Friday, February 7, 2014

Minimum Wages and Capital Intensity

This Atlantic article, reporting on a study done by Aaronson, French and Sorkin, has been making the Internet rounds lately. The big finding: increases in the minimum wage have relatively little effect on employment levels in the fast food industry, but they do induce entry and exit by businesses. McDonalds are replaced by 5 Guys, Chipotle, etc.

Proponents of the minimum wage are probably happy to hear this because it cuts against one of the main conservative arguments against minimum wages: the loss of job opportunities for low-skilled workers. Apparently, the people laid off from a McDonald's are hired again a few months later by a 5 Guys but at a slightly higher (minimum) wage, so what's the harm?

From a business-owner's perspective, what does it mean when one type of restaurant is closed in favor of another? Perhaps different styles of restaurants work best with a certain mix of labor and capital. When the relative price of the two inputs changes, a restaurant that previously had an optimal formula suddenly becomes outdated, and it closes.

Following this chain of reasoning, it implies that a McDonald's is less capital intensive than a 5 Guys, or in other words, it benefits less from adding more capital relative to labor. From anecdotal observation I'm not sure why this would be true, but I think it's a likely implication of the Aaronson-French-Sorkin study.

What I particularly like about the paper is that it also points out a substantial economic loss associated with minimum wage increases which I had never heard about before: the cost to firms from entering and exiting the market. Bankruptcy expenses, tearing down old signs, reprinting menus, and so on are pure losses for the economy, which destroy resources without making us better off. It's not the most sympathetic or easy to sell argument against minimum wage increases, but it is some clever economics.

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