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.