By Daniel MacDonald and Eric Nilsson
In recent testimony to Pennsylvania’s House Labor and Industry Committee on February 6, 2019, Matthew Rousu [Dean and economics professor at Susquehanna University's Sigmund Weis School of Business] made a mistake in how he used the results of a research paper that we wrote on the effects of minimum wages on prices. Since our paper was a major source Rousu used to make his argument against a minimum wage increase in Pennsylvania, we feel responsible for clarifying our findings and his mistake.
Rousu correctly points out that, according to our estimates, a 10% increase in the minimum wage is associated with a 0.36% increase in prices. We used over 30 years of data on minimum wage increases at the federal, state, and city level to come to this conclusion. Importantly, the 0.36% increase we reported was for prices in restaurants. More precisely, the price index we studied was that produced by the Bureau of Labor Statistics for “food away from home,” which largely measures the level of prices in full- and limited-service (i.e., fast-food) restaurants. We note our use of this price index on, for example, pages 2 and 6 of our research paper.
It is incorrect to assume that, because restaurant prices grow by 0.36% in response to a 10% increase in the minimum wage, that prices outside the restaurant industry would also grow by 0.36%. However, that is the mistake that Rousu made.
Having made this mistake, Rousu claims that a 65.5% increase in the minimum wage will cause prices paid by consumers to grow by 2.36%. (This is 0.36% x 6.55.) This is likely far in excess of what would be the case.
The existing research indicates that the impact of a minimum wage hike on restaurant prices is much larger than its impact on prices outside the restaurant industry. That is, following a minimum wage hike, the increase in the price of a Big Mac will far outstrip the increase in the price of, say, a pair of brand name shoes. The reason is simple: restaurants have many minimum wage workers, and an increase in the minimum wage will boost costs for a restaurant noticeably. But outside the restaurant industry, minimum wage workers are far less common, and in these industries a minimum wage hike will cause a small, or no, increase in labor costs.
The existing research suggests it is plausible to assume that prices might increase about five times more in restaurants than they do outside of restaurants. (See, for instance, Lemos, “A Survey of the Effects of the Minimum Wage on Prices,” Journal of Economic Surveys, 2008, 22 (1), pp. 187-212.)
We hesitate to provide an improved estimate for the increase in spending for the typical consumer following a 65.5% increase in the minimum wage, which is what Rousu considered. For instance, we can’t be certain that our estimate for the impact of relatively small minimum wage increases on prices will carry over to a much larger minimum wage increase.
Here, however, is a crude alternative estimate. According to the Bureau of Labor Statistics, restaurant spending makes up about 6% of consumer spending while non-restaurant spending makes up the other 94%. If we assume that a minimum wage hike increases prices in restaurants by 0.36% and increases prices outside restaurants by 0.072% (=0.36/5), then the total percent increase in total consumer spending following a 65.5% minimum wage hike will be 0.58%. This is (0.06 x 0.36 x 6.55) + (0.94 x 0.072 x 6.55).
Our crude estimate that a 65.5% hike in the minimum wage will increase consumer spending by 0.58% is very different from the 2.36% that Rousu claimed.
Daniel MacDonald is an assistant professor and Eric Nilsson a professor and department chair of the California State University San Bernardino Department of Economics. Their paper is titled "The Effects of Increasing the Minimum Wage on Prices: Analyzing the Incidence of Policy Design and Context."