Do Minimum Wage Increases Trigger Recessions or Prolong Depressions?

Minimum wage increases introduce wage shocks into the overall economy. The impact of such disturbances is illustrated by recent business cycles.

The 1990-91 Recession. In 1989 the American economy was prosperous and was enjoying the longest peacetime expansion in American history. The expansion continued into 1990, with unemployment rates staying remarkably stable at about 5.3 percent. Yet labor markets began to weaken significantly in the second quarter of 1990. It is not a coincidence that the minimum wage was raised by 45 cents (more than 13 percent) on the first day of that quarter. Figure X shows that while more than 800,000 jobs were created in the civilian economy in the six months prior to the minimum wage increase, over 350,000 jobs were lost in the first six months afterward.

Within three months of the wage increase, the unemployment rate began rising from the 5.3 percent level, reaching an average of nearly 6.5 percent in the first quarter of 1991. Natural market forces were ready to start lowering unemployment, but they were thwarted by a second 45-cent increase in the wage, to $4.25, in April of 1991. Rather than falling, as often happens a year after a recession begins, the unemployment rate continued to rise, reaching 7.0 percent by the end of the year.

The 27 percent rise in the minimum wage had a general wage-increasing impact, since an increase in the minimum wage increases the demand for skilled and semiskilled workers who indirectly compete against unskilled labor. Compensation per hour in the business sector, which had risen at a 3.5 percent annual rate in 1989, rose at an extraordinary 8.4 percent annual rate in the second quarter of 1990, the biggest increase in many years.34 This wage shock priced many workers out of the market and led to the end of the great job explosion of the Reagan era. By early 1991, the annual rate of compensation increases had fallen to below 3 percent on an annual basis, and the market was showing signs of adjusting to the wage shock of April 1990. However, in the second quarter of 1991 compensation increases rose to 4.6 percent on an annual basis, almost certainly a consequence of the April 1991 increase in the minimum wage from $3.80 to $4.25. This led to a further delay in job recovery.

The 1974-75 Recession. The 1990-91 recession is not unique in being at least partially triggered by a minimum wage shock. A good case can be made that both the short 1979-80 downturn and the recession beginning in late 1981 were exacerbated by minimum wage increases in 1979, 1980 and 1981.35 However, other factors were at work and inflation made this period somewhat atypical. Perhaps a better example is the 1974-75 downturn, which clearly was affected by minimum wage increases.

On May 1, 1974, the minimum wage was increased for the first time in over six years. The increase was a very steep 25 percent, as the wage went from $1.60 to $2.00 per hour. Special minimum wages then in effect for some employees who had begun to be covered after 1966 (e.g., farm workers) were increased roughly proportionately. The unemployment impact was almost immediate, as Figure XI shows. In the four months prior to the enactment of the minimum wage, the unemployment rate was virtually constant at around 5 percent. In the month the minimum wage increase was enacted, the unemployment rate began to rise. By the end of the year, the unemployment rate was at 7.2 percent.36

Compounding the problem, on January 1, 1975, the minimum wage rose another 5 percent, and proportionately more for workers temporarily covered by lower federal minimum wages. The unemployment rate soared in January 1975, and by spring of that year was nearing 9 percent. In the year between the first quarter of 1973 and the first quarter of 1974, compensation of all workers in the private economy had risen 7.3 percent. In the next six months, the annualized rate of increase in compensation rose to about 12 percent. A wage explosion occurred. A sharp slowdown in the rate of compensation increase that normally would have occurred was delayed by the further 1975 wage increase. Again, low-skilled labor was priced out of the market.

The Great Depression: Wage Increases Under the NIRA

These data understate the impact of the codes on employment. In addition to the minimum wage provisions, the codes contained maximum hours requirements. They generally were set at 40 hours per week, below the average workweek of the time.43 Consequently, as unemployment rates stopped declining, the average workweek fell by 13 percent between June and December 1933.44 Over the next 15 months, unemployment rose slightly, standing at 23.5 percent in October 1934. The following year saw a slight improvement, but unemployment still measured nearly 22 percent in October 1935. By this time, the National Industrial Recovery Act had passed from the scene, having been declared unconstitutional earlier in the year by the Supreme Court. In the absence of the act's minimum wage provisions, employment conditions improved dramatically. By May of 1937, the unemployment rate had fallen to almost 12 percent. Again, all the evidence points to the same conclusion: If we introduce a wage shock in the form of a hike in the minimum wage, unemployment rises; if we allow the minimum wage to fall from the effects of inflation or court rulings, unemployment falls.45