The Fiction of a Harmless Los Angeles Wage Hike

Original Article:

  • Author: Michael Saltsman

  • Publication Date: March 2015

  • Newspaper: Los Angeles Business Journal

In the months since Seattle passed a once-unthinkable $15-an-hour minimum wage, other proudly liberal cities – including Oakland, San Francisco and Chicago – have embraced similar wage mandates. Now, Los Angeles Mayor Eric Garcetti has entered the fray with a $13.25minimumwage proposal of his own.

These legislative efforts have been supported by researchers on opposite sides of the country – at UC Berkeley and the University of Massachusetts, Amherst – which have released reports suggesting that wage mandates of this magnitude carry business costs that are negligible at best. (One member of the UC Berkeley team even accompanied Garcetti to pitch his proposal.)

But as cities phase in their new laws and generate unflattering headlines in the process, the academic case for $15 is looking more vacuous than scholarly.

The most recent indication that something is awry with the research came from the owner of an independent bookstore in San Francisco called Borderlands Books. In a blog post explaining the devastating impact of the wage hike on his store, the owner said it would cause an 18 percent increase in his operating costs. (The owner had originally planned to close in March as a consequence, but was given a one-year lifeline thanks to a $100 “sponsorship” fee from roughly 450 of his customers.)

That 18 percent bump in costs is a dramatic economic change for a small business like his. Yet just a few months earlier, the research team at UC Berkeley released a report estimating that operating costs for retailers in San Francisco would rise by just two-tenths of one percent. In the case of Borderlands, that means their estimate was off by a factor of 90.

What went wrong? Nationwide, the average wage for a nonsupervisory retail employee is already close to $15 an hour, which means a $15 wage mandate will affect some businesses more than others. The UC Berkeley report lumped all retailers into one homogenous category, masking the devastating impact on San Francisco’s small bookstores and corner markets when compared with their better-capitalized and higher-margin retail peers.

A similar problem plagues the research output from the University of Massachusetts team. In a recent report, activist-academics Jeanette Wicks-Lim and Robert Pollin produced a “stylized” estimate suggesting that the fast-food industry could absorb a rapid transition to a $15 minimumwage with little more than 3 percent annual price increases.

The devil is in the details. The authors start by underestimating the true cost of the wage change, claiming that a 107 percent jump in the minimum wage would only spur a 59 percent increase in labor costs. (They accomplish this by assuming, for instance, that employees currently earning $18 an hour will hardly notice that a person formerly making $7.25 an hour now makes only $3 less than they do.)

More problematic, the authors assume that restaurant sales will increase annually, and that those new dollars are the equivalent of loose change that can be devoted to covering new wage costs. Were this actually the case, restaurants would currently enjoy one of the largest profit margins of any industry rather than one of the smallest: As sales rise each year, so would their profit margins. Back on planet Earth, annual increases in sales happen in tandem with annual increases in rent, food costs and other expenses that keep profit margins steady year after year.

If you want to understand the true cost of $15, don’t try and look at a whole industry with rose-colored lenses; look at a single store. Data from Janney Capital Markets shows that a typical franchisee for McDonald’s spends about 26 percent of its sales on labor costs and associated payroll taxes, and earns a modest profit of 5.7 percent on what it sells. Even if a $15 minimumwage only causes this business’s labor costs to rise by the 59 percent estimate, prices still have to rise by 32 percent for the location to get back to the status quo – and that’s using the assumptions of the University of Massachusetts team.

Legislators and the local media might finally be wising up to the fact these reports might not match reality. A recent article in the East Bay Express noted that restaurants coping with aminimumwage increase in Oakland were raising prices by up to 20 percent, rather than the 2.5 percent projected by the UC Berkeley team. And in Los Angeles, Councilman Mitch O’Farrell complained about the city’s “outrageous and unacceptable” selection of UC Berkeley to conduct a supposedly independent analysis of the mayor’s minimumwage proposal.

He’s right to be upset. If his fellow legislators are interested in subjecting businesses to an unworkable wage mandate for ideological reasons, that’s their prerogative. But they shouldn’t fool themselves that there’s an economic method or a free lunch in this madness.