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First Restaurants Raise Wages. Then What?

Megan McArdle is a Bloomberg View columnist. She wrote for the Daily Beast, Newsweek, the Atlantic and the Economist and founded the blog Asymmetrical Information. She is the author of "“The Up Side of Down: Why Failing Well Is the Key to Success.”
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Restaurants are running out of chefs. The work is astonishingly unglamorous: hot, manual labor performed in a tiny space. It also pays abysmally; the median hourly wage is just $11 an hour, and the 90th percentile, the elite of the profession, makes a princely $15.35. As student loan burdens have gotten more burdensome and urban real estate prices have soared, restaurants in pricey areas are finding it harder to attract workers willing to endure a long commute in order to spend hours getting hot and dirty.

Why don't they just pay more, demands Kevin Drum? "Offer them, say, $15 per hour, and who knows? Maybe there are plenty of good entry-level cooks available. This would raise your total cost of running the restaurant by, oh, 2 percent or so,  but it's not like restaurants are competing with China. They're competing with other restaurants nearby that have the same problem. If the price of a good cook is going up, it's going to affect everyone." 

This is a frequent question from the left when manufacturers and others complain about labor shortages, and it's fair enough. A 2012 Atlantic article from Adam Davidson pointed out that when it comes to machinists and others, manufacturers often can't afford to raise wages, because they'll lose business overseas. But no one is going to stroll over to Bangladesh for their anniversary dinner, so why can't restaurants just raise wages a bit and add it to the check?

Well, the first thing to note is that Kevin's math seems a little off. As the Bureau of Labor Statistics figures suggest, probably 60 to 70 percent of the kitchen workers in America are making $12 an hour or less. The rule of thumb for restaurants is that labor should be about a third of your total sales, and about two-thirds of the labor cost typically goes to the "back of house" staff, i.e. the people who make the food and wash the dishes. (Waiters and bartenders get paid less because most of their income comes from tips.) So we're looking at spending more like 20 percent of income on the kitchen. And under Kevin's plan, most of those workers are going to be getting a substantial raise of somewhere between 25 and 50 percent of their current salary. In fact, you'll have to raise the rest of the staff's salary by something approaching 25 percent as well, or else they'll get upset and your best people will leave, as one entrepreneur recently discovered when he raised everyone's salary to the same high level.

Okay, but maybe you won't have to raise the dishwashers' pay. And anyway, 20 percent of an average increase of 35 percent (the amount needed to take the median to $15 an hour) would only be a 7 percent increase in costs. Would people really stop going to restaurants over a measly 7 percent of the check?

Well, yes. But not all people, and not all the time. Many people would eat fewer meals outside the home. There's a restaurant near my house that I'd say is 20 percent overpriced for the neighborhood and the quality of the food it serves. It had no competition nearby but still opened empty, and remains mostly that way a year later. The food is good -- not stellar, but I'd be happy enough to eat there, if it weren't for the fact that everything costs too much. If prices at the pub that opened nearby went up by the same amount, I wouldn't simply start splitting my time between the two; I'd eat out less.

Americans spend a phenomenal amount of money consuming food outside their homes, and a major reason is that with restaurant labor so cheap, the convenience and price are attractive to people who don't feel like cooking. If the wages go up, that calculus shifts. And unfortunately those "rich bosses" can't just take it out of their profits, because margins in the industry are under 5 percent, and the difference between making that profit and closing up shop can be surprisingly thin. Empty seats don't just cost you rent; they make it hard to get good servers, because empty seats mean lost tip income. You can end up in a vicious spiral where your service gets worse, so your restaurant loses more customers, so the service gets even worse . . . and it's time to call the bank and tell them you won't be paying off that loan.

This is not to say that every restaurant will fold if kitchen workers earn $15 an hour. Most will. But most were going to fail anyway, because that's what restaurants do. The higher wage would push a few more into failure. The labor supply would be greater, but the labor demand would be lower.

This is, in fact, pretty much what I'd expect to see if the shortage of cooks continues; the market will find a new equilibrium employing somewhat fewer cooks at somewhat higher wages.  Some of this would be driven by restaurants going out of business; some of it would be achieved by using more preprocessed ingredients like shredded cheese, or switching to less labor intensive menus, which sacrifices some quality but slashes your wage bill.

That will be good for the cooks, who do very challenging work for very little money. But I do wonder what it will do to the food culture in urban areas. I'd like to think that this would just put the bad restaurants out of business. Unfortunately, markets don't deliver cosmic justice, nor do they regularly conform to my personal tastes. Those most affected may be the restaurants in more economically marginal areas, or those with a special commitment to serving higher-quality, labor-intensive food. 

That's not to say that restaurants shouldn't pay their cooks more. Leaving aside the question of economic justice, it's simple economics: They're going to have to if they can't find the people they need at the current wages. It's a return to an old theme of mine: To a very large extent, your labor model is your business model. When you change what you pay, you don't just hold everything else equal; you change your business, or your industry, to match the new wages. So seemingly modest changes can have a big impact not just on the workers, but on entire communities. Those changes can be either good or bad. All that's assured is that raising wages has a wider effect.

  1. Two percent is what he got from a back-of-the envelope calculation assuming that 15 percent of your costs are kitchen staff, and a third of them are entry level.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author on this story:
Megan McArdle at mmcardle3@bloomberg.net

To contact the editor on this story:
Philip Gray at philipgray@bloomberg.net