Earlier this year, Seattle increased the local minimum wage to $15 an hour, more than double the federal minimum wage of $7.25. The city’s new minimum wage, the highest in the nation, will be phased in beginning next April.
And Seattle is not alone. According to the National Conference of State Legislatures, seven U.S. states plus the District of Columbia have passed laws this year raising their minimum wages.1
Vermont, for example, will raise its minimum wage to $10.50 per hour by 2018. Massachusetts is closing in on an $11-per-hour rate. And Connecticut, Hawaii and Maryland have passed $10.10-per-hour minimum wage legislation.
These states are doing this in an attempt to increase the disposable income of poor families. President Obama also wants to tackle inequality in America by raising the minimum wage to $10.10 an hour. In fact, he recently signed an executive order mandating that federal contractors pay their workers a minimum wage of $10.10 an hour.
But could this trend of higher minimum wages actually lead to unintended consequences, such as higher inflation?
Higher Wages Could Result in Inflation
The short answer is yes. Inflation can be caused by any number of new or increased costs of production. And, depending on the industry, wages can be a big part of the cost of production.
So, when a company is forced to increase the amount it pays its workers by several dollars, it will either have to absorb the additional cost or pass it on to customers in the form of higher prices. Normally, companies that have a large enough profit margin can afford to absorb the additional costs. But many other companies will see no option but to increase the price of their products or services.
Another important thing to keep in mind is that the increase in minimum wage will go well beyond just those who earn less than the current minimum wage. Imagine, for example, a restaurant that pays most of its employees the minimum wage of $7.25. Let’s say managers who oversee those workers are now earning about $10.25.
What would happen if we increased the minimum wage to $10.10, as president Obama proposes? The managers would most likely request a similar percentage hike in order to keep the same wage gap they once enjoyed. So, the restaurant would have to increase the salary of the managers, even though they already earn above the minimum wage.
The true impact of a higher minimum wage isn’t just a raise for minimum-wage earners. It’s essentially an across-the-board wage hike for just about everyone who gets paid by the hour. And since some of those costs will be passed on to consumers, it’s a cost hike that impacts everyone in the economy. In other words, we’re talking about broad-based inflation.
In Seattle, one Subway franchisee has calculated the real cost of this new minimum wage. He said he will have to raise costs by up to $1 per sandwich.2 Although this doesn’t sound like much, it represents an inflation rate for sandwiches of as much as 20%.
Jeff Opdyke, investment director of the Sovereign Society, has done some research on this subject. Using data going back to 1938, he cross-referenced previous minimum wage hikes with the monthly change in the inflation rate over the next one and two years. He concluded that inflation does, in fact, correlate with minimum-wage increases – especially when wage hikes are large and occur after a long stretch of stagnant wages. Here’s how he describes his findings:
“On an average basis, inflation in the first 12 months following an initial minimum-wage hike was 1.3 percentage points higher year-over-year. After two years, inflation was 2.5 percentage points higher. And when I look at just the years in which the minimum wage rose more than 20% – as is the case this time around – the inflation rate spiked sharply by the second year.” 3
David Rosenberg, chief economist & strategist of Gluskin Sheff, also thinks higher wages will lead to inflation. He says: “36 states are boosting the minimum wage or introducing legislation to do so. We are going to begin to strain scarce supply-side resources in terms of available labor and capital. Then inflation re-emerges.” 4
So, it’s very likely that a new federal minimum wage of $10.10 per hour, which represents a 39% jump, would contribute to higher inflation. And with many states already moving toward that minimum wage or higher, we could see higher inflation sooner rather than later.
Until the next Daily Pfennig® edition…
Assistant Vice President
EverBank World Markets, a division of EverBank