to decide how much it should increase or decrease. That “someone” should not include politicians. Rather, an independent board should be set up to make the annual decision. A great example of this in practice is the UK’s Low Pay Commission, an independent body that conducts research and makes the recommendation for the annual minimum wage change. This board could be set up with a mandate to tie the minimum wage to inflation over the business cycle.
Too often, great ideas are rendered less effective or even harmful as they are designed as policy. The upcoming minimum wage legislation, an important tool in the fight against rising inequality, could end becoming one of these policies. But designing it right could mean long-term success, for the betterment of low-income workers and our economy.
Azi Hussain is the Roosevelt Institute | Campus Network Senior Fellow for Economic Development. He is a junior in the School of Foreign Service at Georgetown University majoring in International Political Economy.