Last week the Seattle City Council passed a massive increase
in the minimum wage. Washington State’s
minimum wage was already $9.97, and the Seattle initiative increases that to
$15 an hour over three years. There is a
slower phase in for small businesses, but in one of the most controversial
features of the new law, franchisees are considered big businesses.
This was clearly done to rope in the fast food industry, one
of the major employers of minimum wage jobs.
Most fast food outlets are owned by small businesses that franchise
their advertising and operating systems from large corporations. In many cases the owners are working side by
side with the employees that just got a 50% raise, courtesy of the Seattle City
Council.
The idea here is that if all the fast food stores have their
costs raised at the same time, all of them will have to raise prices
simultaneously. No one will get a
competitive advantage. If labor accounts
for 10 to 20% of the cost of fast food, and that cost goes up by 50%, then prices
will go up by 5 to 10%. Profit margins
will go down, but overall profits stay the same for the industry as a whole. The
hope is that even if prices go up by 5 to 10%, sales will remain constant,
keeping employment constant. You’d pay
an extra buck for your Big Mac and fries, wouldn’t you? Sure you would. At least, that’s the theory.
This is all riding on an economic concept called price
elasticity of demand. Represented
graphically, price elasticity of demand is the slope of the demand curve on a
supply and demand chart. If elasticity
of demand is high, a small percentage increase in price leads to a large
percentage drop in demand. If demand is
relatively inelastic, even a big increase in price does not lead to a big drop
in demand.
An example of inelastic pricing is gasoline, at least in the
short run. When gas prices spike, you
still have to get to work, so you grumble, but you also buy the amount of gas
for your commute. The plan is that
things will work out the same way for fast food, because, hey, you gotta eat.
There are two things wrong with this plan. One, even if the price elasticity of demand
is low, it is not zero. With gas, when
prices go up, you stop taking unnecessary drives. You slow down a little, coast when you
can. In the longer run, you trade in for
a more full efficient vehicle. You do
all these things to use less of the more expensive product.
The same adjustments will occur when fast food prices go
up. People will brown bag it more, or
forego getting a soda with their chicken tenders. Witness the popularity of dollar menu items
if you think people are not sensitive to the price of fast food.
The other problem is that it assumes that businesses will
remain static in light of this big addition to their costs. The rate of investment in labor saving
equipment will increase, to minimize even further the labor content in the
product. Equipment that now does not
have a fast enough payoff period to be worth doing will make a lot more sense
once these wage increases begin to bite.
With lower demand overall, and labor savings a high
priority, labor will get squeezed. The
remaining workers will get paid more, but there will be less of them. But that’s okay, because the displaced
workers will just go to …
Actually, the employer of last resort for people with low
literacy and no salable skills has been fast food. Fifteen dollars an hour doesn’t help if you
don’t have any hours. I don’t think this
is going to end well for Seattle.
