THE BLOG
11/27/2012 01:53 pm ET | Updated Jan 27, 2013

Minimum Wage, the Poverty Trap, and America's Imperative (Part I)

After having had the luxury this Thanksgiving of consuming liberal amounts of turkey and stuffing with our families, it is worth remembering just how lucky most of us are, or at least those of us who are over the poverty line. For the ones below it, life is truly miserable and not just because of their circumstances but because of a lack of hope on the horizon. If Groundhog Day was a horror movie, these people would be the stars.

At the heart of the poverty challenge lies the controversial concept of the minimum wage. First introduced through the Fair Labor Standards Act by FDR, the federal minimum wage has slowly risen from $0.25/hour in 1938 to $7.25/hour today. That looks impressive in nominal or absolute dollar terms but is misleading from a "real" perspective -- the wage in terms of its actual buying power in today's world. In fact, taking inflation into account, the highest minimum wage occurred in 1968, when it was the equivalent of $10.38/hour in today's dollars, which means that the real minimum wage has actually declined.

This presents three big problems.

The first has to do with consumption. Classical economics holds that a higher mandatory wage leads to higher unemployment since businesses cannot afford to hire more workers, and so a low minimum wage is desirable. That is true in theory but in practice what really determines the success of a business, and therefore its hiring capacity, is consumer demand, which accounts for 70 percent of our GDP and which depends upon the buying power of workers and, of course, their wages. The less people get paid, the less they can buy to support the very businesses that employ them. This circularity makes the correlation between wages and employment uncertain at best and macroeconomic factors like inflation and interest rates complicate the equation even more. At worst then, the negative effect on employment of a higher wage would be counter-balanced by increased business activity and likely short-lived.

The second problem is that of exploitation. Business owners often complain about how the minimum wage is simply too high for low skilled jobs and that the fair wage for any job should be determined purely by the market forces of supply and demand. That would be fine except for the reality that wages for low skilled workers are not determined by fairness but by the desire of businesses to maximize profit, and that workers are not livestock or grain whose worth should be measured solely in terms of supply and demand. In fact, it can be argued that such a wage system is particularly immoral when applied to people with low skills, since most of them have no means of improving their skillset at the wages that businesses would like to pay them and are therefore relegated to a lifetime of indentured economic servitude to their masters.

The biggest issue, however, and the real reason why the minimum wage is not only necessary but must actually be raised, is the cycle of poverty in which the majority of minimum wage earners remain stuck. Consider these facts:
  • The annual income of someone earning the federal minimum wage of $7.25/hour ($15,080) is 35 percent below the federal poverty level for a family of four ($23,050), and even at $10/hour falls short,
  • Two-thirds of all minimum wage workers have remained below this poverty line since 1959, when the federal poverty level was first established, and
  • While some states have a higher minimum wage than the federal level, 28 percent of all American workers still get paid at or below the level required to stay above the poverty line.
Taken together, these statistics show that 20 percent of America's workers do not make a living wage. This is a travesty that is not just unacceptable for an advanced society but one that will undermine our productivity, competitiveness, and economic growth for generations if it is not rectified. The real insidiousness of poverty lies not in the things that people cannot afford to buy but in the future that it destroys.

Take for instance a family of four (or even three) with one breadwinner. The only way for that family to climb out of poverty is for both spouses to work, yet these are the very people who cannot afford daycare and whose children require special attention because of the poor standard of public education in the U.S. and because of the scourges of drugs and gangs in the low income universe. Such families then have to choose between making a little additional living money at the expense of their children's education and development or giving attention to their children at the expense of a decent life. That is a choice that no American should ever have to make; and if that was not enough, the vicious cycle of working around the clock at minimum wage makes it impossible for such workers to attain higher education or advanced job skills -- the very things that can help them climb out of their hole.

This is what makes it a trap, and keeps people locked into their dead-end lives for their entirety and into the next generation.

Raising the minimum wage to enable low wage workers to rise out of their poverty will no doubt be met with resistance from business owners and likely increase unemployment in the short term as fewer people are hired at higher wages. However, as the buying power of these workers increases and expands the market for goods and services, hiring will pick up again as more workers are needed and can be profitably employed because of stronger commercial activity. Alternatively, businesses might raise their prices to keep hiring at current levels but with the economy still growing slowly, no smart business would raise them to a level that would hurt demand; and with inflation at a moderate 2.2 percent, the U.S. economy can handle a temporary uptick in prices without losing momentum. Also, the Federal Reserve has made it abundantly clear that it has no intention of pursuing a contractionary monetary policy (higher interest rates) anytime in the near future, thereby insulating wages and the economy from downward pressure.

It might seem counter-intuitive to raise the minimum wage at a time when our nation is climbing out of a recession but the reality is just the opposite. It is precisely during a time of difficulty when those who are suffering the most need to be given a leg up, not just for their own sake but for the sake of turning those citizens trapped in poverty into consumers and for motivating those who, despite working full time, are so close to the edge of financial despair that their desire to be productive, to innovate and improve their skills, or to contribute to society is bound to decline. From the construction worker who stops caring whether he has welded the beams on a building correctly to the waiter who stops worrying about whether your meal is under-cooked, inadequate wages do no one any favors even if a few more people are hired at the same crappy deal.

Looked at this way, raising the minimum wage is both a moral and practical imperative for our nation. Now that America has evaded the bullet of a Republican presidency and reelected a leader committed to fostering equality and fairness, there will never be a better opportunity to do this.

In Part II of this blog, I will discuss the prevailing attitudes about poverty and how it impacts the minimum wage debate.

SANJAY SANGHOEE has worked at leading investment banks and at a multi-billion dollar hedge fund. He has an MBA from Columbia Business School and is the author of a thriller titled "Merger", which Chicago Tribune called "Timely, Gripping, and Original". Please visit www.sanghoee.com for more details.