Wage Fright: The Minimum Wage’s Impact on Price Growth
Although the national spotlight is turning toward minimum wage growth amid calls for reform, the overall blow to buyers will be soft. by Hayden Shipp, IBISWorld Research Analyst
Fast food worker protests, continued calls for reform from the White House and a recent slew of state and local legislation raising wage floors have thrust the minimum wage into the national spotlight. As usual, the issue is highly politicized, and the effects of a minimum wage increase are vehemently debated between political parties and economists.
One issue that affects families and procurement professionals alike when the minimum wage grows is the potential for price increases as companies pass higher labor costs down the supply chain. Fortunately for buyers, minimum wage growth has only a small effect on aggregate price inflation, according to Sara Lemos’s “A Survey of the Effects of the Minimum Wage on Prices” and J. Frye and R.J. Gordon’s “Government Intervention in the Inflation Process: The Econometrics of ‘Self-Inflicted Wounds.’” Frye and Gordon report that a 10.0% increase in the minimum wage increases inflation by a mere 0.02 percentage points. Most companies do not rely on minimum-wage labor. Only 2.6% of US workers earned minimum wage in 2013, according to the Bureau of Labor Statistics (BLS); moreover, that share has been in decline for decades. Additionally, goods and services that rely on minimum-wage workers account for only a small portion of consumer and procurement department budgets.
The need to understand the market dynamics of minimum wage goods has grown as the push for a national increase in the minimum wage gathers momentum. Moreover, many states and cities have recently increased minimum wages in light of the current stalemate on the issue in Congress; 20 states (plus Washington D.C.) and several major cities have minimum wages that exceed the federal level of $7.25 an hour.
Firms that provide cleaning services, hospitality services and food services respond to minimum wage growth with subsequent price increases that exceed benchmark inflation rates, according to a 2009 study by Jonathan Wadsworth of the London School of Economics and Political Science. The study identifies these services as minimum-wage goods and finds evidence that their suppliers systematically raise prices following a minimum-wage increase. Prior to Wadsworth’s study, several researchers found similar results that were confined to prices at restaurants; restaurants have been the most commonly studied suppliers of minimum-wage goods due to their heavy use of low-wage workers.
Wadsworth explains the price growth that follows a wage-floor increase as the net result of several traits that suppliers of minimum-wage goods share. First, they employ many low-wage workers and have labor-intensive operations. Second, they cannot easily make compensating productivity adjustments to offset higher wage costs. Third, they face little or no competition from imports. Fourth, their services cannot easily be substituted for. And last, demand for their services is relatively insensitive to price.
IBISWorld’s procurement research collection includes reports on 13 markets whose pricing is affected by minimum-wage growth. Following a wage floor increase, price growth in these markets is positively correlated with suppliers’ ability to pass input cost growth to buyers and negatively correlated with their ability to boost productivity. presents these markets and the key metrics that determine suppliers’ propensity to pass wage cost growth on to buyers. Red entries correspond with metrics that strongly support price growth, orange entries with metrics that support limited price growth, and green entries with metrics likely to suppress price growth.
Wage-Cost Pass-Through and Minimum-Wage Goods
The services in the chart are listed in the order in which a minimum wage increase is expected to support future price growth. Cafeteria management services, a food service, is at the top. Multiple studies, including “Restaurant Prices and the Minimum Wage,” by D. Fougere, E. Gautier and H. Le Bihan, and “The Effect of the Minimum Wage on the Fast-Food Industry,” by L.F. Katz and A.B. Krueger, have found that minimum wage hikes have a significant effect on price growth at restaurants.
The effect of minimum wage growth on cafeteria management prices may be even stronger. The restaurant market is fragmented, while the cafeteria management services market is highly concentrated. Such concentration gives suppliers of cafeteria management services greater pricing power. The price for security guard services is also highly susceptible to minimum wage increases. Unarmed security guards often work for minimum wage, and labor accounts for more than half of suppliers’ cost structure. The security guard service market is moderately concentrated, with major suppliers such as Securitas, G4S and AlliedBarton generating a sizeable share of total revenue. Buyers have few substitute options, as burglar alarms and remote monitoring systems cannot replace live guards for many applications.
Moreover, the market’s level of technological change is low. Suppliers are not currently making significant strides toward greater efficiency through automation. For these reasons, security guard providers are highly likely to pass future wage cost increases down to buyers. The market for temporary event security staffing functions similarly, except that it has a lower level of concentration, meaning greater competition. Heightened competition helps mitigate price growth in the event of a wage floor hike. Letter and parcel delivery services round out the top four markets expected to raise prices with minimum wage growth. Package handlers often work for minimum wage or slightly above it. In the Congressional Budget Office’s 2014 report on the minimum wage, the agency argues that companies often preserve pay differentials when the minimum wage rises. As such, raising the wage floor often boosts the wages of employees who are already at the new minimum pay level or slightly above it.
Additionally, the highly unionized workforces of the US Postal Service, UPS and FedEx would likely benefit from minimum wage growth by receiving subsequent pay raises to preserve pay differentials. Market share concentration is very high for these dominant carriers, giving them considerable leeway in raising prices. However, price growth would be mitigated by the threat of increased substitute encroachment; both online communications and trucking companies are viable substitutes for many services that letter and parcel carriers provide.
Also, the US Postal Service, the market’s largest carrier, will be required by the Postal Regulatory Commission to link rate increases to inflation after 2016. This requirement would soften the effect of minimum wage growth on market prices because the minimum wage has a negligible effect on inflation. Buyers are likely to experience lesser, though still statistically significant, effects on price for the remaining nine services in the chart following a minimum wage raise.
Suppliers of these services have either lower wage costs, more competition or better ability to make compensating productivity improvements than suppliers in the top four markets. Buyers should note that prices for the services in the chart are expected to rise at a moderate rate over the next three years even in the absence of a minimum wage hike. The effect of a minimum wage raise on price would therefore be relatively minor compared to the price growth for these services that will occur anyway.
Even in a minimum-wage market, factors such as demand fluctuations, structural changes (e.g. consolidation) and material input cost trends are more influential, on aggregate, in determining pricing than wages for a subset of workers.
Optimizing Purchases of Minimum-Wage Goods
Buyers can take comfort in the fact that they do not need to lock down prices prior to a minimum wage hike to guard against wage-cost pass-through. According to Wadsworth, the prices for minimum-wage goods do not rise in anticipation of a minimum wage increase. Rather, they rise after a new wage floor is introduced; such reactive price growth occurs for up to four years after the minimum wage is raised, with price effects accumulating gradually over time. This finding corresponds with Fougere, Gautier and Le Bihan’s conclusion in “Restaurant Prices and the Minimum Wage.” The authors determine that minimum wage cost growth takes more than a year to fully pass through to prices at restaurants.
Additionally, C. Lee and B. O’Roark, in “The Impact of Minimum Wage Increases on Food and Kindred Products Price: An Analysis of Price Pass-Through,” show that suppliers do not raise prices in the lead-up to the enactment date of a new wage law. Therefore, buyers can afford to wait out the current congressional impasse (as well as debates at the state and local levels) rather than trying to predict when a new wage law will pass so they can lock down contract terms in advance.
After a minimum wage increase is announced, buyers can potentially reduce the impact of wage-cost pass-through by securing a long-term contract. To minimize the risk that any cost pass-through has already occurred, they are advised to secure a contract after the new law is announced but before it is enacted. However, buyers that must make purchases on an ad hoc basis following a minimum-wage increase will have little choice but to pay slightly higher prices.