Introduction
Minimum wage levels worldwide are rising, and the effects of these increases are still speculative. Some argue that increasing the minimum wage would incentivize low-income workers to join the workforce, mitigate increasing inflation, and reduce income inequality. In contrast, others state that an increase in the minimum wage will hinder the job market, increase inflation, and lower consumer demand. The reality is that the effects of increasing the minimum wage have state, territory, and even city-level effects that vary depending on the economic reality of the location.
This article briefly researches the basic effects that the recent increase in the minimum wage will have on the economy of Puerto Rico based on economic trends from states that implemented the same increase in the minimum wage. We discuss the historic increase in the minimum wage in Puerto Rico, the cost of living, and the Kaitz index relation in Puerto Rico and the United States. Based on these correlations we can arrive at the basic effects an increase in the minimum wage will have on the economy of Puerto Rico.
Section 1. Background Overview of Minimum Wage Increases
The minimum wage rate in Puerto Rico and the United States has been fixed at $7.25 since 2009; while the economies in both locations have been anything but static. From 2014 to 2023 30 states and 42 cities have implemented higher minimum wages than the federal minimum. Of these cities, 22 have a minimum wage of $15 per hour or more, including San Francisco, Seattle, Los Angeles, and Washington DC. In Puerto Rico, the minimum wage started to increase in 2022 and has increased every year since. The increase in the minimum wage has contributed to the increase in inflation (before 2022 inflation rates were less than 1%) but is not the only factor contributing to this increase.
In the United States, the increase in minimum wage conversation has shifted from statewide laws to implementing city minimum wages. This shift to cities as a focus of efforts to raise the minimum wage is not the result of any major changes in the legal environment. In general, cities can pass laws on specific issues for which they have explicit permission from the state, but they can pass laws within a broader category of issues, as long as they are not specifically pre-empted by state or federal laws. Instead, the recent increase in city-level minimum wages seems to reflect two developments: first, the federal minimum wage has been stagnant over the past decade; and second, even when state legislatures have enacted a higher minimum wage, it has often been below the level desired in certain high-wage, high-cost of-living cities. The city-level minimum wages are a reasonable compromise to alleviate the increasing costs of living in cities while keeping low minimum wages set by market demand in other urban areas of the state that have other economic situations and realities. This consideration could be feasible in Puerto Rico as the metropolitan area of San Juan has different economic realities than the rural areas in Puerto Rico.
Section 2. Minimum Wage Related to Cost Of Living and the Kaitz Index
To evaluate minimum wages in Puerto Rico and compare it to wages in other states we first consider the cost of living in each state and adjust wages by their index to provide comparable amounts. As per the Cost-of-Living Index (COLI) study performed by The Council for Community & Economic Research (C2ER), the states with the highest cost of living were Hawaii, California, Massachusetts, and Alaska. Puerto Rico’s COLI index is above average, and it ranks number 33 with the highest COLI in the United States. This means that the other 32 states have a lower COLI than Puerto Rico, which could be problematic as it can stimulate further migration to the United States.
To compare state minimum wages and hourly median rates accordingly for all states, wages were adjusted by their COLI. The COLI adjustment puts all wages within the US average line and comparable amounts. This adjustment demonstrates that Puerto Rico’s actual (COLI adjusted) hourly median rate is the lowest in the United States at $11.78 per hour, followed by California at $14.29, and Massachusetts at $16.25 per hour. The hourly median rate in Puerto Rico could be even lower, as jobs paid with federal funds have falsely inflated salaries in Puerto Rico. It is worth mentioning that the low hourly median in California and Massachusetts is primarily due to their high COLI. In all other U.S. States COLI adjusted hourly medians surpass $20 per hour, where the total U.S. hourly median is $22.50. When we compare the adjusted hourly median with the adjusted minimum wage by state, we can see that there is a correlation between States with high Cost of Living indexes and small gaps between their adjusted minimum wage and hourly median wage.
The relation between a region’s hourly median wage and the minimum wage is a consistent way to measure what constitutes a “large” minimum wage shock instead of a “small” one. This relation between minimum and median wages is called the Kaitz Index. Measuring minimum wages using the Kaitz index has several benefits such as measuring impact, standardizing economic factors between locations, and measuring growth. A high Kaitz index suggests the median wage is close to the minimum wage. The likelihood that the minimum wage is greater than a worker’s counterfactual market-determined wage increases when the Kaitz index is higher. When measuring intensity, if a region’s Kaitz index changes drastically before and after the implementation of a policy, we can assume that the minimum wage now affects a larger portion of the income distribution. After comparing the Kaitz Index with each U.S. State’s COLI, we can observe that most States with high Kaitz indexes also have high COLI rates.
The correlation of the Kaitz Index with the COLI can prove that high Kaitz indexes drive high COLI rates, except for outliers such as D.C., Alaska, and New Hampshire, where COLI rates are high, but Kaitz indexes are low.
As for Puerto Rico, the Kaitz Index is the highest in the United States at 78.6, and it will be higher with the recently implemented increase in the minimum wage. The increase in minimum wage to $10.50 will increase the Kaitz Index to 86.8, which is extremely high and impactful. Going over the median Kaitz index of 46 could mean that approximately 43% of the total wages in Puerto Rico could be impacted by the new increase in the minimum wage. This increase greatly impacts Puerto Rico’s economy and possibly could have many inflationary effects including an increase in COLI.
Another significant correlation from the previous graph is that most states with low COLI and low Katz indexes are states that have not implemented higher minimum wage rates and currently have a federal minimum wage of $7.25. Currently, (as of August 2024) 21 U.S. states have the federal minimum wage rate as their minimum wage rate. Even though these states have not increased their minimum wage rate their hourly median is way above minimum wage; these states let the market determine the correct wages to pay their employees to retain them.
Section 3. Effects of the Increase in Minimum Wage
The increase in the minimum wage in Puerto Rico could have a range of economic effects that will vary depending on the overall economic environment, and how businesses and workers respond. Here are some of the effects that could occur with the recent increase in the minimum wage in Puerto Rico:
Positive Effects:
Increased Earnings for Low-Wage Workers: Workers earning the minimum wage will see an increase in their earnings, which can improve their standard of living and reduce poverty. This increase could be considered a redistribution of existing income where more acquisition power is provided to low-income workers.
Boost in Consumer Spending: With more disposable income low-income workers are likely to spend more, which can stimulate demand for goods and services.
Increased Demand: Higher wages can boost aggregate demand, potentially leading to job creation in sectors that benefit from increased consumer spending.
Negative Effects:
Potential Job Losses and Reduced Hiring: As per an Economic Impact Minimum Wage Study[1] performed this year (2024), an increase in the minimum wage to $10.50 would create a temporary unemployment of approximately 12,264 jobs and 2,197 business closures in Puerto Rico. To manage higher labor costs, businesses could reduce hiring, particularly those with tight margins.
Automation: Businesses might invest in automation and technology as a substitute for higher-wage workers, potentially reducing the number of entry-level jobs available.
Increase in Prices and Inflation: In the past year inflation has increased in Puerto Rico. This increase can be attributed to the increase in the minimum wage, rent, utilities, and overall consumer prices. Considering all the variables have increased inflation in Puerto Rico, the largest portion can be attributed to the increase of cost in the human labor force due to the increase in minimum wage.
Cost Pass-Through: Businesses may pass on higher labor costs to consumers in the form of higher prices for goods and services, which can contribute to inflation.
Regional Disparities: Urban regions will be affected the most as the effects of a minimum wage increase can vary widely by region. Rural areas with lower costs of living might experience more negative effects compared to metropolitan areas with higher living costs.
Reduced Competitive Advantage: Smaller businesses with fewer resources might struggle more with increased labor costs compared to larger firms with more flexibility.
Potential Negative Effects on Low-Skilled Workers: Increased minimum wages might make it harder for low-skilled workers and young people to find entry-level jobs if businesses cut back on hiring.
Mixed and Long-Term Effects:
Increased Wage Compression: As the minimum wage increases, the wage gap between low-wage and slightly higher-wage workers might narrow, potentially affecting wage structures within companies.
Effects on Labor Market Participation: Higher wages might attract more people into the labor force or encourage those already working to increase their hours, which could impact overall labor market dynamics.
Adjustment in Business Models: Over time, businesses might adapt by changing their business models, shifting to different pricing strategies, or finding new ways to manage labor costs.
The effects of increasing the minimum wage in Puerto Rico are many and will vary accordingly with current market conditions. The effects of increasing the minimum wage are not fixed and are still a subject of ongoing debate among economists. Empirical studies often show a mix of positive and negative effects, with the specifics depending on local economic conditions and the scale of the wage increase. This being said, the increase to the minimum wage does not have standard results and will be custom to Puerto Rico’s changing economic conditions.
Section 3. Findings & Conclusion
Increasing the minimum wage is a complex policy decision with both potential benefits and challenges. It aims to improve the living standards of low-wage workers and reduce income inequality, but it can also affect employment levels, business operations, and economic dynamics. After our research, the key findings of this article include:
In Puerto Rico, the minimum wage started to increase in 2022 and has increased every year since. The increase in the minimum wage has contributed to the increase in inflation (before 2022 inflation rates were less than 1%) but is not the only factor contributing to this increase.
Puerto Rico’s Cost-of-Living Index (COLI) is above the United States average at 102.6, and it ranks number 33 with the highest COLI in the United States.
Puerto Rico’s actual (COLI adjusted) hourly median rate is the lowest in the United States at $11.78 per hour, followed by California at $14.29, and Massachusetts at $16.25 per hour. The hourly median in Puerto Rico could be lower as employment paid with federal funds has temporarily inflated the median hourly rates.
The correlation of the Kaitz Index with the COLI can prove that high Kaitz indexes drive high COLI rates. Puerto Rico has the highest Kaitz Index in the United States at 78.6, and it will be higher (approximately 87) with the recently implemented minimum wage increase.
Approximately 43% of the total wages in Puerto Rico could be impacted by the new increase in the minimum wage. This increase greatly impacts Puerto Rico’s economy and possibly could have many inflationary effects including an increase in the Cost of living.
Increasing the minimum wage in Puerto Rico could have a range of economic effects, both positive and negative. Some of the positive effects include more spending income for low-income workers and re-distribution of income, while some of the negative effects include job loss, regional disparities, and higher prices.
In conclusion, increasing the minimum wage for low-income workers does not equal economic growth, and other variables such as location and business characteristics must be considered when increasing the minimum wage. Increasing the minimum wage for all businesses equally in a state (or territory) can be harmful to small businesses in rural areas. If we were to consider minimum wage practices in high-income, low-cost-of-living states such as Texas and Pennsylvania, we would keep the federal minimum wage of $7.25 per hour and let the market define the correct hourly wages. Increases to the minimum wage rate must be well thought out and follow other state’s best practices such as Washington, Minnesota, and California, where minimum wages are set by location and Company size. Metropolitan areas such as Seattle, San Franciso, and Minneapolis have higher minimum wage rates than the rest of the state due to the higher cost of living conditions in these areas. Additionally, Companies with less than $500k in earnings (Minnesota) or with less than 6 employees (West Virginia and Arkansas) are immune to applying the set minimum wage rates by the state and are only bound to the federal minimum wage rate. These exceptions are good practices when increasing the minimum wage in a state (or territory), as the economic realities of business are not the same for everyone and cannot be treated as such. The lack of these considerations with the recent minimum wage increase in Puerto Rico could lead to increased inflation, increased cost of living, and a stagnant economy.
[1] Minimum Wage Analysis Puerto Rico General Minimum Wage, by Abexus Analytics commissioned for the Puerto Rico Department of Labor & Human Resources. https://www.trabajo.pr.gov/docs/Avisos/General%20Minimum%20Wage%20Report.pdf
Disclosure
The views in this article are solely the responsibility and the opinions of the author and HI Project Consultants, LLC. Opinions should not be interpreted as reflecting the views of any other company affiliates. All information used in this article is public, published information referenced in each table and/or graph.
About the Author
Hector Rivera, MBA, PMP, ChE, is an economic advisor with over 20 years of experience in the fields of economy, finance, and federal funds. He has been a part of “Fortune 500” financial firms in New York City, top consulting firms in Puerto Rico, and Leadership roles in Government Agencies in Puerto Rico such as COR3 and FOMB. Currently, he is HIPC’s Economist and Director.
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