Minimum Wage Debate: Why All The Fuss Now?

Repost from a year ago…

This is obviously an extremely complex issue. One can formulate many questions regarding this topic, and there is no clear answer because each person will think differently based on his/her values and opinions. One can ask “How much should the minimum wage be?”. On one side, people will say that $x per hour is necessary due to reason x, y, and z, and the other side will argue that raising the minimum wage will kill jobs. You can probably figure out how each political party will generally align itself with. I also have a belief and have my answer, but that’s really just an opinion, so that’s not what I am going to be writing about here.

Rather, I would like to pose a different question. The current minimum wage has been in effect for quite some time now (and even raised a few times, albeit very incrementally). I am sure there has been calls in the past to raise it significantly, but the movement and the attention they are getting is now higher than ever before. So what’s so different now?

When I think of a typical minimum-wage job, I (like most people, I’d imagine) think of fast-food, or maybe retail. For both, I think teens play a major role in those jobs, primarily because there simply are not that many jobs that teens are qualified for.

The chart below shows the unemployment rate of 16-19 year old from ’02 to ’14. Teen unemployment rate, which hovered around 16-17% prior to the Great Recession, shot up to almost 26% in ’10. It has come down since then, but there is another side to this story.

* Source: Bureau of Labor Statistics, United States Department of Labor

Bureau of Labor Statistics (BLS) calculates the unemployment rate by dividing the number of unemployed by the labor force. This labor force figure, however, is not the population. Rather, it is the number of people excluding those not in the labor force. Compared to pre-recession years, 16-19 year old age group has seen a dramatic increase in “Not in labor force” figure. By having more people out of the labor force, it window-dresses the unemployment figure to be better looking than it would be otherwise. Check out the big decline in labor force participation rate for 16-19 year old age group:

* Source: Bureau of Labor Statistics, United States Department of Labor

As you can see above, the labor force participation rate has dropped from over 47% in ’02 to less than 34% in ’14. Another significant highlight is that we really have not seen any improvement here in recent years. So what did I mean by window-dressing above? The chart below shows the percentage of employed 16-19 year old. It is a “simple” percentage, just taking number of employed and dividing it by population.

* Source: Bureau of Labor Statistics, United States Department of Labor

While ’14 has been better than ’10, the amount of improvement is much smaller than what is depicted in the first chart above. In reality, there is significantly less number of teens working overall, in any job, compared to pre-’07.

It doesn’t end there. The chart below shows the percentage of 16-19 year old working in “Leisure and hospitality” category (which covers fast food) from ’03 to ’14. Not only are there less teens working overall, percentage of working teens in that category has declined. This naturally means that there are more 20+ year old working in this space, probably receiving, on average, less wage than before. And I would bet that a lot of those 20+ year old are ones with a family, which means that earning minimum wage will be insufficient.

* Source: Bureau of Labor Statistics, United States Department of Labor

I also don’t think the issue is within this category alone. BLS publishes data on people receiving prevailing federal minimum wage (or below). The first chart below shows the 16-24 year old age group, and the second chart shows the 25 and over age group.

* Source: Bureau of Labor Statistics, United States Department of Labor

* Source: Bureau of Labor Statistics, United States Department of Labor

In both charts, you can see that there are still unusually high percentage of people receiving minimum wage, despite the improvement we made since ’10.

The logical question to ask here is “why did we not see this in ’10 when things were even worse than now?”. It’s hard to draw any direct correlation to answer this question, but I believe the widening wealth gap angered these workers even more. Since January ’10:

  • S&P 500 index has doubled.
  • Real estate prices, according to S&P/Case-Shiller U.S. National Home Price Index, has gone up about 15%.
  • Even bond prices went up with 10-year Treasury yield going from 3.61% to 2.15% (!).

Meanwhile, minimum-wage workers did not get the chance to participate in those asset price increases because they don’t own those assets.

In summary:

  • The “Great Recession” in ’07-’08 permanently took away some jobs from certain sectors of the economy.
  • Those people affected by this structural damage (older workers, presumably with family) went to seek employment elsewhere, even if they are overqualified for the job. This meant that many workers found themselves getting paid less than their previous jobs, sometimes even minimum-wage.
  • Meanwhile, people who would normally work those minimum-wage jobs (teens) found it more difficult than ever to gain employment.
  • We now have high percentage of the workforce at or below prevailing federal minimum wage.
  • Wealth gap has widened between those making minimum wage and the rest of the population.

8% Rate of Return: Realistic or Fantasy?

Many personal finance articles, especially those devoted to savings for retirement, tend to use the 8% figure as expected rate of return over time.  These articles typically carry a sentence: “if you save $x starting age x, you will have $x at age 65, assuming 8% return.”

While I do not question the value of compounded return (money making money) and the need to save for retirement, the 8% rate of return is misleading for the general population.  These articles state that the stock market has returned 8% over long-term, and that is certainly true, depending on the time period evaluated for the calculation.  Nevertheless, I believe the general population cannot count on having 8% compounded annual growth rate (CAGR) over the next 30 years.

The Lump Sum Dilemma

Before discussing why I believe 8% CAGR is unlikely, we first need to establish the reality facing the general population: we do not have a large lump sum to be invested.  Why is this important?  The lump sum dilemma has significant impact in your end balance.


From 6/1/1970 to 6/1/2000, the S&P 500 index went from 72.72 to 1,454.60, representing 10.5% CAGR over the 30-year period.  As you can see on the chart, the index had an amazing 30-year run.  I intentionally cherry-picked the 30-year period with one of the best returns for the index in modern era because the high rate of return magnifies the effect of lump sum dilemma.

So let’s assume that we will earn 10.5% CAGR over the next 30 years.  If you invest $180,000 and earn 10.5% CAGR over the next 30 years, that investment grows to $3,598,660.24.  Amazing power of compounded interest is at display here as the balances increases almost 20-fold and you have almost $3.6 million in the bank.  Nice!

Unfortunately, this does not really apply for the general population as described above. We save incrementally: for example, $6,000 annually for 30 years, ultimately investing $180,000 total.  Under this scenario, the investment grows to $1,085,288.97 at the same rate of return (10.5% CAGR).  While it is still a nice outcome, the balance is more than $2.5 million less than the lump sum investment.  Put another way, the balance is 69.8% less.

In addition to preventing us from taking full advantage of compounded interest, the lump sum dilemma leads us to the next problem.

Market Volatility


Here is the chart that shows the S&P 500 index from 3/1/1985 to 3/1/2015.  Over this 30-year period, the index has gone from 180.66 to 2,044.16, representing 8.42% CAGR.  If we began saving $500 monthly in 3/1/1985 at this rate, we would have $762,343.13 on 3/1/2015, thanks to monthly compound rate of 0.676% (resulting in 8.42% annual rate).  However, this does not mean that same can be said for investment in the stock market.  If we bought $500 worth of S&P 500 index on a monthly basis beginning in March 1985, our investment would be worth $610,494.07 on 3/1/2015.  The result is still good as we gained 7.23% annually, but the end balance is 20% less.

Not having the lump sum for an investment, and as such, investing on a monthly basis introduces a wild variable: market volatility.  Due to market volatility, time point to time point CAGR most likely will not translate to actual realized CAGR if you invest monthly.

In the above example, the end balance was about 20% less, but that difference could be larger with some bad luck.  From 2/1/1979 to 2/2/2009, the S&P 500 index went from 96.28 to 735.09, representing 7.01% CAGR.  If we began saving $500 monthly in 2/1/1979 at this rate, we would have $585,807.92 on 2/2/2009, thanks to monthly compound rate of 0.5662% (resulting in 7.01% annual rate).  In comparison, monthly $500 investments into S&P 500 index over that same time period will result in $406,306.63.  This balance is 30% less, and represents 4.98% CAGR.  We lost over two percentage points.

Repeating History

We have now seen that the lump sum dilemma and market volatility will make it extremely difficult to realistically obtain 8% return over the long term.  Even if we did not have those two problems however, it may still be difficult to realize that rate of return because future simply may not provide what the history has provided over the last 60 years or so.

The S&P 500 index closed at 2,053.40 on 3/13/2015.  Even if we eliminate the lump sum dilemma and market volatility as variables, S&P 500 index will have to  be at 20,662.66 on 3/13/2045 for investors to get 8% return.  Can we get to that level?  In the past 60 years, we’ve had many advancements in variety of fields: agriculture, technology, finance, and transportation to name a few.  Will we have something equivalent in the next 30-60 years that will result in similar creation of wealth?  If yes, what will they be?

Pitfalls of Overestimating Return

You may have caught a glimpse of the power of compounded return in earlier examples.  What was not clear, however, was the rather dramatic effect of lower rate of return.  The chart below shows $100,000 initial investment with various rate of return over 30-year period.  Each percentage point drop in the rate of return has significant impact on the balance 30 years later.  Think carefully in your retirement planning to avoid ending up with less money than you envisioned.