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Indexing the minimum wage is a good idea — by any measure

Minimum wage rally in the Capitol Rotunda
MinnPost photo by Briana Bierschbach
Supporters of raising the state minimum wage held a rally in the Capitol Rotunda on Feb. 25.

This is one in a series of articles funded by a grant from the Northwest Area Foundation.

To index or not index?

That is the question that seems to be keeping the Minnesota Senate and House apart on the issue of raising the minimum wage. On Tuesday, the House proposed a compromise: Index the wage, but use the implicit price deflator for personal consumption expenditures to measure inflation instead of the Consumer Price Index.

How are these two measures different? And what difference would this make for the minimum wage?

What the CPI assumes

The Consumer Price Index (CPI) measures the general level of prices for goods and services that a typical household purchases each month. (A nice summary of the details is here.) The Bureau of Labor Statistics calculates the CPI by measuring the cost of purchasing a fixed basket of goods and services over time, with the goods and services consisting of the typical stuff a household purchases every month. (The specific categories are food and beverages, housing, apparel, transportation, medical care, recreation, education/communication, and other goods and services.)

Inflation is a rise in the general level of prices as measured by a price index like the CPI. So, one way to measure the inflation rate is to calculate the percentage change in the CPI from one year to the next. For instance, from 2012 to 2013 the CPI rose by 1.46 percent, so inflation was about 1.5 percent as measured by the CPI. 

So why not just stop there and index the minimum wage using the CPI? Economists usually focus on two problems with the CPI.

First, the CPI doesn’t take into account changes in the quality of goods and services over time.  For instance, suppose we observe that the price of a particular make and model car in 2013 is higher than it was in 2012. Are the two cars really the same? Perhaps the 2013 car has better brakes, a more efficient fuel pump, or a better sound system as part of the standard equipment. The 2013 model isn’t just more expensive, it’s a better car and the price reflects this. The CPI doesn’t differentiate between identical goods becoming more expensive and goods improving in quality and thus might lead us to think that prices are rising faster than they really are.

Second, the CPI incorporates something economists call “substitution bias.” For example, if the price of chicken rises, a typical consumer will probably substitute pork, beef, or some other protein and purchase less chicken. The CPI, however, assumes that when prices change households continue to buy the same amounts of goods and services that they did before the price changes. This makes the CPI rise more than it should and leads to an overstatement of inflation.

The differences

The implicit price deflator for personal consumption expenditures differs from the CPI in a variety of ways. Two important differences are:

  • The implicit price deflator includes a wider range of goods and services than does the CPI.
  • The implicit price deflator takes account of substitution bias by using the actual quantities of goods and services households purchase over time in the calculation rather than using fixed quantities as is done in the CPI.

Effect on the minimum wage

It turns out that it doesn’t make too much difference which index you choose. Here’s a way to see this:

Minimum Wage: Too low or too costly? Suppose that Minnesota’s minimum wage had been indexed starting in 2004. The minimum wage that year was $5.15. Using the CPI as an index, it would be $6.35 today, whereas using the implicit price deflator, it would be $6.16. That’s about a 3 percent difference over 10 years, with the gap widening over time. This is probably what would happen over the next 10 years if we choose the implicit deflator rather than the CPI.

So why the resistance to indexing the wage? On the one hand, indexing the minimum wage reduces the uncertainty businesses face regarding their labor costs by taking changes in the minimum wage out of the political arena. On the other hand, it takes away something for which the Legislature can take credit: an increase in people’s paychecks. Further, if businesses are counting on the ability to get more productivity from their workforce without increasing their workers’ real pay, firms will also resist indexing the minimum wage.

Which brings us back to the original question: Should we index the minimum wage? Yes, we should, in order to reduce business uncertainty about their costs and so that workers’ wages reflect their productivity. It doesn’t matter which price measure we use to do it.

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Comments (39)

Agreed

Can't believe Senate Democrat's are pushing back on this.

A few questions from a layman.

First, which industries, if any, tend to lag behind the inflationary curve? In other words, which are the last to be in a position to increase prices due to inflation?

What happens in an industry in free fall, i.e, one in which the market price for goods or services is falling and inventory and labor costs are climbing? Do they simply throw in the towel?

Second, would the use of either index result in lowering the minimum wage if and when we experience deflation?

Third, are you arguing that there should be a one to one correspondence between an increase in worker productivity and wages? If not, then what would you suggest the relationship be? If increased productivity is the result of increased capital investment, then what?

I have no problem taking politicians out of the equation. They tend not to operate on either principle or data, but on electoral and financial pressures. On the other hand, it seems to me that auto-pilot carries with it its own set of concerns.

Answers...

Public Utilities lag behind the inflation curve to some extent because their pricing is regulated, however they don't employ minimum wage workers. Beyond that, economies are complex and diverse, no industry "lags" predictably, and the only industries we're interested here are the ones that employ minimum wage workers. You go into business, you pay your money you take your chances... I think they call it... "markets".

Industries that go into free fall collapse, regardless of labor costs.

Some of you guys seem to be hung up on minimum wage workers and productivity somehow being tied together. The least productive individuals in our society are the highest paid, i.e. executives. In fact, executive productivity is almost impossible to even calculate because they produce nothing and frequently are not even responsible for day to day operations. American workers have ranked as some of the most productive in the world for several decades now, their wages lag behind.

...and next consider the 'maximum' wage...

If, as we do, live in a nation that is still perplexed debating, frowning, weighing anothers right to minimal survival in relation to what should or should not be be considered a ' minimum wage' - which appears to say little in relation to 'a livable wage' - should, in a sense of fairness in the workplace, the market place (the domestic sensibilities possibly considered also)...should we not also be justifying a "Maximum wage' for all consumers; rich poor and middle class so embraced in the greater picture?
Wages affect all; so recognize equally here, minimum or maximum survivors within a creeping capitalist system within this democratic society with appropriate checks and balances across the board so to speak?

It was a careless thought on a lousy-cold day...forget it

Indeed

If we're willing to give government the power and control to impose a minimum wage paid by employers, what's to prevent them from arguing that they're justified in imposing a maximum wage?

Not the point I think you were trying to make, but thanks for debunking the heretofore notion of that being an unlikely scenario.

One can argue anything

However, economics does better at imposing a maximum wage than it does a minimum, particularly with a taxation system that encourages corporations to use forms of compensation other than wages at the top end of the scale.
A maximum wage law would be much too easy to evade.
So, it is an unlikely scenario.

Indexing is not a good idea for many reasons

And I will start with one of your last statements.

"so that workers’ wages reflect their productivity"

If I understand you correctly, a worker making $10.10 an hour gets his indexed raise of 2.5% and immediately becomes 2.5% more productive. Correct? Because if the wages need to be index to reflect productivity, it has to follow that the work is more productive as soon as the wage increase is made.

Maybe this is theoretically so, but in practice, I have not seen it. Workers who become more productive typically get paid more - at least in my business they do.

But there are employees, unfortunately, whose productivity does not change. They operate at the same level week after week. And there is nothing wrong with that!! They can and do provide valued services. And at least in my business, they still get regular increases - though not necessarily annually.

But it begs the question - how can a business automatically increase wages every year and at the same level of employee productivity and survive? The assumption must be that I will be able to pass that increase costs on to my customers.

Unfortunately, in today's global economy, that is not very often a valid assumption. Many of the end users my business serves can buy from me (and my customers) or from others around the globe. Who have have a far different cost structure.

McDonalds can probably pass the cost along - but a manufacturing support business like mine can't.

Besides the economic and productivity issues above, here are 2 other problems with indexing:

* It will likely cause the businesses to incur automatic pay increases for all hourly workers - not just those on minimum wage. Huge issues (in fairness and shop morale) if the $10.10/hr worker automatically gets a raise and the $12/hr work does not.

* It forces the company to increase hourly pay, when other forms of compensation (bonus, profit sharing, benefits) might be more valuable to the employees.

So if we feel the minimum wage needs to go up, then act accordingly. But not automatically.

Soooo

"Maybe this is theoretically so, but in practice, I have not seen it. Workers who become more productive typically get paid more - at least in my business they do."

How many minimum wage workers to you employ? What's the range of pay for your workers? How much do you get paid?

answers

How many minimum wage workers to you employ? None

What's the range of pay for your workers? $9.50 to $26 per hr plus benefits.

How much do you get paid? Because we had a great year, which included a lot of overtime and a nice employee bonus, I was the 4th highest paid employee in the company. (As owner, I do not take part in the company bonus plan) Based on last year's profit, the company was able to invest ~$350,000 in new and updated plant equipment. (which, if I was as greedy a capitalist as you make all small businessmen out to be - I should have pocketed as my income. But I did not)

Your welcome to come and review my financial statements if you like. Just send me a note.

Meanwhile, please come up with your own personal observation from being a small businessman to refute my position or some other facts. Your questions above don't cut it.

Productivity and wages.

Minimum wages workers are typically the most productive workers in our economy. The wage of $7.25 an hour undervalues their labor. No one is saying that higher wages will increase productivity, although in theory sometimes it does, we're just saying that productivity should be paid for.

http://www.nytimes.com/2013/01/13/sunday-review/americas-productivity-cl...

So true, Paul

It's been my experience that minimum wage workers are more productive and work harder than nearly every person with an MBA or Six Sigma certification that I've ever had the misfortune to work with. Those people are completely devoid of any ability to embrace any intuition or data that can't be justified through their metrics or preconceived notions....they're nothing but efficiency driven, robotrons. It's the people on the front line, whose day to day experience truly leads to innovation, that should be reaping the financial rewards.

Most actual production

is done by machines (robots, computers) these days, not by workers.
The whole concept of productivity needs updating.

Well...

Again, we're talking about minimum wage workers, not manufacturing jobs. You're taco was not assembled by a robot, and most people still go through check-out lanes if they can. But yes, we do need to update the concept of productivity.

hybrid systems

These hybrid systems seem destined for unintended consequences. Either accept the mainstream economic price equilibrium for labor and help the poor in other ways. Or artificially set a wage for the working poor and have the politicians monitor its effectiveness. But to patch together a selection of political judgement and market indices makes for a weak social fabric.

Equilibrium?

Victoria,

Almost anything anyone can do may produce unexpected consequences. The problem is your assuming that there's a "market" of some kind that works towards "equilibrium". There is no such market, markets produce disparity, not equity. If "equilibrium" were a natural product of "markets" there would be no such thing as sweatshops and slave wages. Economies don't exist as "equations", the function of economies in democracies is to produce an acceptable standard of living for all participants and citizens.

All economies are created by their participants, there no such thing as a "natural" or "organic" economy, and Capitalism is certainly not "natural". By definition modern Capitalism is artificial, so the claim that minimum wages are somehow an "artificial" component is simply incoherent.

markets are a myth?

Paul,

If I follow you, you do not believe there is a market system that produces price points. So why would we use an index from this non-system to adjust the minimum wage?

Victoria...

No, you don't follow me. I didn't say markets don't exist, I said the market your relying on to produce wage "equilibrium" doesn't exist. Consider the possibility that there is not just one all encompassing "market" that functions according to illusory principles.

The title

…of the column says it all. We can argue about what constitutes "productivity" and how it should be measured until the proverbial cows come home, and Paul's comment about the relative productivity of executives is right to that point, but in the end, the arguments will do nothing to enable a low-paid worker to survive economically in the society.

Arguing that your business can't survive unless you pay your workers starvation wages is… um… not very persuasive. Employers would prefer that employees work for free, and that there be no taxes on business activity whatsoever. It's the nature of industrial capitalism to embrace such notions. That doesn't make them good policy for the society as a whole.

Someone who's working full-time ought to at least be paid a living wage – not necessarily "prosperous" in the sense that most of us think of it, perhaps, but at least able to provide the basic necessities. That's not currently possible, and in a consumer-driven economy such as ours, the fact that it's not currently possible simply shows that squeezing wages is, in the macroeconomic sense, counterproductive.

Exactly...

If minimum wage was $2.22 an hour, that's what these employers would pay, and they would be hurling the same arguments against higher pay that we see now.

And of course

increased wages feed back into the system through increased taxes and increased spending (read demand) which stimulates the economy.

A serious question

as you raised it in the 2nd paragraph.

Businesses like mine determine wages based on a lot of factors. A part of it what we can afford to pay to remain competitive. Yet we also have market forces that cause us to make sure we are paying a good wage (threat of losing employees to higher paying companies, costs of training new employees, productivity value of experienced employees). So there are pressures both upward and downward on wages that businesses have to balance all the time. It's never a race to the bottom - as some would like to believe.

The problem I have is why is it a businesses responsibility to insure "living wages" for everyone? I thought society had a mechanism to bridge the gap. Isn't helping those less fortunate a big part of the reason why both myself, personally, and my company pay taxes? Why we ALL pay taxes. So, if we are not meeting their needs, should we not be taking a more global view and raise the taxes high enough to make sure that it does? Instead of imposing a requirement on businesses who may (or may not) be able to afford it?

Of course, shared burden is not a real popular position for those on either end of the political spectrum. Not when you can spend your time trying to force others to sacrifice / pay for what you personal want to see happen.

Actually

Tim,

Shared burden is basic premise of liberal democracy and most progressive economic agendas, we actually in complete agreement. This is why we're talking about imposing minimum wages instead of living wages. There are two problems: A) Republican's demand tax and service cuts as a matter of principle, thus creating practical barriers to adequate safety nets, medical care, and food security. If you can't get livable income from the government then it has to come from the employers. Talk to your Chamber of commerce which has effectively become a wing of the Republican party. They demand lower taxes, cut in services, AND they want to eliminate minimum wage entirely. B) When a living wage would be around $15.00 an hour, but the minimum wage is barely $7.00 an hour, the public is bearing almost half the employers labor costs, that actually represents an imbalance because the employer is the primary beneficiary of that economic activity. And indexed wages starting at around $10.00 would reduce the public burden to around 30%.

American wages have stagnated for almost three decades now.

3 Paradigms

Hi Tim,
Please keep in mind that Paul believes in paradigm 1, as shows in his answer. I disagree with him and believe that 2 & 3 are more likely. I personally think benefits for the low income folks are better for them than a higher minimum wage. I mean those benefits are paid for almost exclusively through income and business taxes. Whereas all of us will pay higher costs as the min wage is increased, even those Paul intends to help.

3 possible paradigms as to who is being subsidized by a low minimum wage, that is offset by tax payer funded programs for those with low incomes.

1. Society is subsidizing the businesses by paying their expenses. (ie neutral to regressive tax?)

2. Society is subsidizing the poor who are unwilling to work hard to improve their income earning potential. (ie progressive tax)

3. Society is subsidizing all of us by keeping our "Service/Product Industries" less expensive. And they are doing this at the expense of the tax payers. (ie progressive tax)

Who says

they're unwilling to work hard? Most minimum wage workers would have you gasping for air if you attempted what a lot of those people do on a daily basis. You people can't function beyond your beloved metrics.

Perspective

I spent some time working at McDonalds as the grill guy. I was incompetent at taking orders so they kept me away from the counter, but I could do a 48 burger turn with the best of them. And I spent a lot more time handling hay bales, cleaning barns, shoveling grain, pulling weeds, etc. The point of this rambling is that I know a lot about hand labor.

Now let's look at what I said more closely.
"unwilling to work hard to improve their income earning potential"

Now I worked hard while handling those bales in July, especially when unloading into the barn... (no wind...) But that is not what I am talking about.

Minimum wage jobs are great for younger and older people, they provide good training, flexible hours and some extra cash. However I am still working to understand for what reason a 22 to 65 year old would be trapped in a minimum wage job. Especially in the Twin Cities and other metropolitan areas.

There is something keeping these folks from moving ahead at their employer. Even at McDonald's after a couple years they should be a shift Supervisor, unless they are doing something really wrong. Thus paradigm #2...

REJECT WN I don't care what you did in your youth.

I worked my way through college as a landscaper, lifeguard & bouncer. I couldn't do that today nor could you keep up with the labor that you used to do. My issue with you is your continued disparagement of people that you feel are beneath you, all under the guise of pondering some grand, sociological question like "why are poor people poor?" The only answer your looking for is one that validates your opinion that it's always their own failing and abdicates you from experiencing empathy for their situation. There is no template that these folks pop out of...each has their own unique story. I couldn't care less what happened in their lives. I have zero desire to pass judgement, but I want them to have the opportunity to have some dignity in their lives and be paid a couple of bucks more an hour while they're trying to figure out how to achieve whatever it is they're looking for.
I have to say that there's something quite pathological about a person who seems to have so much desire to keep hard working, disadvantaged people from getting a slight bump to a wage that is already one of the lowest in the country.

IF...

If 'profit' were viewed as "wages", then should there be a maximum wage activated also as we so 'democratically' define a scale of acceptance for all in the workers world...from factory floor to boardrooms?

Tim's numbers....

Tim Milner has been arguing against the new minimum wage and the indexing for a few weeks now on behalf of small business owner like himself. In answer to my question, how many MW workers to you employ, what's the average hourly wage of your employees, ect. Time graciously provided the following answers:

"How many minimum wage workers to you employ? None

What's the range of pay for your workers? $9.50 to $26 per hr plus benefits.

How much do you get paid? Because we had a great year, which included a lot of overtime and a nice employee bonus, I was the 4th highest paid employee in the company."

Thank you for sharing Tim.

Now, the reason I asked this question isn't because I'm interested in Tim's business, I'm just illustrating a point that seems to saturate this discussion when "small" business people argue about minimum wages and indexing... to wit:

Note that Tim is already paying his lowest paid employees the minimum wage lawmakers have currently agreed upon, AND he's had a "great" year. Yet he's been arguing here for weeks that this wage will damage our economy and be an undue burden on employers. You want "facts" Tim? Here's a fact: $9.50 an hour seems to be working just fine for your business.

Now here's the next question: since you had a "great" year and have over $300,000 to reinvest, what kind of raises did you give your lowest paid workers? If the current minimum wage proposals were law, you'd be required to give your $9.50 an hour employees a 2% raise... less than 20 cents an hour. What say you?

Excellent Point

Usually people are not paid below $9.50/hour in the metro unless it is a real simple and/or low effort job.

For what reason would we want to mandate higher wages for these particular positions?

As I have mentioned before, what do you think is "trapping" 21+ yr old adults in these positions?

What choices are they making that keep them in these "entry level positions"?

"Foul!)

I gotta call it John. Asked and answered.

We're not going to pretend that $9.50 is already the mandated minimum wage and continue as-if we're trying to mandate more. The economic calculations and rational for the proposed minimum wages have been explained. We're not trying to raise the minimum wage because it's a "trap" (that's your stereotype, not our rationale) we're trying to raise it because the current wage is simply an insufficient wage.

Basically we employers who seem to think they're entitled to pay substandard wages to employees in jobs they classify as "entry-level". There's no solid economic rational for that, and in fact, that rationale has depressed wages across the board to such magnitude that it's actually harming our economy. Economically it makes no sense for anyone to work for substandard wages entry level or otherwise. Sure, some people can work for more or less money than others, but anyone that works should make enough to above the poverty line and we've already explained why that is.

So John, I assume since you didn't respond that despite have had a "great year" in your own words, you're $9.50hr employees are NOT getting a 2%+ raise. Meanwhile, let me ask: are the high paid executives in your company also not getting a raise or a bonus of any kind despite having such a great year? And are you saying that YOUR income as the owner remains flat even though you had a great year? I know you put money back into the business I also noticed that you didn't tell us how much more ore less you and your executive team actually made. I assume by the way that a 2% or less increase in revenues isn't your idea of a "great" year, so you must have seen a revenue increase well above last years inflation index.

Not again...

Now you have me confused with Tim... And you avoided the questions again.

By the way, if I owned a company I would rely on profit sharing in good years over higher wages. Because next year may not be so rosy and we would hate to have to lay off good employees. Besides it may promote good habits and extra effort.

Ahhh...

the proverbial carrot/stick analogy. The problem is that people keep moving the carrot in order to keep from fulfilling their part of the bargain.

Better Employer

You really need to get a better employer. All 3 of the companies I have worked at over the past ~20+ years have paid out profit sharing in some form for all full time employees.

I wasn't referring to myself...

I've done very well, but I thank you for your concern. No, I'm speaking of the minimum wage workers that you seem to take great delight in disparaging here on a daily basis. The fact that you've worked for only three companies in 20 years+ highlights how woefully out of touch you are with the challenges of today's workforce, especially those laboring in minimum wage positions, most through no fault of their own.

Sorry John and Tim

I keep getting you guys confused. John, again, your question questions have been asked and answered, I'm not going to repeat myself just so you can keep arguing.

No Answers

You just said I was stereotyping them...

Like I said

"You just said I was stereotyping them..."

You're not entitled to another answer just because you don't like the one you got.

Confusing

How can I be stereotyping anyone by asking your thoughts, and striving to understand the reality and demographics of these individuals?

Very confusing

Oh, please....

you're not trying to understand anything. Your self-described favorite question as to "why are poor people poor?" is nothing more than an attempt to validate your view that these people deserve their lot in life while abdicating yourself from feeling any sort of empathy for them. You've proven that time and time again.