Being told that your hourly wage will be freely raised would undoubtedly be met with unanimous approval. Likewise, two-thirds of Americans - and more than 40% Republicans – favour Joe Biden’s proposal to more than double the federal minimum wage from $7.25 to $15 an hour. Biden plans to phase in the new minimum over 4 years, allowing time for firms to adjust, consequently increasing median pay over time.  

Unfortunately, economists are less enthusiastic about his new policy. When asked whether it would result in a substantial blow to unemployment, 40% were undecided and the rest evenly split. This is largely due to little experience in large minimum wage rises.  The increase to $15 an hour is more than what 30% of workers were paid nationwide in 2019 and is feared to cause large-scale unemployment as firms fail to absorb the increased cost.  

The simplest of minimum wage theories is the Keynesian argument. It advocates that higher wage rates will increase disposable incomes of lower-paid workers, who have a high propensity to consume. Subsequently, the multiplier effect will be magnified as increased spending feeds through the circular flow of income. In the long-term, it may support the creation of better paying jobs in high-productivity cities, prompting larger-scale migration as displaced workers seek better opportunities. However, behavioural theory is rarely as straightforward, particularly when economists are evenly split on the correct solution. 

The modern minimum wage controversy has become acknowledged as a test of the applicability of neoclassical price theory: which domains the theory can be said to properly apply to. In Neoclassical Theory, mandated minimum wages are considered equivalent to any other price floor. Two assumptions are made:  

Firms maximise profits 

The low-skilled labour market is competitive, i.e., the firms have no monopsony power 

If the mandated wage was less than the market-clearing wage at equilibrium, firms would reduce the quantity of workers demanded, given a downward sloping labour demand curve. The magnitude of reduction is dependent on the wage increase and the wage elasticity of labour demand. Consequently, some workers receive higher wages and are better off, whereas others with work worth less than the new minimum are laid off or work fewer hours. The wage gains of those still employed are traded off against wage losses of the newly unemployed. 

Nonetheless, firms may have more scope to absorb the extra cost than expected. The match between a job and worker creates a surplus divided between the employee and employer, the proportion dependent on the bargaining powers of each faction. Minimum wage regulations may help workers capture more of the surplus, as there is little associated employment cost of higher pay from profits.  

Withal, the scope for firms to adjust is not infinite. The current minimum wages differ widely between states: the proposed wage would be double that of 21 states, 80% in 28 states and 100% of current minimum wage in Mississippi. The four-year procedure may outstrip firms’ capacity to absorb high labour costs or raise prices without unemployment. 

So rapid before 1980, convergence in incomes between poor and rich states have slowed dramatically since and the productivity gap between ‘superstar cities’ have widened. The Federal minimum wage, adjusted for inflation, rose steadily between 1930 to 1960 and stagnated and declined after. The thereafter low minimum wage enabled firms to rely on pockets of skill labour, barely efficient and disincentivised to invest in modern materials and processes. Like a catalyst, the imposition of Biden’s $15 minimum wage could pressurise these inefficient ‘zombie firms’ to collapse and make way for innovative, new businesses, or incentivise low-efficiency firms to increase investment and greater benefit the economy.  

Offering a free hourly wage raise to 1.6 million Americans comes with its costs, as well as its benefits. But the benefits are great indeed. The most crucial dilemma now is how to minimise its costs and adverse side-effects. The current minimum wages widely differ between states: the proposed wage would be double that of 21 states, 80% in 28 states and 100% of current minimum wage in Mississippi. The four-year procedure may outstrip firms’ capacity to absorb high labour costs or raise prices without unemployment. It may be advisable to extend the time period for the programme, or decrease the magnitude of the minimum wage increase, for example, to $10.