Tuesday, February 7, 2017

The $15/hour Minimum Wage - A Parable

Unintended consequences of public policy are often glossed over by the public and politicians alike. I can understand the sympathy for a minimum wage. Its proponents simply want all workers to enjoy a comfortable life. However, they rarely acknowledge the downsides of arbitrarily dictating the value of certain work in society. I thought I would attempt to show how raising the minimum wage can result in unemployment or foregone employment with a simple story. This example is not meant to argue that the unemployment rate in a country or state will necessarily go up when the minimum wage is increased. The economy is too complex and there are too many interacting forces working simultaneously to make such a bold claim. However, it should make the ardent supporters of a large increase in the minimum wage understand more fully its impacts on workers, businesses, and customers (i.e. society).

Eddy & Anne's Bake Shop
Eddy and Anne are bakers who met in school and co-own a small baked goods shop. They pride themselves on quality ingredients, hand-mixed batters, and friendly customer service. The shop is open Monday to Saturday from 8:00 am to 6:00 pm. Their staff consists of four bakers and one cashier. The bakers are knowledgeable and hard-working and earn $10 per hour for their efforts. Each baker is allotted one day off per week. The cashier is a young woman, Sally, who takes college classes at night while working 5 days a week at the bakery. Sally earns $8 per hour as the cashier. Eddy and Anne value her interaction with their customers and her positive attitude.
The owners have put up their own money and taken out loans to start the shop. They have chosen a modest annual salary of $50,000 per owner to support their respective families. The total labor costs, including the owners who work in the shop filling in for bakers and the cashier on their off days, amount to about $220,500 annually. The shop makes $364,000 in revenue in an average year and incurs expenses (rent, cost of ingredients, equipment) of $122,000 each year. This leaves a net profit of $21,500 at the end of most years. Eddy and Anne typically pay their staff a holiday bonus of $1,000 per employee. The other $16,500 of profit is stored away in the company bank account to insure against a down year in sales, increases in costs, and/or to invest in new equipment or ingredients.
The state where Eddy and Anne live and work has recently passed a minimum wage law requiring employers to pay $15 per hour to all full-time employees. Every worker at their shop must now be paid at least that amount, given their full-time status. This law alone will increase their labor costs by $67,770 and turn their net profit of $21,500 into a net loss of $46,650.
Eddy and Anne consider many options. They think about reducing their own salaries, but they are already taking modest salaries for entrepreneurs who have risked their own savings. Besides, even lowering their salaries to the new minimum wage would only cut the net loss to $24,700. They reconsider a crucial element of their business: hand-mixing. Customers seem to like the idea of hand-mixing and Eddy and Anne figure they may pay a premium price partly because of this practice. However, to keep their business afloat they reason they can invest in 4 stand mixers and layoff their least experienced baker. The don’t want to sacrifice any of their beloved staff, but the mixers will save time and increase the amount of work each baker can perform. The mixers cost $700 a piece for a total of $2,800, but that will be far offset by the salary of $37,650 that they save by laying-off one baker.
That one change would save the bakery about $35,000 but would still leave it with a net loss. Eddy and Anne think about raising prices, but their customers already pay a premium compared to grocery store baked goods. They worry that increasing prices by the amount they would need to break-even would drive away too much business. And they still would not be operating at their previous profit level.
Eddy and Anne decide that as much as they hate it, they should lay-off Sally as well. She makes the shop a better place, but the owners can’t reason paying nearly twice what they normally would for a cashier. Instead, they decide to split days working at the register and with the bakers. One week Eddy will work 2 days at the register and 3 days in the back with the bakers, then flip with Anne the next week and work 3 days at the register and 2 days in the back of the shop. This last change would reduce their labor costs to $212,950. That would be below the original, pre-minimum wage salaries of $220,480 by about $7,500.

The owners of the bake shop have had to sacrifice one element of operations they considered a competitive advantage over grocery stores. They also had to fire two beloved employees whom they also consider friends. Yet, with the layoffs and use of new equipment they anticipate being able to keep the shop open and operating at the same profit level as usual. The remaining bakers on staff will be $12,550 richer each year, but at the cost of two of their fellow employees’ old salaries. It will be a bittersweet reward for them. The shop will survive and the community will continue to enjoy its treats, but they may not know or understand the costs of the new minimum wage.