Noth­ing like an ex­per­i­ment on min­i­mum wages

The Pak Banker - - OPINION - Noah Smith

RE­CENTLY, McDon­ald's de­cided to raise wages for many of its hourly restau­rant work­ers. The rise is mod­est, from about $9 to about $10, but al­ready the com­pany's ex­ec­u­tives claim that they are see­ing im­prove­ments in ser­vice qual­ity: "It has done what we ex­pected it to -- 90 day turnover rates are down, our sur­vey scores are up-we have more staff in restau­rants," McDon­ald's U.S. pres­i­dent Mike An­dres told an­a­lysts at a UBS con­fer­ence... "So far we're pleased with it."

So far the com­pany's fi­nan­cial re­sults haven't suf­fered -- just the op­po­site; sales are ris­ing. With stag­nant wages one of the hottest top­ics th­ese days, and calls to raise min­i­mum wages re­sound­ing across the coun­try, sto­ries like this one are ob­vi­ously eye-catch­ing. If rais­ing wages im­proves worker per­for­mance enough to help the bot­tom line, then there's no trade­off be­tween how much com­pa­nies can af­ford to pay work­ers -- at least within rea­son -- and how many work­ers they can af­ford to em­ploy. Ob­vi­ously if you raise wages high enough -- imag­ine man­dat­ing $1,000 an hour! -- a lot of peo­ple will be put out of work. But it could be that most Amer­i­can com­pa­nies are in a safe zone where hik­ing wages mod­estly makes eco­nomic sense. But why? If it helps the bot­tom line to raise wages, why haven't com­pa­nies done it al­ready? Many min­i­mumwage boost­ers, when asked this ques­tion, point to the the­ory of "ef­fi­ciency wages." This just says that pay­ing work­ers ex­tra may make eco­nomic sense, be­cause it will make the em­ploy­ees feel val­ued and loyal, as well as en­cour­ag­ing them work harder to keep their jobs.

This the­ory prob­a­bly does ap­ply to many in­dus­tries. But it can't ex­plain ex­pe­ri­ences like McDon­ald's. Ef­fi­ciency-wage the­ory says that com­pa­nies pay em­ploy­ees more than the bare min­i­mum they can af­ford, but it as­sumes that com­pa­nies do, in fact, pay enough to get the pro­duc­tiv­ity and loy­alty boost. If em­ploy­ers like McDon­ald's aren't catch­ing on to the ben­e­fits of pay­ing work­ers more, we need to look be­yond ef­fi­ciency-wage the­ory.

One pos­si­bil­ity is that com­pa­nies sim­ply don't have a firm idea of the de­mand for their prod­ucts. In most eco­nom­ics the­o­ries, we as­sume that com­pa­nies know how much con­sumers are will­ing and able to buy at any given price. But in re­al­ity, no com­pany re­ally has this in­for­ma­tion. A de­mand curve is a purely hy­po­thet­i­cal ob­ject -- in re­al­ity, we only see how much de­mand ex­ists at the cur­rent price, not at all pos­si­ble prices.

Sup­pose I sell ham­burg­ers for $4 each. How do I know how many fewer ham­burg­ers I'll sell if I raise the price to $5? I can do a whole lot of sta­tis­tics to try and pre­dict the change in de­mand, based on de­mo­graph­ics, in­come and other fac­tors. I can look at ar­eas where burger prices are higher, and use sta­tis­tics to try to fig­ure out how those ar­eas might be dif­fer­ent from my own. But ithere's no sure­fire way -- th­ese meth­ods are rid­dled with un­cer­tainty. So rais­ing or low­er­ing my price is al­ways a risk. The only al­ter­na­tive may be to try chang­ing prices and see what hap­pens. Some peo­ple have stud­ied price ex­per­i­menta- tion, though in­ter­est­ingly it ap­pears to be more the do­main of op­er­a­tions re­searchers than econ­o­mists. But the same logic ap­plies with wages. A com­pany usu­ally doesn't know whether hik­ing pay would boost pro­duc­tiv­ity enough to im­prove the bot­tom like -- the only way to find out is to give it a try and see what hap­pens. This could be what we're see­ing in the case of McDon­ald's. The com­pany took a risk and raised wages, and the re­sults were good.

This brings us back to the min­i­mum wage. We can think of min­i­mum wages as a pol­icy ex­per­i­ment -- we try im­ple­ment­ing $15 in Seat­tle, and if it works, we try it in other cities. But it's also pos­si­ble that min­i­mum wages force com­pa­nies to con­duct ex­per­i­ments of their own. Lots of em­ploy­ers might be able to raise wages with­out be­ing forced to lay off work­ers. But they don't know this, be­cause they're too afraid to try. A big min­i­mum wage hike might force com­pa­nies to over­come this fear -- like throw­ing a re­luc­tant first-time swim­mer into a pool.

Of course, both pol­icy ex­per­i­ments and price ex­per­i­ments carry the same risk. If $15 is too high, then a wave of lay­offs could fol­low, and com­pa­nies wouldn't be al­lowed to pull wages back down -- as McDon­ald's cer­tainly would have done had their wage hike not worked out. But the idea of price ex­per­i­men­ta­tion pro­vides a rea­son why raises in the min­i­mum wage might not be so harm­ful.

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