So, low-wage workers are being hurt in the current economy not only by weak labor demand for the least skilled, but also by the eroding of institutions that have historically protected them. In the current debate, however, the weak demand explanation has received most of the attention. The eroding institutions argument has received short shrift given its importance.
Workers with higher skills are always less likely to be low-wage workers and, in this regard, policies that stress skill upgrading are sure to be helpful. But the findings reported here show that the low-wage share has become better educated over time — and that this educational upgrading has failed to lower the share of low-wage workers because of real-wage declines even within education categories. Thus, skill improvements alone will not solve the problem of the increasing share of the workforce in the low-wage sector, particularly in the short and medium term. The steady increase in the likelihood of low-wage work — irrespective of changes in the economic returns to work and the characteristics of the labor force — makes a powerful case for policies that improve the demand side of the labor market, address the erosion of labor market institutions, and supplement the earnings low-wage workers can command with wage and income supports.
Increasing Labor Demand. The post-1996 period of the current economic recovery provides excellent evidence that increasing the demand for low-wage workers can play an important (and underappreciated) role in raising the wage levels and employment opportunities of low-wage workers. Persistently low unemployment rates have led to dramatic real wage gains for low-wage workers.21 And the tight labor market has led to historically large declines in the unemployment rates of disadvantaged workers who have been left behind in prior economic recoveries. Between 1996 and the first half of 1998, for example, the overall unemployment rate declined by 0.9 of a percentage point, to 4.5 percent. But the unemployment rates for workers traditionally lower down in the hiring queue declined more than the average — a 1.5 percentage point drop for African Americans, a 2.0 point drop for Hispanics, and a startling 3.5 point drop for young (ages 18 to 35) minority high school graduates (a particularly disadvantaged group).
This suggests the need to rethink the question of when wage growth threatens to become inflationary, in the sense of triggering ever-increasing price growth. Conventional wisdom held that inflation would begin to spiral upwards with the unemployment rate pegged at 6.0-6.5 percent. This parameter guided Federal Reserve monetary policy through much of the 1980s and 1990s, with low-wage workers suffering as a result. But the recent sharp decline in the unemployment rate to 4.5 percent — with no accompanying acceleration of inflation (indeed, inflation is also at a historic low) — has taken the unemployment rate as a key indicator into uncharted territory. The evidence is quite clear about the distributional consequences of the unemployment/inflation tradeoff. Declines in unemployment are more beneficial to lower-income families, whose wages are more sensitive to labor market tightening. Inflation at modest levels does more damage to those at the top of the income scale. (Spiraling inflation, obviously, hurts everyone).22
Strengthening Labor Market Institutions. Minimum wage law and union membership are the major factors at issue here. The general consensus is that the declines in the real minimum wage and in union membership explain up to two-fifths of the increase in wage inequality since the 1970s.23
The minimum wage has played an important historical role by providing a wage floor below which employers could not set wage rates. This floor is particularly important for female workers who, as already noted, represent close to 60 percent of minimum wage workers. In recent years, the 10th percentile of the female wage distribution has, for all practical purposes, been set by the legal minimum. Thus, the fall in the minimum wage of 30 percent in real terms over the 1980s played a major role in both the expansion of low-wage work and the increase in wage inequality, particularly among women. Here again, the conventional wisdom among economists has changed. It was generally held that increases in the minimum wage led to job loss among the low-wage workers it was supposed to protect. But now a growing body of empirical research has shown that this is not true, at least for increases of the magnitude implemented in the United States. The most recent 90-cent increase, for example, lifted the earnings of low-wage workers without leading to job losses.24
Unions have also played a historical role in the labor market, increasing the bargaining power and compensation both of their members and of workers outside the unionized sector. As with the decline in the minimum wage, empirical research has identified the decline in union membership among the workforce as an important contributor to the increase in wage inequality. As noted earlier, low-wage workers have historically been under represented by labor unions. However, recent efforts to organize low-wage service workers do look promising.
Wage and Income Supports. A stated goal of welfare reform is to make work pay.25 One policy that has been implemented to increase the wages of low-wage workers beyond what they command in the market is employer-based wage subsidies. The problem with this approach is that, as the minimum wage literature has pointed out, the demand for low-wage labor is relatively insensitive to changes in its price — implying that large employer-based wage subsidies will be required to generate the desired increase in employment, and that the negative trends over the past few decades have made such an approach ever more expensive. Nevertheless, certain approaches have had some success, particularly those that are combined with training and job development.26
An employee-based wage subsidy — such as the Earned Income Tax Credit — is generally considered a more effective way to subsidize work. Transportation and child care subsidies will also help, by directly raising the spendable incomes of low-wage working families.