Tuesday, April 26, 2016

Could A Higher Minimum Wage Increase Employment?

One of the debates among the Democrats is how much to raise the minimum wage. The President wants it near $10 an hour, Mrs. Clinton is talking about $12, while Bernie Sanders and others are saying $15. Of course Team Republican freaks out as to how any increase in this wage floor will cause job losses. As David Henderson noted:
As is well known in economics, a skillfully set minimum wage, in the presence of monopsony in the labor market, can actually increase employment…To say that a firm has monopsony power is to say that the supply curve of labor to the firm is upward-sloping. That is, the firm is not a price-taker in the labor market. So when the firm that employs n workers and pays Wn per worker wants to hire one additional worker, it needs to pay more to each worker than it paid when it hired n workers. Call this new wage Wn + x. But that means that the cost of hiring that n + 1st worker is not the wage, Wn + x, that the firm pays the worker: it's that wage, Wn + x, plus x times n. The reason: it pays all the other n workers that increment, x, also. Because the firm recognizes this, it hires up to the point where the value of marginal product = Wn + x + x*n. Now, if the government skillfully sets a minimum wage a little above Wn + x, the firm knows that it can't reduce the wage by hiring fewer people and also knows that it won't raise the wage by hiring a few more people and so it hires more people. The main reason people started talking about monopsony in the context of the minimum wage in the 1990s was the study, and later the book, by David Card and Alan Krueger.
Let’s flesh this out in a hypothetical town called Old Haven – which is loosely based on the one company town where Yale dominates the labor market for certain types of labor. Let’s assume that Old Haven used to have lots of law firms hiring secretaries with the labor demand curve (D) given by c – d(Wage) and the labor supply curve (S) given by a + b(Wage) with a = negative 8000, b = 84,000, c = 1,960,000, and d = 80,000. I have pegged my example such that a perfectly competitive market would have generated a wage rate = $12/hour and employment = 1 million secretaries. One day Old Haven woke up to the horrors of Cellini & Barnes, which basically merged all of its law firms into a monopsonist that wanted to lower the wage rate to $7.94 an hour but realized it had to obey the local minimum wage of $8 an hour. Cellini & Barnes ends up hiring only 664,000 secretaries. The good news is that the local citizens rebelled and decided to pass a minimum wage of $12 an hour, which induced Cellini & Barnes to hire 1 million secretaries. I wonder if such a development would ever lead Mark Perry to write:
Recent evidence from Old Haven’s experiment of raising its minimum wage by 50% has shown that such changes in certain situations can lead to a 50% increase in employment.
Of course, a later proposal might be put on the ballot to raise this minimum wage even further at which point the Wall Street Journal starts going really crazy. Speaking of going crazy - Ed Resner (former McDonald’s CEO) writes:
I can assure you that a $15 minimum wage won’t spell the end of the brand. However it will mean wiping out thousands of entry-level opportunities for people without many other options. The $15 minimum wage demand, which translates to $30,000 a year for a full-time employee, is built upon a fundamental misunderstanding of a restaurant business such as McDonald’s. “They’re making millions while millions can’t pay their bills,” argue the union groups, suggesting there’s plenty of profit left over in corporate coffers to fund a massive pay increase at the bottom. In truth, nearly 90% of McDonald’s locations are independently-owned by franchisees who aren’t making “millions” in profit. Rather, they keep roughly six cents of each sales dollar after paying for food, staff costs, rent and other expenses. Let’s do the math: A typical franchisee sells about $2.6 million worth of burgers, fries, shakes and Happy Meals each year, leaving them with $156,000 in profit. If that franchisee has 15 part-time employees on staff earning minimum wage, a $15 hourly pay requirement eats up three-quarters of their profitability. (In reality, the costs will be much higher, as the company will have to fund raises further up the pay scale.) For some locations, a $15 minimum wage wipes out their entire profit. Recouping those costs isn’t as simple as raising prices. If it were easy to add big price increases to a meal, it would have already been done without a wage hike to trigger it. In the real world, our industry customers are notoriously sensitive to price increases
Arcos Dorados Holdings is the largest franchisee and is publicly traded. While its operating margin is around 6%, it also pays royalties equal to 5% of sales to McDonald’s. It reports payroll expenses equal to about 20% of sales. If it were true that there was no effect on menu prices, then a 50% increase in payroll costs would leave these joint profits at around 1% of sales. But here is the problem with this assumption – the minimum wage increase would apply to the competitors of McDonald’s as well. Higher prices for Whoppers will provide room for a modest price increase in Big Macs.


Sandwichman said...

IN THEORY... a minimum wage set above the "subsistence" wage but below the "equilibrium" wage will increase net social welfare -- which is an end --whether or not it increases employment, which is only a means to an end.

The trick, then, is to determine what the subsistence wage and what the equilibrium wage are. Good luck with that.

Most arguments against raising the minimum wage seem to be ignorant of such complications as public goods, externalities, multiple equilibria and the distinction between private income and social welfare. They seem to subscribe to a kind of stick-figure reckoning in which there is only supply, demand and price... and nothing else.

Oh, and the lump of labor, which is a fallacy when people are calling for shorter hours, becomes an infallible article of faith for those arguing against an increase in the minimum wage. Funny how that happens.

Jack said...

Caution, anecdotal evidence to the contrary!!

About seven or eight years ago I gained a new and good customer at the high end auto sales agency that I had worked for before my retirement. The man was the primary manager of a family owned business that ran two or three McDonald outlets in Nassau County, Long Island. I can't say that I know his profit statements. I don't even recall his personal financial qualifications that I was then privy to because of the leasing requirements for the vehicles. I can say, however, that the man had no difficulty qualifying for and paying the cost of two SUVs over a four or five year period. Each of those vehicles were priced near to $100,000. And he used them to go duck hunting. He was only one of several family members that earned their income from those two or three McDonald outlets. I'd guess that the stores were doing a bit better than is suggested by Mr. Resner's anecdote. And that is all his comment amounts to, an anecdote without supportive documentation. My anecdote has the validity of a real person spending his personal income in a real pair of transactions in the real world.

ProGrowthLiberal said...

More on what is missing from Resner's analysis:

(1) royalties = 5% of sales are profits he does not mention;
(2) rent to the owner of the property is 8.5% of sales.

So if the poor franchisee only get 6% of sales, we are very close to total profits being 20% of sales.

Yep - the franchisee is getting profits without any commitment of capital. A sweet deal.

Jack said...

"(2) rent to the owner of the property is 8.5% of sales."
And let's take a guess regarding who owns the property. In the auto sales business only a fool rents the property. I'd venture to guess that a successful fast food franchise is no different.

ProGrowthLiberal said...

Jack - a lot of the property is owned by McDonald's. A similar business model exists for Burger King. Note both of their 10-K reports both royalty income as well as income for leasing out the property to the 3rd party franchisees.

Denis Drew said...

If a minimum wage hike is priced right it will bring in more dollars for fewer hours of work -- but the employment picture doesn't end there. The extra dollars will be diverted from purchases higher wage folks would have made to buying decisions lower wage people make.

If lower wage people make exactly the same buying decisions as higher, then, the effect on employment will be null (it's a little trickier, but that's the idea). The difference will be in consumption: the lower wage will consume more and the upper less (that's the idea).

In practice, consumers tend to aim their purchases somewhat more towards vendors who hire in the same pay spectrum. Poor people buy other poor people's second-hand cars -- used car lot too pricey. Middle wage people buy off the used car lot. Higher wages put you in the showroom.

1/11/14, NYT article "The Vicious Circle of Income Inequality" by Professor Robert H. Frank of Cornell: " .. higher incomes of top earners have been shifting consumer demand in favor of goods whose value stems from the talents of other top earners. ... as the rich get richer, the talented people they patronize get richer, too. Their spending, in turn, increases the incomes of other elite practitioners, and so on."

Upshot, a higher minimum wage – if priced right – should predict a few more customers at Mickey D’s and a few less at Olive Garden. Likely that’s what we saw in Card and Krueger (1992) -- studying firms with “giant” 33% labor costs no less.

Further clarification: if orange sellers and apple sellers started out charging the same prices but orange sellers toyed with their price until they could get more money for fewer oranges from apple sellers, then, the businesses that apple sellers prefer to buy from, cabbage sellers, would suffer – but the firms that orange sellers buy from, lettuce sellers, would prosper.
* * * * * *
Anybody ever ask minimum wage earners -- say, in the south where lower living costs supposedly justify a lower minimum (never done before) -- what they want? They presumably understand the workings of their labor market -- give them some respect like union workers.

Academics don't typically think from a trapped at the bottom point of view. Trapped means you definitely want $15, not $12 -- you will wait until you get a job and then hold on to it. Presumably those who need the jobs the most will hang on to them the most.

And why doesn't anybody ever bring up the possibility that selling less labor for more dollars might be preferable -- like selling anything else. Any measurable drop in employment after a minimum wage hike may be the difference between those who dropped out because they no long need two (or three) minimum wage jobs and the less number of new employees attracted by higher wages.
* * * * * *
American born taxi drivers (me for 28 years) used to earn $800-900/wk up to a couple of decades ago -- now probably more like $400-500/wk for 60 grueling hours -- American born wont work for such. Ditto for fast food -- at $10/wk, Chicago's labor still all Mexican and Indian.

100,000 out of my guesstimate 200,000 Chicago gang-age minority males are in street gangs, I presume because they wont slave for $400/wk. Fed min was $440 half of today's per capita income ago (1968).

What you have here is a market clearance gap which rich country workers existing side by side in an exploitative American labor market with poor country workers fall into. In Chicago, fast food jobs have been outsourced to Mexico and India -- taxi jobs all over the world. :-)
* * * * * *
Why do we always talk about fast food with highest labor costs (33%). Think Walmart too (7%).

ProGrowthLiberal said...

Let me tackle this question in a couple of ways:

"Why do we always talk about fast food with highest labor costs (33%). Think Walmart too (7%)"

I talked about McDonald's here mainly be it was a former McDonald's CEO that got all huffy. But OK - the Walmart CEO might be get huffy as well one day.

There are two very different businesses in terms of value-added relative to sales (the latter being your denominator for those percentages). Walmart's cost of products are around 75% of sales so value-added is only 25%. So if Walmart wages are 7% of sales (I'll take your word for this as I have no idea) then its wages represent 28% of value-added.

McDonalds cost of food is around 35% of its revenues so its value-added is 65% of sales. You are suggesting that this is higher than what is happening with Walmart and this may be qualitatively right but as a percent of value-added, the difference is not yuuuge.

Denis Drew said...

Afraid you lost me there. Most of this discussion is over my head (and over Jimmy Hoffa's but we still function :-]).

If Mickey's labor costs are 33%, then, if the minimum wage doubles from $7.25 to $15 prices are said to go up 25% (but people have to eat). Walmart quotes its average wage as $12.50 (may have gone up) in which case I guesstimate $15 would raise that to $17.50 -- or 40% increase in labor cost. 40% of 7% is about 3% increase in prices -- not likely to cause much grief -- the competition has to do the same and as I explained above it all might send more money the way of low wage firms.

Denis Drew said...

Just to think min wage re-distribution of spending through a little further (a little is all I'm capable of):
Suppose higher income people usually spent 100 dollars on lower wage hours (fast food) and 100 dollars on medium wage hours (widget making).
Suppose after a minimum wage raise they spent 110 dollars on 90 minimum wage hours with only 90 for medium wage hours.
Suppose the minimum wage workers spent the extra 10 dollars in exactly the same places (almost): 10 on fast food and 10 on widgets.

Same hours worked -- different consumption of goodies?

Problem with that is that 10 dollars now spent for min wager hours will now buy 9 only hours of work.

But wait; the 9 min wage hours will now pay an extra 10%. Suppose those workers in turn spend them in the same proportion. Then, the extra money that goes to the next min wage hour in turn ...
... starts to sound like how banks create money with credit while holding back 10% for liquidity doesn't it?

Just saying.

Jack said...

Worse than a wage level that puts the worker below the level of a living wage are the endless arguments regarding the potential effects of a minimum wage. How about simply acknowledging that worker exploitation is rampant throughout the world and here at home.
The effects of higher wages when the wages being paid are abusively exploitative is not a subject for debate. Such an argument has been going on, and will go on, forever. That's an employer practice. Argue about things that have no clear cut conclusion as a defense against providing a fair and level playing field between labor and industry. Pay a fair wage and let the chips fall where they may. The one result that we can be certain of is that continuing to allow exploitation wages results in continuous poverty for a great many for the sole purpose of allowing a very small number of others to continue to increase their own personal wealth. Any other debate is bullshit and plays into the hands of abusive business practices.