By Hillary Hoffower and Nick Lichtenberg in Business Insider
The federal minimum wage is currently at a standstill.
Image credit – Lucy Nicholson – Reuters
President Joe Biden campaigned on raising the minimum wage from $7.25 to $15. But the $15 proposal was struck from his stimulus plan for not meeting the rules of budget reconciliation. Progressives have long been campaigning to hike the minimum wage, but have met with opposition from Republicans as well as more moderate Democrats. It hasn’t been raised since the last time Biden was in office, as vice president in 2009.
At its core, the impasse seems like the result of political differences. But what if economics could explain it? A wonky economic theory may hold the key to why it’s stubbornly stuck at $7.25.
Meet the “Optimum Currency Area” (OCA) theory, coined by the late Canadian Nobel Prize-winning economist Robert Mundell. He created the OCA theory in 1961 as an idea of currency allocation extending beyond national borders. Geographic and geopolitical regions that share similarities could also share a currency for greater economic efficiency, he proposed.
These similarities are a large and integrated labor market; flexibility in pricing and wages and capital mobility; a centralized budget; and similar business cycles.
Mundell’s theory laid the groundwork for the euro, which was implemented in 1999 across 19 countries in the European Union. Whether the EU has grown beyond an OCA is an open question, as some pointed to Greece’s struggles during the Great Financial Crisis in arguing that the region that shares the currency is too vast.
Maybe the US has grown beyond being an OCA, as well, as Will Wilkinson, senior fellow at the left-leaning Progressive Policy Institute, argued in a recent edition of his “Model Citizen” SubStack. While the US has characteristics of Mundell’s theory, as a homogenous nationalized market with one national currency — the dollar — it also comprises various geographical regions with different living costs and underlying economic conditions. And that’s where the minimum-wage debate comes in.
$1 isn’t the same in West Virginia as it is in California
Both the euro and the dollar are floating currencies, which change value based on how the currency trades against other countries’ currencies. A pegged currency, meanwhile, is fixed to another currency or another measure of value. Until the 20th century, many currencies were pegged to gold.
But Mundell’s theory says that floating national currencies, like the dollar, are “internally pegged,” which means that while the US dollar’s value fluctuates in the market internationally, it’s fixed domestically. As Wilkinson explains, “the West Virginia dollar is pegged to the California dollar is pegged to the Michigan dollar, and so on.”
The problem is that those states have very different economies and costs of living, and a dollar in West Virginia will go a lot farther than a dollar in California.
So, a plan to raise the minimum wage in all states could run into a problem where the appropriate floor is different in different places.
That happens to be exactly the reason cited by moderates who voted against the minimum-wage hike, such as Sen. Joe Manchin of West Virginia, who said he favors an $11 federal minimum wage as more affordable for local businesses.
Arindrajit Dube, a professor of economics at the University of Massachusetts, Amherst, told Insider that one of three ways the federal minimum wage could come out of its log jam would be allowing for it to differ by region or having a longer phase of increasing the threshold in different parts of the country. But progressives are strongly opposed to that, he said.
Dube said there are similarities between the Optimum Currency Area (OCA) theory and thinking about where the federal minimum wage should be, although he said the theory is mainly concerned with how much factor mobility (the ability to move production like labor) there is between integrated areas, rather than just comparing cost of living.
“With minimum wage, there are a lot of local differences in costs of living within relatively nearby areas,” he said. “Even if there are moderate amounts of labor mobility, there still may be other reasons why prices and cost of living and wages are somewhat different or granular.”
Even within one state, he added, there might be substantial differences such as a rural and urban divide. He cited Oregon as an example of a systematic way of doing regional variation. The state has a three-tiered state minimum wage system: the Portland metro area, smaller cities and metro areas, and rural areas. This means states aren’t quite perfect OCAs, either.
What $15 is worth depends on where you live
In January, Insider’s Juliana Kaplan and Madison Hoff analyzed just how much $15 is worth using regional price parities from the US Bureau of Economic Analysis for 2019, the most recent data available. According to the BEA website, this compares “buying power” among different places in the US — how expensive goods and services are in a state or city, relative to average national prices.
Per their findings, 17 states have regional price parities above the national average. You can see how that translates to the value of $15 per the map below.
Hawaii, for example, has the highest regional price parity of 119.3, meaning its state price level is 19.3% higher than the overall national average. A minimum wage of $15 would really be worth $12.57 in the state. In Mississippi, however, which has the lowest regional price parity of 84.4, the value of $15 is worth $17.77.
“In the most expensive states, costs are 15% to 20% above the national average, while these costs are 15% to 20% lower than average in the most affordable states,” Felix Koenig, assistant professor of economics at Carnegie Mellon University’s Heinz College, told Kaplan and Hoff. Koenig said this implies $1 “buys approximately 40% more in the cheapest states compared to spending it in the most expensive state.”
The politics of the minimum wage are important, too
Of course, there are more technical reasons that more directly lead to the current standstill. Namely, Dubesaid, there’s nothing to propel a federal minimum wage hike right now. He added that it needs another legislative vehicle for Congress to push it forward, such as if it were included as part of a bill being passed through reconciliation. It could also pass with a 60-vote majority, he said, but that would require a compromise.
Ben Zipperer, an economist with EPI, told Insider that Republican legislators and certain Democratic senators are the main obstacle right now to passing a minimum wage hike.
But regional variation could be factoring into partisan differences in whether a minimum wage hike is necessary. Blue states are typically higher cost-of-living areas than red states, which might explain why Democrats are pushing to raise the threshold more than Republicans.
“I actually think our current system is appropriate: we set a federal floor, and then states can set wages above that. The federal floor is the absolute minimum an employer should be allowed to pay someone for an hour’s worth of labor,” Zipperer told Kaplan and Hoff back in January.
“In fact, EPI’s Family Budget Calculator shows that this year a single adult in virtually every area of the country will need at least $15 per hour in wages in order to make ends meet, meaning $15 is an appropriate minimum wage nationwide.
For now, Senators Mitt Romney and Kyrsten Sinema are working together on a minimum wage proposal, and some progressives have urged Biden to overrule the Senate’s decision. Until then, the American OCA will live on, imperfect as it is.