Raising the Minimum Wage: Cure or Curse?

There’s been a lot of talk lately about raising the minimum wage, both on the federal and local level.

In his State of the Union address earlier this year, for instance, President Obama announced an executive order raising the minimum wage for federal contract workers to $10.10 per hour from $7.25, and he called for a similar increase for all minimum wage workers nationwide.

Meanwhile, Port Authority of New York and New Jersey commissioners are pushing for a similar wage increase, just one example of similar efforts happening nationwide.

These moves come amid still sluggish growth in average hourly earnings, broad dissatisfaction across the political spectrum about the distribution of wealth and income in the United States, and growing concerns about how technology and globalization are altering the labor market.

Yet whether raising the minimum wage is good for the economy or not spurs heated debate. Some argue that it’s a no-brainer that a higher minimum wage will be good for the economy as it will lead to higher incomes, more consumer spending and economic growth. At the other end of the spectrum, others argue that a higher minimum wage will lead employers to use less labor, thereby hurting the jobs market.

So it’s no surprise, then, that many investors are wondering whether raising the minimum wage would be a cure or a curse for today’s sluggish recovery. The truth is that it’s likely to be both.

Public policy involves tradeoffs, especially when it comes to income redistribution. The debate about increasing the minimum wage is no different.

A Congressional Budget Office report published in February 2014 concluded that raising the federal minimum wage to $10.10 an hour, and thereafter adjusting it for inflation, would boost incomes of most low-wage earners, lifting many families above the poverty line. But at the same time, according to the report, it could also involve the displacement of as many as 1 million workers and a reduction in incomes of business owners of approximately $17 billion.

Why job losses? Higher wages make automation more attractive to employers and could make certain lower-skilled minimum-wage employees uncompetitive. Meanwhile, another report from the National Bureau of Economic Research published in January reached similar conclusions about the tradeoffs between employment and incomes when raising the minimum wage.

So what does this mean for investors? In our opinion, like most economic phenomenon income inequality is a complex topic not lending itself to any single solution. So even if we see widespread adoption of higher minimum wages, they’re likely to be a wash for the broad economy and the impact on income distribution is likely to be modest.

In the absence of a quick fix, modest income growth—especially among lower and middle income Americans—suggests that consumer spending is likely to be constrained, and may even shrink relative to other sectors of the economy, such as such as manufacturing. As such, we remain cautious toward consumer sectors, particularly given their relatively high valuations.

It’s also worth noting that the consumer discretionary sector would be particularly vulnerable to a rising minimum wage due to the large number of leisure and hospitality workers who earn at or below the minimum wage and as these industries aren’t yet automated.

Sources: Linked to throughout Post, BlackRock research

© iShares Blog

Read more commentaries by iShares Blog