Why the proposed minimum wage act wouldn’t affect restaurants
White House considers raising minimum wage
While the fast food industry won’t bow to an increase to $15 an hour in minimum wage, the White House is considering whether to sign the Fair Minimum Wage Act of 2013, which would raise the federal minimum wage to $10.10 per hour by 2015, in three steps of 95 cents each. After 2016, the wage will adjust with inflation to keep pace with the rising cost of living.
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Thirty-year high minimum wage
The increase to $10.10 an hour would be a page-turner. Over the past three decades, minimum wage in the United States (after adjusting for inflation) was below $8.00 an hour. An increase to $10.10 would mean going back to pre-1980 levels. These adjustments use the CPIs (consumer price indexes) collected from the U.S. Department of Labor.
Minimum wage and inflation relationship positive
Since the 1970s, the correlation between inflation and minimum wage has been positive, with the strongest correlation between the urban CPI and the minimum wage at 0.45. This reflects the fact that minimum wages increase from time to time to adjust for the cost of living and keep workers out of poverty. Indeed, several states have already been doing that for a while.
But higher prices could be a result of higher wages. If minimum wage were raised without any productivity gain that could arise from lower employee turnover or training costs, it could create a ripple effect throughout the entire labor market. The restaurant industry would pass the increase in wage cost to customers, knowing that wages of other restaurants would also increase.
Even if higher wages weren’t passed on to customers in the short-to-medium term, possibly because of a weak economic environment, higher wages would lead to higher spending in nominal terms in the future. This would result in higher menu prices and inflation if capacity or productivity didn’t rise accordingly.
Positive relationship between minimum wage and employee expense
Over the past eight years, we’ve seen a positive relationship between minimum wage and employee expense as a share of revenue for the industry. When the government started to increase wages in 2006, inflation also rose, albeit not as much (see chart in the middle of the page). The use of inflation-adjusted wage expense shows that wage expenses increased more than how much fast food companies raised prices for their menu. That has driven expenses for fast-food companies higher, with the industry’s employee expense rising from 25.5% to 26.0% as a percent of sales.
But the relationship is not perfect
Despite further increases in the minimum labor expense in 2008, however, employee expenses as a share of revenue didn’t increase further. Possible explanations include increased spending at fast food restaurants as overall income rose. This supports traffic, overall utilization, and profit margins. The start of the recession in 2007–2008 also pushed people to cut their food expenditures and choose cheaper eating-out options. Improved productivity could have been another contributing factor.
Outlook for fast food and consumer service
With wages expected to increase possibly 39% from now to the end of 2015, it would be odd to say that higher wages won’t influence inflation. Fast food retailers such as McDonalds Inc. (MCD), Yum! Brands Inc. (YUM), Wendy’s (WEN) and Burger King (BKW) may be negatively affected in the short to medium term.
But in the long term, margins won’t likely be affected by much as these companies (and others in the restaurant industry) pass on higher wage costs to customers who are earning more in nominal amount, including those who work at minimum wage. This also applies to the iShares U.S. Consumer Services ETF (IYC) and Consumer Discretionary Select Sector SPDR Holdings ETF (XLY). On a side note, last time wages rose this much within three years, the U.S. market had gone into the final stage of bull market (2006 to 2008). This is something to look out for, and possibly something investors will want to research further.