Evaluating New Minimum Wage's Effects

Michael Pakko Commentary

Evaluating New Minimum Wage's Effects
Michael Pakko

With the passage of ballot initiative No. 4, the minimum wage in Arkansas will increase in three steps to $8.50 per hour in 2017, $1.25 above the current federal minimum, making Arkansas one of many states to increase the minimum wage above the federally mandated level.

A question I frequently hear is “How will this affect the Arkansas economy, good and bad?”

This is an Opinion

We'd also like to hear yours. Leave a comment below, tweet to us at @ArkBusiness or
email us.

One way to address this two-sided question is to consider how regional differences in prices and wages interact with minimum wage laws in various states. Arkansas is a state with relatively low wages and a low cost of living (prices). This factor tends to exacerbate the economic impact of the new minimum wage regime.

Consider prices first: Statistics from the Bureau of Economic Analysis show that the cost of living in Arkansas is more than 7 percent below the national average (2012 regional price parities). As a result, any given wage allows for more purchasing power than it would in a state with higher prices. For example, Connecticut, a state with much higher prices, is scheduled to raise its minimum wage to $10.10 an hour in 2017.

With a cost of living nearly 16 percent higher than the U.S. average, Connecticut’s current minimum wage of $9.15 translates to only $7.51 after adjusting for lower purchasing power, while the current federal minimum in Arkansas is equivalent to an adjusted rate of $7.82.

In 2017, Connecticut’s $10.10 minimum wage in 2017 will command only $8.72 in purchasing power, while Arkansans will realize an adjusted $9.17 under the $8.50 statutory minimum. Arkansas’ lower minimum wage will continue to provide greater purchasing power for low-wage workers than Connecticut’s much higher dollar-rate.

Other economic effects of minimum wages increases — including the unintended consequences and side effects that economists sometimes warn of — depend on how broadly the minimum wage increase affects labor markets. The key consideration is whether or not an increase will be “binding” on labor market outcomes.

In North Dakota for example, anecdotal evidence suggests that the federal minimum wage is largely nonbinding. A shale oil boom has caused a chronic labor shortage, driving wages above the minimum for even the lowest paying jobs. A small increase in the minimum wage for North Dakota would likely have very little impact.

But a minimum wage increase in relatively low-income Arkansas is likely to have more pervasive effects. One direct measure is the percentage of hourly workers presently earning a wage rate at or below the federal minimum. Figures from the Bureau of Labor Statistics for 2013 show that percentage to be 6.9 percent for Arkansas, compared with a national average of 4.7 percent.

Another general approach is to adjust statutory minimum wage rates for interstate differences in average wages. For example, average weekly wages in Arkansas were 81.6 percent of the national average in 2013, the lowest in the nation. Any given minimum wage will therefore be likely to affect a larger share of the total state labor market in Arkansas than in other states, resulting in more significant market responses.

Consider average weekly earnings as an adjustment factor to show how legal minimum wage rates in various states compare after adjustment for differences in average wages.

The comparison between average wage-adjusted measures for Arkansas and Connecticut is similar to the price-adjusted comparisons.

There is another dimension to the impact of the new minimum wage law: Low-skilled labor will become more expensive in Arkansas relative to neighboring states. When it comes to competing for jobs in the region, this is likely to be a factor.

So, returning to the question of how the new minimum wage schedule will affect the Arkansas economy, for both good and bad: After accounting for differences in regional prices and wages, the impact of the new minimum wage law in Arkansas is likely to exceed the expectations of both its advocates and its critics. For more information, visit ArkansasEconomist.com.

(Michael Pakko is the state economic forecaster and the chief economist with the Institute for Economic Advancement at the University of Arkansas at Little Rock. He’s also an adjunct professor of economics at UALR.)