Over the past year, we have seen wages rise considerably, especially in low-skilled jobs. According to the Bureau of Labor Statistics, the average wage for a non-management employee of a limited-service (e.g., fast-food) restaurant has risen by $1.22 per hour over the past 12 months from $12.04/hr. to $13.26/hr. That is an increase of 10.1%! Many places are even higher. In my current little slice of Heaven (Cape Cod, Massachusetts), the local Five Guys Burgers and Fries offers $16/hr.
During the past few years, as minimum wage activists have been advocating for a $15 minimum wage, many economists (myself included) argued that such a wage increase would cause a substantial loss of jobs. Yet, even at wages above $16, many firms struggle to find workers. These data present us with a conundrum: how can we explain an increase in wages without decreasing employment? Were minimum wage activists right all along that increasing the minimum wage would not lead to unemployment and that firms were simply choosing to underpay workers?
Let’s see what the Economic Way of Thinking has to say.
The problem with drawing the conclusion that minimum wage hikes wouldn’t have an effect is reasoning from a price change. Prices, including the price of labor (wage), are not arbitrarily determined. In the case of wages, wages are determined by the marginal revenue product of labor. In other words, the wage is equal to the contribution that the marginal employee makes to the company’s revenue on the margin. Thus, wages can increase in two ways: 1) increasing the productivity of labor (i.e., increasing the amount one worker can produce) or 2) increasing the revenue earned by selling one more unit.
So, what is going on in the current market? Partly, we have a shift in the supply of labor, as extended and increased unemployment insurance has kept some workers out of the labor force. Employers have had to offer higher wages to lure workers from their alternative options. But, to make these wages possible, employers also need to have more productive workers (quantity supplied must align with quantity demanded).
For employers, the current source of increase in the marginal revenue product of labor is from price increases. Over the same period (the past 12 months), we have seen general inflation. In fact, fast-food prices have risen by nearly the same amount as wages: 9.1%, according to the Bureau of Labor Statistics (CPI calculation). So, employees are more productive because they can now produce more revenue for the firm; the demand curve has shifted out. Thus, their higher wages are achievable without the need for layoffs.
But wages cannot rise infinitely. If the marginal revenue product per worker is less than the wage, then the worker will not be hired (or fired, as the case may be). And, likewise, firms cannot simply pass 100% of price increases onto customers. So, we are seeing a situation as we have now: firms remain understaffed despite unusually high wages. So, firms find other margins to adjust along to bring quantity supplied back into alignment with quantity demanded. These margins include: operating reduced hours, increased automation, reduced offerings, etc. The Law of Demand remains in effect.
So, the answer to the fallacy expressed above (that firms always could have paid a $15 wage) is that the situation has changed. Ceteris is never paribus; we must be cautious before overturning a scientific law.
READER COMMENTS
Luis Cabral
Sep 6 2021 at 6:35pm
You set the premise that “the wage is equal to the contribution that the marginal employee makes to the company’s revenue on the margin.” I understand that that’s what most econ textbooks teach, but the case can be made that it is not true in many industries. Neither are the conclusions drawn from an inaccurate premise.
Jon Murphy
Sep 7 2021 at 10:51am
Sure, but the case falls apart under empirical scrutiny. Wages do track productivity when measured properly.
andy
Sep 8 2021 at 6:25am
In such case the managers should be fired, shouldn’t they? Just by hiring some more people they would make raise the profit of their company. I’d wager that this is especially true in the low-wage industries as that is much more homogeneous market with significantly less opportunity for wage discrimination.
Knut P. Heen
Sep 7 2021 at 8:42am
The average wages of workers as a group may change because the pool of workers change. For example, if restaurants have to scale back their activity due to the pandemic, they may let the least experienced workers (and least paid workers) go first. Hence, the average wage increases because the average productivity of the employed workers increase even though the restaurant business as a whole is less productive due to the pandemic.
Moreover, the pandemic increases the cost of being employed in a sector dealing with customers in person (you may catch the disease with a higher probability). This reduces the supply of workers in the sector and introduces a risk premium in the wages.
Finally, the main problem with the federal minimum wage is that it is federal. If we had one minimum wage for each worker in the world, there would be no problem. The labor market is not the same market in all urban and rural areas. A restaurant in one area may have trouble getting workers at $20/hour while a restaurant in another area may have to declare bankruptcy if they had to offer $10/hour. This is one of the reason why some businesses favor the minimum wage. It typically kills competition from areas where land is cheap.
Jon Murphy
Sep 7 2021 at 2:27pm
That’s possible, but would only explain wages on the way to the bottom of the pandemic-led recession, not the current level of wages.
Yeah, I have been thinking about that, too. I didn’t discuss it here because Scott Sumner recently posted some data that makes me think the effect may not be as strong as I once thought.
Regardless, even with a risk premium affecting the supply curve, the increase marginal revenue per laborer (the demand side of the equation) has increased as well.
Steve Courtney
Sep 7 2021 at 10:01am
This is definitly a challenging topic. Over the past 30 yrs or so, manufacturing has left the country in mass exodus thanks to nafta and the tpp. These jobs were a great source of income, myself included.what has also happened is the increase in franchises and companies like disney buying up everything under the sun.
Lets take mcdonalds for example. Here in florida, they were paying entry level positions 8+ an hr. In upstate n.y. (where cost of living is less expensive than here in orlando) these franchuses are paying 13.5 an hr. Yet a number 1 costs the same. So whose making out here in saved labor costs? The franchisee owners and mcdonalds Corp. Also, places like Amazon and Disney,( the happiest place on earth except for those who work there) were paying squat. So my question is, whats the difference if your company manufactures ptiduct xyz and makes a billion dollars a year and pays its employees a livable wage with nice benefits, or your comoany sells products xyz abd makes a billion dollars a year and doesnt pay squat?
Jon Murphy
Sep 7 2021 at 10:59am
US Industrial Production (a measure of manufacturing output) is near a record high. In fact, US Industrial Production is about 41.5% higher now then when NAFTA was signed and went into effect. Furthermore, the US is not a party to the TPP. An an empirical matter, your statement is incorrect.
Nah. In the past few months, I have lived in Maryland, Massachusetts, and now Upstate NY. Prices vary widely. There’s about a dollar difference.
Their profit margins haven’t changed much over the years (excepting the most recent year).
Marginal productivity, like I said
Knut P. Heen
Sep 8 2021 at 11:08am
Productivity depends heavily on how busy the restaurant is. The burger price may not be that important. Volume is the important factor when margins are small.
This is an important reason why rural retail jobs tends to be less productive than urban retail jobs. Selling one burger per hour is not going to produce wages at $15/hour unless you charge more than $15 per burger.
Smw345
Sep 12 2021 at 10:54am
Realistically no minimum wages should exist as wages are determined but market conditions. By creating a barrier on one end of labor it actually limits the growth of businesses as they are less inclined to hire unskilled labor at hire wages, it becomes a risk. Alot of what we are seeing right now is a labor shortage caused by the government supplementing incomes and businesses forced to increase wages to find workers (no minimum wage require to rise wages just bad government policy). Alway, this rises aren’t do to free market principles which is why we are facing some of the worst inflation in decades. Some people might not mind inflation but it effects the poor communities the most and increase proverty. Of course that will lead to more government policies as they try to correct that but in doing so it really just pushes the issue somewhere else. The market will always self correct to find an equilibrium, that equilibrium can not be controlled unless you eliminate the free market and that would be horrible.
Warren Platts
Sep 15 2021 at 4:07pm
It seems to me you are conflating cause and effect. As you say, wages are like other prices in that they are not arbitrarily determined. Then you go on to say that wages are determined by productivity — unlike other prices that are determined by supply & demand. The exact same barrel of oil will vary wildly in price depending on supply & demand. It is the same with labor: wages will be low in a slack labor market and high in a tight labor market. Period.
No need for price increases because the price of a widget is determined by supply & demand for the widgets themselves, not the wages of the workers making the widgets. If there is no price increase, other things being equal, the owners will simply have to accept lower profits or else go out of business. (We are talking about real prices & wages, right? If workers’ wages go up but inflation goes up just as much, then the wage increases are an illusion. No doubt one of the benefits of inflation is that it acts as a stealth wage cutter!)
So we have the exact same workers making the exact same number of widgets, but in a tight labor market, you want to say the workers have magically become more productive. OK fine, but to say that it is the increase in productivity of the workers that is causing the wage increase is putting the cart before the horse, it seems to me. The changing supply & demand for labor is exogenous to individual workers; any increase in productivity is a side effect of a tightening labor market.
Jon Murphy
Sep 17 2021 at 8:02am
Productivity is part of supply and demand. Supply and demand are not arbitrary, either. See chapters 3 & 4 for a refresher.
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