Who Really Pays The Cost of Minimum Wage?

Businesses can adjust to rising input costs in several ways. This paper explains how government policy changes and neighborhood factors can affect prices, menus and closures.

By Nate Griffin – November 16th, 2021

Key Points:

• A recent study looks at effects of Los Angeles' Minimum Wage increases.

• No findings of significant loss of employment associated with the increase.

• The incidence of cost burden fell on customers in high-income neighborhoods and business owners and landlords in low-income neighborhoods.

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Income inequality is a key issue that is hotly debated today. While there are various ways to address the problem, raising the minimum wage is often the first solution to be proposed. President Joe Biden is even calling for for a $15 federal minimum wage.

The call for an increase comes as inflation continues to erode the value of the dollar all while the current federal minimum wage of $7.25 per hour hasn't budged since July of 2009.

But with growing demands to raise the minimum wage, some ask, who really bears the cost of the increase?

A recent study posted in the NBER Working Paper Series investigates the effect of the minimum wage increases within Los Angeles County. This analysis takes advantage of a natural experiment created by legislation in LA County and the California state government.

Beginning in 2016, the City of Los Angeles began incrementally increasing minimum wage in roughly dollar increments. Initially at $9.00 per hour, the minimum eventually reached $15 per hour in July of 2020. At a schedule slightly behind Los Angeles, California began incrementally raising the statewide minimum wage, which will eventually reach $15 per hour in January of 2022.

The differences between the city-mandated minimum wage and state minimum wage allow for the researchers to compare changes in menu pricing among businesses in the higher-wage areas against price changes in lower-wage areas. This creates an opportunity to understand the magnitude of the effect of the labor-price increases on menu price, while controlling for state wide trends.

Background

Los Angeles County contains 88 different jurisdictions and a population of over 10 million people making it the largest county in the US. Within LA County, there are the cities of Los Angeles, Beverly Hills, San Fernando, Santa Monica, among others, each with their own unique socio-economic profiles.

When the City of Los Angeles enacted it's minimum wage increase, Santa Monica, Malibu, and the Unincorporated parts of LA County chose to adopt the same schedule. The remaining municipalities chose to not participate, instead following the mandates of the state minimum wage.

Data

The primary source of data for this study is a survey conducted by the of restaurants located within Los Angeles county over a four-year period.

The survey included phone calls and site visits to the 800 restaurants in the sample where they collected pricing data on menu items. Pricing on these items was collected twice per year for the duration of the study.

The authors also utilize the Quarterly Census of Employment and Wages (QCEW), which provides statistics on wages in various industries. As well as the Producer Price Index for various food products to control for changes in input factor prices.

The restaurants were placed into one of four categories depending on their physical location:

1. City Non-Border: Restaurants that are more than one mile away from any municipality subject to the state level minimum wage

2. City Border: Restaurants that are more than one mile away from any municipality subject to the state level minimum wage.

3. State Border: Restaurants less than one mile away from any municipality subject to the LA City level minimum wage.

4. State Non-Border: Restaurants more than one mile away from any municipality subject to the LA City level minimum wage.

Results

Esposito, et. al. find that, despite the increases in minimum wage, the economy continued to add employment between 2016 to 2019. And the full-service and limited-service restaurant sectors also continued to increase employment during this period.

This finding is consistent with other notable studies such as the Card and Kreuger 1994 analysis of minimum wage increases in New Jersey. And more recently, a 2018 study from researchers at the University of Washington, which examined Seattle's minimum wage increase to $13 per hour. Both of those studies found little decline in overall employment as a result of the minimum wage increases.

Further, when analyzing the restaurant survey data, the researchers don't find a connection between the timing of minimum wage hikes and menu price increases. That is, while both menu prices and wages increased during the study, they did not increase in a coordinated way.

Using the State Non-Border group as a control group, the researchers find the following:

• For the control group (State Non-Border), Minimum Wages increased by 29.8 percent and menu prices increased 16.4 percent for the duration of the study.

• In the City Non-Border group, wages increased 21.4 percentage points more than the control group, but prices only increased by 1.9 percentage points.

• Using a differences-in-differences framework, the pass-through rate of wage increases on average is about 9 percent (1.9/21.4).

• Restaurants reacted differently in the higher income neighborhoods – further away from the lower minimum-wage border – where most of the minimum-wage increases were passed through to customers.

• In lower-income neighborhoods, however, almost none of the labor cost increases were passed to customers in the form of menu price increases.

Restaurants can take action in several other ways to mitigate cost increases on input prices.

For instance, restaurants in the City Non-Border group changed their menus more than those in the State Non-Border group. On average,13.3 percent more in low-income census tracts and 3.7 percent more in high-income census tracts.

Though there are likely many reasons for menu changes, these restaurants could be experimenting with new menu items to either lower costs or attract new customers.

Restaurant closures are another talking point in the minimum wage debate. For the control group (State Non-Border), about 26 percent of restaurants closed down in low-income census tracts and 24 percent of restaurants closed in high income census tracts during the study period.

City-wage restaurants further away from border competitors had a lower closure rate than the reference group. However, city-wage restaurants with nearby competition from the lower minimum-wage restaurants had a higher closure rate than the control group.

This finding indicates that restaurants that are near the border – and that also have higher labor costs – encounter fierce competition from restaurants just across the border that have the advantage of lower wages. Eventually, this causes some higher-wage restaurants to close up shop.

Policy makers should be aware of this when considering minimum wage increases.

Reference:

Esposito, C., Leamer, E., & Nickelsburg, J. (2021). Who paid Los Angeles' minimum wage? A side-by-side minimum wage experiment in Los Angeles County. NBER Working Paper Series. https://doi.org/10.3386/w28966