The restaurant trade and the minimum wage

I see a lot of worry. My clients have seen once-in-a-lifetime declines in demand and have struggled to make payments that don’t go down when revenues do.

That means office rent, lease payments, and bank debt.

At a recent gathering of restaurant owners, one man took me aside and worried about another cost that he can reduce, but doesn’t want to.

I will give you a second to ponder this. A small business owner can reduce his costs and is choosing, for the moment, not to.

The cost is labor. And he is hiring low-wage workers, paying just over the minimum wage (currently $7.25 as set by the U.S. Department of Labor and many states).

The difficulty is that many restaurant owners – his competitors – are paying their workers less. The workers are often recent immigrants who are, knowingly or unknowingly, being paid less than federal or state mandates for their hourly work.

The restaurant owner has a choice, apparently. Comply with the law and pay his workers more or flout the law and pay less.

For most restaurants, labor equals 25% to 30% of total sales. The so-called back of the house is the prep, cooking, and cleaning portion of that – and it makes up about two-thirds of the total.

My friend indicates that his unlawful competition is paying the back of the house $2 less per hour. If that is true, the lawbreaking restaurant owner is gaining up to a 5.5 percentage point advantage in cost structure over his compliant neighbor.

(Check my math: $2 over $7.25 dollars is 27.5%. Multiply that times the 20% for the back of the house, and you get 5.5%. For the lower end of the range, and assuming $1 of difference and not $2, the percentage is 2.1%.)

In good times, most independent restaurants want to make, say, 5% on the sales dollar.

So one of the biggest decisions an owner can make is whether or not he or she wants to break the law. Profitability – viability, even – can depend on it.

My conclusion to the ethical dilemma is to blame the law. Minimum wage laws make good politics, but they break the law of supply and demand.

Here is a supply-demand curve borrowed from a commentator critical of the 2007 labor bill signed by President George W. Bush.

The economic theory is that by mandating a minimum price for labor, the demand for labor goes down (moves leftward along the curve) from equilibrium at E* to the arrow point. The minimum wage displaces some employment, especially for people whose marginal productivity may be low – those beginning their careers, teenagers, and adults lacking a high school degree. Unemployment for these groups is at record highs.

But the cheaters employ labor at the true equilibrium, which complies with economic law but breaks labor law. Is this a big deal?

I think it is. We don’t want our businesses breaking labor laws, because the downstream effects of a small break in the law are always magnified. Workplace safety can be compromised, migrants hire mules to take them over the border, and the country is wracked by a debate about the consequences. The halls of Congress ring with calls for punishment for those who hire illegal workers, as if this addresses the legal problem. Don’t they realize this is a symptom of a government mandate on labor costs?

I think much of this could be avoided if we ended the infraction of economic law. Everyone knows we are breaking that law. Everyone thinks it is a small thing. I think the consequences are large.

Some people will claim that by repealing the labor law the misery of a few would be increased because the unscrupulous or penny pinching will immediately lower their wages. This is undoubtedly true. But no policy can satisfy every person. We are talking about the greater good, not the universal good. And greater overall employment will start careers, get kids off the streets, lower costs for some businesses, and provide a domestic alternative to our imported low-wage workers. It may even reduce the migration pressures on the U.S.’s southern border.

Let’s put the laws of economics and the laws of the land on the same page. The struggling business owners – ones with a strong conscience, like my restaurant friend – will appreciate the relief.

Note: I asked Kay Plantes, an MIT-trained economist, to review this post. Her comments, received over the course of a couple of emails, include the following:

“This is a really complicated topic. Your blog is correct – but when you lower the minimum wage, those now paid at the minimum wage often get paid less … and that sets in motion a loss of income that has its own effect on the number of jobs available. The research on the opposite side shows minimum wage laws do not affect unemployment but that work was done before this monstrous recession …”

Kay also provided a link to Barry Ritholtz’s economics blog, which has a strong view on wages and their effect on this economy, and which also discusses the problem of income inequality (which my modest proposal could, admittedly, exacerbate):

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