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.