On July 24^th, the federally required minimum wage increased to $6.55.  This is the second hike of a 3 tier increase.  The third hike will occur on July 24^th of 2009 and the minimum wage will go up to $7.25.

There has not always been a minimum wage.  Minimum wage laws were first established by the Fair Labor Standards Act in 1938.  The law was brought about to protect unskilled workers. 

In the thirties, there was a high supply of workers, yet a limited number of job opportunities.  Often unskilled workers were cornered into accepting extremely low paying and hazardous jobs.  Enactment of the wage law required employees to be compensated a minimum wage, at that time… 25 cents per hour. 

Since then, there have been several changes to the act.  It has been amended to extend coverage to more employees and, of course, to adjust the minimum wage as to keep up with inflation and the changing economy. 

More often than not, the issue of minimum wage makes its ways into political platforms.  Some candidates focus their campaign agendas on increasing the minimum wage.  Senator Obama proposes to index the minimum wage to inflation so that the wage increases with inflation.  Senator McCain has no strong stance one way or the other on the issue.

Though many people support an increase in the minimum wage, often the economic implications of forcing a minimum wage is overlooked.  In the short term, increasing the minimum wage has negative economic effects.  And in the long run, the impact is nullified as markets adjust to accommodate for the changes.

Let’s look at this a little closer…

In the short term

There is a limited supply of jobs and a certain amount of demand for those jobs.  Generally, the demand is greater than the supply.  This is what creates unemployment.  As the minimum wage increases, the labor force tends to grow as well.  This is because there are more people willing to work more jobs or longer hours at the higher wage rate. At the same time, the supply of jobs decreases because the jolt in labor costs causes employers to scale back jobs or hours.

So you have… more demand for jobs and a lower supply of jobs … or… more supply of labor and a lower demand for labor… either way you look at it, the end result is more unemployment.

Increasing minimum wage may benefit the few who are fortunate enough to have or find minimum wage jobs.  They get to bring home a bigger paycheck.  But that bigger pay check for one person may mean a smaller or no paycheck for another person. So, for the economy as a whole, changing the minimum wage is not a good thing.  It just means more people are looking for jobs, but there are fewer jobs to go around.

In the long run

In a free economy, over time the supply and demand markets will automatically adjust to new equilibrium.  In order to accommodate for the forced wage increase, other markets change.  The higher labor costs are eventually distributed to everyone in the form of higher prices for goods and services.  These higher prices affect the Consumer Price Index (CPI), which contributes to inflation rates. 

So in the long run, the economy is basically right back where it began.  The increase in wages eventually results in market adjustments… which results in higher prices… which results in inflation.  So whether you are making a lower minimum wage a year ago and a higher minimum wage two years from now… it still buys the same thing because of the changes in prices and inflation. 

Bottom line, while it sounds nice when politicians say they will increase the minimum wage… changing wage laws does little to improve the economy overall.