Why a Higher Minimum Wage Can Result in a Lower Unemployment Rate

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Those who argue in favor of raising the minimum wage often point to examples of when the unemployment rate fell after the government increased it. One reason why this can happen is the unemployment rate only includes people who are actively looking for work. As a result, the more people who give up looking for work, the lower the unemployment rate will be.

One of the most popular statistics reported by the government is the unemployment rate: “the percentage of the total labor force that is unemployed.”1 However, this statistic is not an accurate measure of unemployment. If a person has not searched for a job in the past four weeks, they are no longer counted as a member of the labor force.2 The U.S. government classifies them as a discouraged worker: someone “who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment.”3 If a higher minimum wage results in companies laying off employees or hiring fewer new ones, then more people will become discouraged workers. Although increasing the minimum wage is supposed to help reduce income inequality, it can have the unintended consequence of driving more people out of the labor force due to a lack of job opportunities. Ironically, this can cause the unemployment rate to go down.

To measure the true economic impact of a minimum wage increase, the labor force participation rate is a better statistic than the unemployment rate. The labor force participation rate is “the percentage of the population that is either … working or actively seeking work.”4 For example, in June 2015, the U.S. added 223,000 jobs, and the unemployment rate fell to 5.3% from 5.5% in May.5 However, the size of the labor force decreased by 432,000 as the labor force participation rate fell to 62.6% from 62.9%.6 The unemployment rate fell by .2%, but the labor force decreased by .3%. The unemployment rate went down because of the sharp increase in the number of discouraged workers.

While a higher minimum wage can sometimes result in a lower unemployment rate, forcing companies to pay a higher price for labor will not benefit all workers. According to the law of demand, “all other factors being equal … the higher the price, the lower the quantity demanded.”7 If all other factors remain the same, the higher the price of minimum wage labor, the less hourly units of labor a company will purchase from workers. Raising the minimum wage is an economic policy that is motivated by good intentions, but it will not produce good results for everyone who wants a job.

Notes

  1. Investopedia, s.v. “Unemployment Rate,” accessed May 10, 2016, http://www.investopedia.com/terms/u/unemploymentrate.asp
  2. “Labor Force Characteristics,” U.S. Bureau of Labor Statistics, accessed May 10, 2016, http://www.bls.gov/cps/lfcharacteristics.htm#discouraged
  3. Investopedia,v. “Discouraged Worker,” accessed May 10, 2016, http://www.investopedia.com/terms/d/discouraged_worker.asp
  4. “Labor Force Participation,” U.S. Bureau of Labor Statistics, accessed May 10, 2016, http://www.bls.gov/bls/cps_fact_sheets/lfp_mock.htm
  5. Claire Zillman, “U.S. economy adds 223K jobs in June as unemployment dips to 5.3%,” Fortune, July 2, 2015, http://fortune.com/2015/07/02/june-2015-jobs-report-unemployment/
  6. Ibid.
  7. Investopedia, s.v. “Law of Demand,” accessed May 11, 2016, http://www.investopedia.com/terms/l/lawofdemand.asp
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5 thoughts on “Why a Higher Minimum Wage Can Result in a Lower Unemployment Rate

  1. Thanks, Karsten, for reading my essay. The problem with the unemployment rate is that it can decrease when the number of discouraged workers increases. This makes it a useless statistic in determining the economic impact of a minimum wage increase.

    I didn’t include it in my essay, but another statistic to look at is the employment-population ratio. Also, the ratio of full time to part time jobs is an important statistic. Australia has a high minimum wage, and, as a result, a much higher percentage of part-time jobs than Canada and the United States.

    Liked by 1 person

  2. Good article. As I stated on my post a while back I used to be a staunch advocate of the simple view that basic economics shows us. By increasing the price ceiling with increase unemployment. I don’t really follow said motto anymore because life is simply to complicated to put into such a basic economic model. If you actually look at micro-economic small increases of the minimum wage actually increase employment because they lower the Marginal cost of hiring new workers. Also, as I stated in my article, unless their is a solid correlation between unemployment levels and minimum wage increases (as I looked at Europe it seemed to be random) then it goes to show raising or lower the wage levels might not have such a straight forward effect as Econ 101 suggests. However, we could all be wrong in arguing the need to increase minimum wage. Maybe we should be arguing reforms of the welfare state to give more incentive for people to work while still assisting them or we should be talking about the possibility of a guaranteed minimum income. The world is full of to many variables for us to truly know what discussion we should be having.

    Liked by 1 person

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