For example, the recent Congressional Budget Office study on the impact of raising the national minimum wage to $10.10 an hour (and then indexing it to inflation) shows that 24.5 million workers would benefit from the increase: 16.5 million directly and an additional 8 million indirectly. The CBO predicts that 500,000 low-wage jobs would be lost. That’s 49 beneficiaries per one job loser.
Why are opponents of a raise so wrong about this? They’ve actually got Econ 101 on their side, at least in theory, which holds that mandating a wage above the “market wage” should lead to extensive job losses. Why is the textbook model so off?
Economics offers another, more nuanced theory to explain what’s going on here. It’s called “efficiency wage theory” (EWT), and it was derived to explain why we often see the “law of one price” broken in the labor market. According to this “law,” one would expect that low-wage workers, say those in fast food, in the same area should make the same wage, and that that wage would typically be around the minimum. But EWT argues that some employers will pay more than they have to based on the “you-get-what-you-pay-for” principle: Paying above the minimum inspires effort above the minimum, and that translates into higher productivity, which absorbs the higher labor cost.
Okay, that’s all theory. What about reality?
This New York Times piece documents a number of fast-food joints that pay well above the minimum, even while competitors pay less. How do these employers’ remain competitive? Through EWT in action. They get better service from their higher-paid staff, as well as less turnover. That means better customer care, fewer vacancies and lower training costs — all productivity gains that absorb the higher wage costs.
“The No. 1 reason we pay our team well above the minimum wage is because we believe that if we take care of the team, they will take care of our customers,” said Randy Garutti, the chief executive of Shake Shack.
Another major benefit of paying $15 an hour? As one employer told the Times, “We don’t have any turnover. We don’t have to train people constantly.”
This dynamic is one of the ways minimum wage increases get absorbed, along with slightly higher prices and lower profit margins, and yes, in some cases, some employment losses or hours cutbacks. It’s also one of the myriad ways in which the real world is a lot more complicated, and interesting, than textbook economics would have you believe.