The Economy

Dec. 21, 2004
Cape Cod economics shows that higher wages don't always lead to inflation.

The minimum wage currently set by the federal government is $5.15 per hour. However, that means nothing to the businesses on Cape Cod, where the minimum wage is $8.50. At least that is what firms currently are offering to such traditional minimum-wage workers as chambermaids and dishwashers, as well as the ubiquitous burger flippers. Of course, some people think it should be higher. Sen. Edward Kennedy recently released a report saying the minimum wage should be $15.28, because that is the amount necessary for anyone who wants to spend no more than 30% of his or her income on a two-bedroom apartment in Boston. But leaving aside Tedward's unique brand of economics, what is the reason and the effect of such a high minimum wage on the Cape? The principal reason is a familiar one: low unemployment. The unemployment rate on Cape Cod is less than 3% and has been for several months. Yet the unemployment rate in Nebraska also is below 3%, where the minimum wage certainly isn't 65% above the federally mandated level. In Cape Cod, there is very little elasticity of demand, because there aren't very many indigenous workers. Hence the recipients of the $8.50 hourly wage are almost entirely foreign. Some are Irish and Australian, which follows the traditional pattern, but this year most of the new workers are from Bulgaria and Nepal. In previous years, there was an influx of workers from Brazil and Jamaica, which also has occurred this year. According to traditional economic theory, a big hike in wage rates results either in substantially higher unemployment or a similarly large increase in prices. Indeed, it is difficult to argue with that logic on an a priori basis. Yet the fact remains that on the Cape there is a labor shortage rather than a labor surplus. Have prices risen? At least in the sort of eateries that I frequent, prices go up every year, whether it is New York, Washington, Chicago, South Florida, or Cape Cod. However, there has been no evidence that prices have risen any more this year than in the past, and they certainly haven't gone up any 65%. A normal 5% increase is more like it. There are several alternative explanations. One is that because of the very strong tourist season this summer, demand has risen, hence covering the increased cost. Another is that the immigrant employees work much harder than the native Cape Codders, so productivity has risen and offset the higher wage costs. A third possibility is that profits are down and more firms than usual will not reopen next spring, although that seems unlikely. Several general economic conclusions can be drawn from the experience of this island economy:

  • When labor shortages arise, wage rates will jump substantially, especially in service industries where firms cannot close down and move their operations elsewhere.
  • There is no evidence that the boost in wage rates has caused inflation to accelerate. Instead, productivity has risen.
  • If demand were to slacken in the future, the $8.50/hour jobs would disappear, and wage rates would fall back to the federally mandated minimum wage. That, of course, is an argument for not raising the federal wage, because it could not be lowered again.
  • The difference between the current situation and previous business cycles is that the big gains in wage rates are being tied to productivity, and hence are flexible downward when economic growth slackens. Consequently, there will be no stagflation when the economy finally does slow down.
To a certain extent, this is what I have been saying all along, but the minimum wage on Cape Cod represents an extreme situation, being 65% above the national level. Even in this case, though, inflation has not accelerated as wages have soared. Michael K. Evans is president of the Evans Group and professor of economics at the Kellogg School of Business, Northwestern University, Evanston, Ill. His e-mail address is [email protected].

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