Pizza makers’ wages go up. Prices for frozen pizza go down.

Photographer: Sean Proctor/Bloomberg

Other Employers Will Soon Feel Restaurants’ Pain

Conor Sen is a Bloomberg View columnist. He is a portfolio manager for New River Investments in Atlanta and has been a contributor to the Atlantic and Business Insider.
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Restaurants have been wrestling with a challenge that the rest of the economy is just now confronting: What happens when labor costs are going up but you can’t raise prices?

The story of the labor market over the past several quarters is that employers looking to hire cheap service labor are having a harder and harder time. Compounding the problem is the fact that restaurants, retailers, logistics firms and distribution centers are fighting over a similar pool of workers. This has pushed wage growth for leisure and hospitality workers to an eight-year high of 4.3 percent.

On the Upswing
Year-over-year wage growth for leisure and hospitality workers
 
Source: U.S. Bureau of Labor Statistics

This wage growth is becoming particularly painful for restaurants, which are struggling to pass along price increases to consumers. This is acute for restaurants because although they provide a service, their competitor (grocery stores) provides a good. The cost of the service would tend to rise with wage growth, even as the cost of the goods would fall because exchange rates and cheaper energy used to produce that food. 

Dining In
Year-over-year change in the price of food at home for urban consumers
 
Source: U.S. Bureau of Labor Statistics

This vise squeezing restaurants is turning 2016 into a terrible year for restaurant closings. It also provides a cautionary tale for the U.S. economy as a whole.

The conventional wisdom right now, from investors and economists and politicians, is that a lack of wage growth is the main thing holding back the economy. When wage growth returns, consumer spending will increase, and companies will hire and invest more to meet that demand, fueling even more wage and price growth, and we’ll be off to the races. But while the wage growth has increased, the rest of the story hasn’t played out yet. Companies still lack pricing power. Instead, higher wages are leading to lower profit margins and stagnating corporate profits.

What are workers doing with their additional income? We know they’re not saving it. The personal saving rate has hovered in a narrow range of 5.5 to 6 percent since early 2014. Part of it is being eaten up by rent growth, as a lack of housing construction continues to put upward pressure on housing costs. Another cause for concern is health-care costs. Out-of-pocket health-care costs for consumers have surged recently, up 4.9 percent, in part because of increases in health-care premiums. 

The Growing Bill From the Doctor
Year-over-year change in out-of-pocket health costs for urban patients
 
Source: U.S. Bureau of Labor Statistics

There are two possibilities for how this plays out. An optimist would say that the labor market just needs a little more time. As the labor market continues to tighten and wages continue to increase, consumers will not just continue to spend what they’re earning but also will look to borrow as well. Companies will respond to that added demand by hiring and investing to meet it. The psychological scars of the financial crisis will continue to fade, and we’ll end up back in an economic environment like we had in the 1990s.

The alternative view is more disheartening. Wage growth will continue to get swallowed up by higher housing and health-care costs. Households will remain tight-fisted and focus on paying down debt rather than taking out more of it. Downward pressure on profit margins will lead companies to cut costs, and hence workers, to protect profits. Growth will stagnate, and fiscal policy will remain unhelpful.

We’ll start to see in 2017 which path the economy is taking.

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

To contact the author of this story:
Conor Sen at csen9@bloomberg.net

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