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Press Release

    Worst Time to Increase Labor Costs

    10/19/2002

    Chad Moutray is chief economist in the Office of Advocacy of the U.S. Small Business Administration. This article originally ran in the Chicago Sun-Times.

    With unemployment at 5.6 percent, the stock market stalled, consumer spending showing signs of stagnating and fear of a potential war with Iraq, there is a general unease. And although last month the Federal Reserve left interest rates unchanged, two Federal Reserve governors dissented by voting to lower interest rates to spur economic growth. We are in an uncertain economic climate. Yet some in Congress are considering a last-ditch effort to increase costs on small business by raising the minimum wage. Clearly, now is not the time for a minimum wage hike.

    A higher minimum wage will have potential negative employment implications for the demographic groups it is designed to help, and it will not be effective in reducing poverty. Proponents of an increase point to the declining real purchasing power for individuals who depend on the minimum wage to support their family. Yet, economists have long argued that increasing the minimum wage results in increased unemployment and/or reduced hiring.

    Moreover, the very individuals the minimum wage law was designed to protect--entry-level, low-skilled workers--are the most prone to losing employment when businesses are under a cost squeeze. Given the employment picture for minimum wage earners, it would be a mistake to exacerbate the problem. For instance, the Bureau of Labor Statistics reports that teenage unemployment has risen from 16.1 percent to 17.2 percent since January 2002. Overall youth employment in July, in fact, was at the lowest rate since 1971.

    Supporters of increasing the minimum wage often state that earners suffer because they must support their families in poverty. However, the U.S. Census Bureau reports that nearly two-thirds of minimum wage recipients either live with their parents or are the secondary earner in the household.

    Only 14 percent of minimum wage recipients are the sole earners in their household, and sole breadwinners qualify for the Earned Income Tax Credit. In 2000, that tax credit supplement was around $2 per hour--as much or more than many of the current proposed increases in the minimum wage. In fact, recent studies suggest that the tax credit is a better tool for reducing poverty than increases in the minimum wage and, best of all, it does not have negative side effects such as higher unemployment.

    Another argument against increasing the minimum wage would be the labor market itself. The latter 1990s produced an economic climate in which many firms paid wages exceeding the minimum because of competition for workers. In such a competitive market for laborers, the minimum wage is virtually irrelevant because market forces work without intervention. Further, firms were able to pass on those increased costs to their customers.

    The economic climate is much different today. There is not as much demand for entry-level workers, and with a weaker economic picture, consumers are more price-sensitive. Yet, other costs (such as health insurance premiums) are rising. The ability to pass along wage increases to the consumer will certainly be hampered--especially for small businesses.

    This leaves reducing the least productive workers or hiring fewer new employees as the primary option available to businesses. Thus, it is clear that any policy that threatens to increase labor costs will create more unemployment, serve to only exacerbate the problem, and weaken the overall economic situation.

    Research from the Office of Advocacy shows that small-business hiring has led us out of past recessions. Small business creates between two-thirds to three-quarters of the net new jobs in our economy and employs 48.7 percent of Illinois' private work force. Moreover, 98.3 percent of the businesses in Illinois are small businesses. In addition, the small business sector provides opportunities for the 27.2 percent of Illinois' firms that are women-owned and the 12.5 percent that are owned by minorities. Clearly, any policy shift that increases costs to this important sector will slow economic recovery and job creation.

    Our priority should be to revive the economy and create jobs--not to impose additional costs on small businesses and risk losing the jobs we already have.