Sometimes, the wheels of economics take some time before a market gets to a new equilibrium. This is particularly true in labor markets. Economists have long recognized that wages are “sticky downward” (explained at the end of this article). We have also examined labor hoarding by employers, search costs of looking for a new job, and a host of other factors that are, taken together, unique to labor markets. But, although it may take a while, the law of demand remains immutable: if a firm raises a price for a product and nothing else changes, the quantity of that product demanded will fall. This leads us to an update on the $20 fast-food minimum wage (which I previously wrote about here).
Franchise Owners Cutting Hours
Los Angeles TV station KTLA recently ran a story describing yet another factor that contributes to slow adjustments in the labor market. This is unpaid labor by firm owners. “California fast food franchisees are responding to $20 minimum wage by cutting hours” is the headline. The story describes the plights of several workers who have seen their hours reduced. In many cases, the reduction has been to under 30 hours per week. This, of course, gets around the ACA requirement that full-time employees must be provided health insurance.
When there are fewer hours worked, sales should decrease. One reason is that fewer hours can lead to shorter business hours. But the owners of these restaurants don’t like that solution. So they are working shifts themselves. Although the article doesn’t say this, my guess is that they’re not paying themselves $20 per hour. In fact, I’ll go further and speculate that the wage these folks are earning is $0. Talk about a cost-cutting solution.
KTLA ran a survey. The results are interesting, but there were only 82 responses when I captured this:
KTLA survey results (July 12, 2024, 3:30 left coast time)
A Hypothetical Example
Let’s take a simple example. Suppose Tony’s Shakein’ Shop has five employees. Each works 29 hours per week. Tony is a good boss. He pays his employees $15 per hour. But no health insurance. Tony’s weekly payroll is (5 employees) x (29 hours/week/employee) x ($15/hour) = $2,175 per week. (Download the very simple Excel worksheet here.)
Now the minimum wage rises to $20. If Tony doesn’t change anything, the weekly payroll will increase to $2,900. And Tony’s profits will be $2,900 – $2,175 = $725 lower each week. That’s $37,700 per year. Quite a dent.
What can Tony do? One option is to reduce employee hours. If each worker is limited to 21.75 hours per week, the total weekly payroll will be $2,175. Problem solved!
Or maybe not. Total hours worked falls from 145 to 108.75. With fewer worker-hours per week, Tony will not be able to produce and sell as much. Revenue and profits will fall. What can Tony do?
KTLA interviewed several fast-food franchise owners. They found that some were filling the gap, working the unfilled hours. In our example, Tony would have to work 36.25 hours per week to fill the gap (140 – 108.75). Here’s the summary of the calculations.
(click for larger image)
He may be able to handle that workload for a while. But remember, those hours are on top of running the business and everything that entails. Eventually, Tony will be exhausted. At that point, he will face some very hard choices.
The trick in all this is paying Tony $0 per hour. As noted in many other contexts, when a minimum wage is imposed, the true minimum wage is $0 — the wage earned by those who lose their jobs. In this case, it’s Tony who takes the hit.
Addendum: Sticky Wages
As noted above, economists are pretty sure wages are “sticky downward.” That means the labor market is slow to adjust to excess supply. In the labor market we call that unemployment. When unemployment increases, the real wage rate (the dollar wage adjusted for inflation) should fall. As the real wage falls, quantity demanded of labor rises and quantity supplied falls. This moves the market back toward equilibrium. The problem in the labor market is that this process takes longer than most other markets.
One good explanation is the search costs of unemployment. I used to tell this story to my students.
Suppose you’ve just been fired. You know why. Management didn’t provide enough resources. Marketing couldn’t identify ways to target the market segment. Sales didn’t understand the product. Engineering screwed up the user interface. With all that, you’re not going to accept the first job offer that comes along. Instead you’ll keep looking. You are unemployed.
From a macroeconomic perspective, you don’t know whether you lost your job because of what happened in your former company or because the economy was headed into a recession. In fact, the second reason probably didn’t even occur to you. So you continue to believe the labor market is fine, you were a good employee, and you just need to wait until the right job comes along.
If, in fact, a recession is starting, that job may not exist any more. That means you’ll wait quite a while. Which means you’ll be unemployed longer than would otherwise be the case. To economists, you are foolishly holding out for your former wage when the market wage is falling. Of course, since most people aren’t aware of macroeconomics, they are not foolish, merely ignorant.
The result: the average wage rate does not fall as fast as it would if unemployed workers understood macroeconomics and were fully aware of the current economic situation. This comes close to describing “rational expectations.” It also explains why rational explanations models do a pretty bad job of modeling real-world behavior.
Wages are sticky downward. After you’re fired, you hold out longer for your previous wage. If you get a raise, it’s because you were more productive, worked hard, and earned it. The idea that your raise might be to just keep up with inflation is anathema. Therefore, wages are not sticky upward — they are flexible.
I hope this explains the macroeconomics of the labor market. There are about two decades of good labor market theory that started around 1980 and ran through 2000. Since then, much of the work has been empirical.
Comments and questions are welcome.
