Rethinking the minimum wage


The federal minimum wage stands at $5.15 per hour – roughly equivalent to the price of a latte and piece of pumpkin loaf at Starbucks. A vast majority of states simply match the federal level. California, being the most often cited exception, sets its minimum wage at a less-than-awe-inspiring $6.75 per hour. In 2002, the median compensation of a public company CEO was $10.83 million. The Business Roundtable, which is an association of CEOs, estimates that the average CEO works 58 hours per week. This means that the average CEO earns $3,591 per hour, or about 697 times more than the average minimum wage worker. Said another way, the average CEO needs to work less than three hours to earn the same amount that a minimum wage worker earns in an entire year.

Two thoughts instantly spring to mind. First, $5.15 is a joke. The federal minimum wage is set ineffectually low, reflecting the relative fragility of the skilled and unskilled labor lobbies. Second, it is good to be a CEO – in a relative sense, perhaps too good.

There is nothing intrinsically correct or incorrect about any particular minimum wage or median CEO compensation level. If CEOs create millions of dollars of value then they deserve to be compensated for such. If minimum wage workers contribute less then they should earn less. Nevertheless, the methods currently used to set their respective wage levels are flawed and thus result in objectionable outcomes. The federal minimum wage is set by a political process that essentially determines the absolute lowest market-clearing wage and then subtracts a dollar or two (just to ensure it is meaningless). CEO compensation is set by board committees using the best (translate – least bad) facts available and something of a crystal ball, which is all that can be done given that the CEO labor market is neither transparent nor fluid.

The independence of these processes reflects a fundamental failure to appreciate that we live in a dynamic socioeconomic environment. It is a mistake borne out of historical inertia that we should independently derive these figures. A suitable remedy calls for dispensing with the fixed federal minimum wage. Instead, the federal minimum wage should fluctuate in fixed proportion to average CEO compensation (or some other basic measure of executive compensation). For example, taking today’s ratio as the base case, a 10% rise in average CEO pay would lead to a 10% rise in the federal minimum wage. Such a shift in policy would create an effectual minimum wage that is self-regulating in terms of its socioeconomic market dynamics.

An instant challenge is that an effectual minimum wage creates market inefficiencies. Anyone with a week’s worth of economics training could draw a graph to prove that this is the case. Well, as with most subjects, a little knowledge about economics and finance is a dangerous thing. Such a basic model assumes away the welfare state and the iterative effects of wealth distribution. If we start from the position that either (i) the welfare state exists (last time I checked, it did) or (ii) people evaluate their compensation in relation to that of others, then the effects of a minimum wage become nebulous. With a more realistic understanding of the economy, one can derive many a model that proves the exact opposite, that is, that an effectual minimum wage can be the genesis of profound economic growth. Economics cannot tell whether an effectual minimum wage is good policy, let alone whether it is right. At its core, the choice is a moral one.

The actual construction of the system would require accommodation of differing types of businesses, especially small businesses. Similarly, the actual ratio between the minimum wage and measure of executive compensation would be a point of contentious dispute. Despite the potential imperfections and complexities associated with such a shift in policy, it is hard to imagine how the proposed system could be much worse than the present one. Unless, of course, one thinks that there is some socioeconomic justice in having the average CEO earn 697 times the wage of other productive contributors to society.

Fred Pollock’s column appears biweekly.