Raise the Wage: The Minimum Wage’s Effect on the Restaurant Industry

Overview

The popular myth is that the typical minimum wage worker is a young high school student who is looking to earn pocket money in lieu of living expenses. This could not be further from the truth. According to the Department of Labor, “89 percent of those who would benefit from a federal minimum wage increase to $12 per hour are age 20 or older, and 56 percent are women” [9]. Within the past year the US has seen a number of fast food workers strike for a $15 an hour minimum wage. Would this increase be too high too fast? Back in 2007 when the minimum wage was looking to increase from $5.85 to $7.25 per hour, there was much wailing and gnashing of teeth from the restaurant industry. In 2007 I also wrote a small post which examined the possible effect of a minimum wage increase on the restaurant industry. Research studies have exhibited that an increase in the minimum wage would not be such a bad deal for the restaurant industry.

Labor and Prices  

One effect that the minimum wage increase will have on the industry is that labor costs will increase. Understandably, businesses have a strong desire to keep their costs low so they do not impact profit margins. Typically, labor accounts for about 30 percent of a restaurant’s overhead. This number is slightly below what is spent on food so it represents a significant portion of restaurant operating costs. For Darden Restaurants Inc labor makes up about 43 percent of its cost of sales [2]. Over the course of two years the federal minimum wage will increase by 40 percent. Margins in the casual dining restaurant are very slim, so any increases in costs will cut into the restaurants’ bottom line. As a result of the increases in labor costs, restaurants will be forced to raise prices on their goods. For example, Darden Restaurants Inc has adjusted prices in the past in response to state minimum wage increases. These increases were enacted so that Darden can maintain its profit margins.

Economists Daniel Aaronson and Eric French examined government-collected price data to determine the impact of minimum wage increases on prices. They found that “a 10 percent hike in the minimum wage increased restaurant prices on the whole by 0.7 percent, and prices at limited service establishments by 1.6 percent [1].”

The fast food sector of the restaurant industry provides a number of low skilled minimum wage earning jobs. Aaronson and French’s research shows that prices in this sector can expect to increase by 1.5 percent per every 10 percent increase [1]. With the minimum wage expected to increase by 40 percent over the next two years, if Aaronson and French’s model holds then prices will increase 6 percent in some states. Most likely this would occur in states that follow the federal minimum standard rates and those that do not have their own specific state minimums. Fast food chains that do a significant amount of business in states such as Georgia, Texas, Louisiana and Tennessee amongst others, could potentially feel the full impact of price increases. For states that are already above the federal minimum wage the impact could be less severe as these states may choose to not enact any further increases to their minimum wages.

Another consequence of price increases in the fast food sector would be its disproportional effect on the poor since poorer families spend a relatively large fraction of their incomes on such goods [4].

Employment

Aaronson and French in their research have constructed a model that attempts to determine the impact of minimum wage increases on employment. “In a perfectly competitive labor market, the authors find that a 10 percent increase in the minimum wage will result in a 2.5 to 3.5 percent decrease in employment. [1]”

While conventional theory dictates that minimum wage increases lead to higher unemployment levels, a study by David Card and Alan Krueger, two economic professors at the University of Princeton challenged this notion. They believe that the U.S. is far below the point where wage increases will begin to start costing jobs. Card and Kruegar conducted a study on minimum wage hikes and focused specifically on the New Jersey minimum wage hike in 1990 and its effect on the fast food industry. Unemployment rates and wages were compared in New Jersey and in Pennsylvania. What they found was that “employment actually expanded in New Jersey relative to Pennsylvania, where the minimum wage was constant. [4]”

Card and Krueger repeated this study and focused on the 1996 federal minimum wage increase with respect to New Jersey and Pennsylvania. In this instance the situations were reversed as New Jersey was already above the $4.75 mandated wage and Pennsylvania was increasing its wage from $4.25. They found that greater employment growth occurred in Pennsylvania than in New Jersey. Although they doubted that Pennsylvania’s strong employment growth was caused by the minimum wage increase they believed that the wage increase at worst, did not lead to unemployment as would be expected. “There is certainly no evidence in these data to suggest that the hike in the federal minimum wage caused Pennsylvania restaurants to lower their employment relative to what it otherwise would have been in the absence of the minimum-wage increase. [5]”

 Potential Benefits of Increased Minimum Wage

An increase in the minimum wage will produce some detrimental effects for that industry but there are some benefits to be had as well. I believe that there are employee benefits as well as employer benefits. The employee benefits are those that focus on the pluses experienced by minimum wage workers while the employer benefits are those that actually benefit the restaurants. An employee benefit would be that corporate restaurant chains would be forced to share some of their vast wealth with the people who helped create that wealth. In an economic outlook report issued by the National Restaurant Association they stated that “The industry is heading into 2007 as an economic powerhouse. [6]” The same association has also estimated nationwide industry sales of $536.9 billion next year, up 5 percent over 2006 [6]. With sales of this magnitude it may be feasible to require that more profit be passed on to employees especially since workers need a minimum amount of income to survive and pay bills. At the current rate of $5.15 and hour, “today’s minimum wage workers have less buying power than minimum wage workers had half a century ago. [7]”

Restaurant employers could benefit from the minimum wage increases as well. Card and Krueger studied restaurants in Texas after the federal minimum wage was raised from $3.80 to $4.25. They concluded that job growth was faster at those restaurants which were affected by the increase [9]. Some restaurants were not affected by the increase because they already paid at or over $4.25.

A higher minimum wage could help businesses like Applebee’s and Darden reduce their worker turnover which could increase the level of worker experience and reduce overall training costs. “High employee turnover is destructive to a company because it means that the company workforce lacks experience and continuity; it means that experienced workers have to spend much of their time training new hires; it means that managers have to spend both time and money finding replacements [8]”.

Conclusion

An increase in the minimum wage will mean that restaurants will most likely be forced to increase prices on their offerings in order to compensate for the higher labor costs. But as the article mentions, if prices increase and sales are not affected then fast food restaurant franchisers could reap the benefits of higher royalties. While conventional economics hint that higher wages will lead to higher unemployment, studies by Card and Krueger show that wage increases (at least as they apply to restaurants that rely on minimum wage workers) will not necessarily lead to higher unemployment. Their studies have shown that unemployment rates have fallen in states when the minimum wage was increased. An increase in the minimum wage could also pave the way for increases in restaurant productivity and a lowering of employee turnover.

References

[1] http://www.epionline.org/studies/aaronson_06-2006.pdf

[2] “Darden sees little impact from a minimum wage hike” Reuters News. (20 Dec. 2006) Factiva.

[3] Becker, Gary and Posner, Richard “How to Make the Poor PoorerThe Wall Street Journal (26 Jan. 2007): pg A11. Factiva

[4] http://www.uvm.edu/~vlrs/doc/min_wage.htm

[5] http://www.irs.princeton.edu/pubs/pdfs/90051397.pdf

[6] “UPDATE 1-US restaurants see 2007 sales up, oppose wage hikeReuters News. (12 Dec 2006) Factiva

[7] http://www.businessforafairminimumwage.org/

[8] http://www.huppi.com/kangaroo/41More.htm

[9] http://www.dol.gov/featured/minimum-wage/mythbuster

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s