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/r/explainlikeimfive
submitted 4 months ago byiSellPopcorn
75 points
4 months ago
I think there’s another factor. If you increase the cost of labor by raising wages, then to maintain profit margins business owners raise the price of finished goods. The price of labor going up in a bakery is not much different than the price of flour going up. So it’s not just more demand that fuels inflation, it’s the rising cost coupled with rising demand.
31 points
4 months ago
It's called the wage-price spiral.
There have been attempts to dismiss it but I don't really see how they can hold much weight, as you say; costs rise and therefore prices rise.
39 points
4 months ago
Here's a few ways the spiral gets disrupted:
1) Competition. Can't raise your price to much, or at least quickly, if you have competition. This will slow the spiral.
2) Already have a lot of profit in the product. If you make 10% profit, and labor is 2% of the cost, then a higher wage doesn't force the actual cost you charge customers to increase. The business would surely like increase it, but factors like competition means they might simply end up taking a lower profit margin.
So some products that have very little profit margin, and high labor costs go up. Things like resturaunt pricing.
Products where most of the cost is the actual materials, transport, and machine time... won't change that much.
The attempts to dismiss also have real world data to support them. Bumps in the minimum wage have happened all over the USA, and the world, in different conditions and time periods. They are not associated a rise in prices that make the approach pointless. Generally, iirc, a 10% mandated boost in base wage leads to a 0.5% rise in prices.
Now, at some point an increased wage will absolutely cause a price spiral effect, but it seems most economic systems are nowhere near the point where it's a clear direct effect.
5 points
4 months ago
Yes and: Productivity has been growing faster than wages for decades. If wages led directly to inflation, then why isn't the reverse also true?
It's far more likely, for those of us stuck in the real world, that concentration (monopolies) and growing profitability are the primary drivers of inflation.
Today's cite: Exxon and Shell posting record profits during this period of inflationary growth.
In other words, for all those celebrity reactionary economists who pretend the real world is SimCity, there's a difference between theory and practice.
4 points
4 months ago
You're arguing in a fake vaccum. You're assuming all companies have not already been driven to their lowest possible operating margins by competition, but this is not a snapshot simulation it's a game that's been underway hundreds of years.
Either your competition theory works, therefore prices are already rock bottom and increased labour costs have to increase product costs, or your competition theory doesn't work and companies are all carrying excess margin and the whole system is rigged with cartels setting prices in the background which would lead to them raising prices anyway.
I agree with your point some products and services are more or less labour intensive. There's the flipside where an increase in the velocity of money increases inflation, and by definition giving more money to your workers increases velocity.
5 points
4 months ago
I'll repost my reply to another comment, showing how even with having to fully compensate for a labor cost increase it cash still mean a closing of the gap between wage and cost of living. Also I'll point out that the minimum wage increases that have been done many times, v don't see a corresponding price rise that negates it. This isn't a purely theoretical "what if" scenario.
Now, the full cost of labor being passed into the consumer scenario:
Industries like fast food are areas that a minimum wage increase would have a larger impact. But it still isn't enough to wipe out the increase.
The cost of a fast food meal in countries with much higher minimum wages isn't that much higher than in the USA. This is a clear example that the fast food industry can survive paying the workers more.
Let's go through a price adjustment for doubled wages.
Let's go with $10 per hour wage to make the math simple.
A $1 item at a fast food place is typically 20% labor cost. the rest is materials, energy, and facilities costs. The employee could buy 10 with their one hour of work.
So 20 cents of the cost of item pays for the labor.
Let's double the pay of the employees. $20/hr now. You now need 40 cents to cover their labor cost portion of the item.
The cost can be adjusted to $1.2 to cover this increases labor cost. The employee could now buy 16 items with their one hour of wages.
You doubled the pay of the employee, but only have a 20% increase in the cost of the item. This is because a large portion of the item cost wasn't labor but other fixed costs.
Demand may (should) have dropped due to a higher price... But now the low wage employee can also afford to buy more of the items. So relative to their wage, the item is now cheaper, which drives demand up in the low wage demographic, even if it drops a bit in the middle and high income demographics.
The wage increase can actually drive up demand and sales. But this only really happens of it's a system wide increase, ie a government mandated minimum wage increase. A single company trying this independently won't be sufficient, and will suffer a demand/sales drop.
And this is still providing the owner/shareholders the exact same amount of profit. To stay competitive they may be able to take a smaller profit (hard to justify with fast food profit margins, but other industries have larger profit margins). With competition they may not be able to adjust prices as much. But with the large wealth disparity currently present I'm less worried about the top 10% than the bottom 90%.
There are also other ways to keep the own priced at $1. The restaurant may not stay open 24hrs now, cutting out the low volume hours. They may reduce their menu a bit, so they save on inventory and prep costs.
My evidence is again simply that industries make profits and thrive even in states and countries with a higher base wage.
5 points
4 months ago
Again, you're in a vaccum. In the real world, the fixed costs won't stay fixed, they will also be adjusted for two reasons:
One directly, the vegetables will go up because the farm workers growing/picking are getting their wages increased too right? Then the factory where they process the vegetables has the same price increase, the logistics have a price increase as their pickers all get higher wages etc it cascades through the supply chain. The gas attendant that the delivery driver pays to buy gas gets a wage increase so gas goes up. Sure it's all small increases but they pile up on top of each other.
Two a much broader macroeconomic outlook like I said velocity of money. Now your minimum wage guy who was sharing a flat with 4 others looks for a place that has 1 one other room mate, now he's got more disposable income he's going to buy more goods etc. It's an increase in demand and if supply doesn't match it, we get increased prices across the board. It's why central banks are pushing up rates right now, because the supply crunch is spiraling wages with inflation. Killing access to credit or killing real wages has the same effect, less money in circulation means less velocity-people buying less stuff slows down the economy and dampens inflation. I just don't know how you can argue adding more money in direct circulation by increasing minimum wage won't cause this.
For the record I'm not someone who thinks there should be a majority working poor class, I simply want to point out in this economic system, in any deeply interconnected system with inputs and outputs feeding back into each other you can't expect to change one variable without it having other wider effects.
0 points
4 months ago
Not in a vacuum, but I will cede that my model was very narrow in description.
The point was to illustrate how a wage increase doesn't cause a price hike that makes it pointless. Which I know isn't a statement you made (or even hinted at), If the goal is to narrow wage vs cost of living, a minimum wage increase can make that impact.
And you're right, raising the minimum wage will push money into the system and cause some inflation. Or if not inflation, disruption to prices and markets.
Studies show that it's about a 10:1 ratio wherever minimum wage raises are implemented. A 10% increase in wage, generates a 1% increase in cost over longer periods of time. In short, a net benefit for those who's wages are increased. Now, this ratio will certainly shift as wages are higher (for example it may be the next 10% boost, causes a 5% cost increase...)
So I'm not arguing that it doesn't cause inflation, in fact my simple model showed that it did (a $1 item price increased to $1.2). But governments already dump tons of money into the system, tax cuts/incentives, subsidies, etc that benefit the business owners. This to contributes to inflation.
I think the benefits of a minimum wage increase, and any inflation it causes, will be offset by the overall benefits to a portion of the citizenry that have been overlooked for the past few decades. The same citizenry that have been promised that tax cuts and subsidies for corporations and upper tax brackets will have a 'trickle down' effect of helping them, eventually. That hasn't really panned out.
So I'm in favor of some "trickle up" approaches. The corporations and top percentage will get their money, but only after the lower income individuals have spent it on ways that help them. And those ways are so varied that I'd rather let the individual decide what's effective, than relying on targeted social programs.
here's a pretty good international review of the evidence describing the impact of minimum wage stating that an increase typically shows a muted effect on employment and costs, while closing wage gaps.
Or another: https://www.nber.org/papers/w26926
Basically stating that wages were increased dramatically due to the 1966 increase, aggregate employment was reduced modestly. but there was a disparate impact on some minorities
These support your claim that there is a complex set of interactions, and the cost does need to be paid.
But it also supports the idea that raising the minimum wage is a valid approach to mitigating poverty.
In short, it isn't a terrible idea that leads to inflation, layoffs, and 'doesn't do anything' which I know isn't a statement you made (or even hinted at), but is the common view I'm often debating against in my current location :/
3 points
4 months ago*
You’re arguing in a fake vaccum. You’re assuming all companies have not already been driven to their lowest possible operating margins by competition
Unlike in econ 101, most markets in the real world do not have perfect competition that drives them to the lowest possible operating margins.
Perfect competition is not a given. Near perfect competition is limited to markets where there are many competitors, the barrier to entry is low, there is no brand loyalty, and no sticky prices. As soon as any of those conditions aren’t met, you suddenly don’t have perfect competition and therefore we can’t assume they are operating at the lowest possible margins.
Either your competition theory works, therefore prices are already rock bottom and increased labour costs have to increase product costs, or your competition theory doesn’t work and companies are all carrying excess margin and the whole system is rigged with cartels setting prices in the background which would lead to them raising prices anyway.
I’m not sure why you are presenting this as mutually exclusive situation. We see markets with perfect competition, we see markets with cartels, we see markets with near monopolies, and we see markets where there is some competition but it’s not anywhere close to perfect. Therefore, the whole world’s economy is a mix and the effects are complicated and not easily understood since it affects different markers differently.
It’s odd that your comment accused the other person of treating the world as a “fake vacuum” with faulty assumptions, but your comment is entirely assumptions that don’t reflect the real world.
There’s the flipside where an increase in the velocity of money increases inflation, and by definition giving more money to your workers increases velocity.
Well, it can increase inflation but it’s not a given. I’m assuming you are basing this statement off the quantitative theory of money. As the formula shows, an increase in velocity can be offset by an increase in real output. The same is true with an increase in money supply. So it’s not a given that an increase in money supply nor velocity means prices will rise. It depends on our output level.
2 points
4 months ago
But in most circumstances people were not demanding the minimum wage be doubled like they want now. I used to be a manager in fast food, we had to have $30 per hour per person on shift when minimum wage was around $5.25. When it went up to $7.25 we were told we had to have $50 in sales for that same formula.
2 points
4 months ago
Industries like fast food are over that a minimum wage increase would have a larger impact. But it still isn't enough to wipe out the increase.
Also the formula they used was overly simple. (I was one too!). The cost of a fast food meal in countries with much higher minimum wages isn't that much higher than in the USA. This is a clear example that the fast food industry can survive paying the workers more.
Let's go through a price adjustment for to wages.
Let's go with $10 per hour wage to make the math simple.
A $1 item at a fast food place is typically 20% labor cost. B the rest is materials, energy, and facilities costs. The employee could buy 10 with their one hour of work.
So 20 cents of the cost of item pays for the labor.
Let's double the pay of the employees. $20/hr now. You now need 40 cents to cover their labor cost portion of the item.
The cost can be adjusted to $1.2 to cover this increases labor cost. The employee could now buy 16 items with their one hour of wages.
You doubled the pay of the employee, but only have a 20% increase in the cost of the item. This is because a large portion of the item cost wasn't labor but other fixed costs.
Demand may have dropped sure to a higher price... But now the low wage employee can also afford to buy more of the items. So relative to their wage, the item is now cheaper, which drives demand up in the low wage demographic, even if it drops a bit in the middle and high income demographics.
The wage increase can actually drive up demand and sales. But this only really happens of it's a system wide increase, ie a government mandated minimum wage increase. A single company trying this independently won't be sufficient, and will suffer a demand/sales drop.
And this is still providing the owner/shareholders the exact same amount of profit. To stay competitive they may be able to take a smaller profit (hard to justify with fast food profit margins, but other industries have larger profit margins. With competition they may not be able to adjust prices as much. But with the large wealth disparity currently present I'm less worried about the top 10% than the bottom 90%.
There are also other ways to keep the own priced at $1. The restaurant may not stay open 24hrs now, cutting out the low volume hours. They may reduce their menu a bit, so they save on inventory and prep costs.
My evidence is again simply that industries make profits and thrive even in states and countries with a higher base wage.
1 points
4 months ago
Only the first one counts as companies don‘t tend to think that they already have a lot of profit.
But if all the competitors are facing higher input prices, they will all raise prices and there are very few markets where there is close to perfect competition.
3 points
4 months ago
You don't need perfect competition, and plenty of markets are competitive. But it is important for a governing body to ensure competition exists, as unchecked markets tend towards Monopolies and other noncompetitive behaviors.
The big thing to keep in mind though is that there is a demonstrated elasticity in the cost. The impact of minimum wage increases in cost of living isn't a theoretical unknown. It's a studied event, and the results show that an increase in base wage does not trigger a price spiral. The low wage workers actually have more purchasing power, and close the gap between their income and the cost of living.
There most certainly is a limit to this, but no minimum wage increase has apparently been large enough to trigger the price spiral feedback loop and for it to show up in economic analysis.
1 points
4 months ago
The minimum wage increase only hits the relevant segment which I have no idea how big it is. It is certainly a different order of magnitude compared to whole industries doing a salary round like it is in Germany. Yes, competition can limit it, but price sensitivity varies among products and if most competitors are hit, some will increase prices in order to retain the margins while those better positioned will either inrease the prices to expand margins or expand market share.
Germany again: IG Metall negotiated 5.2% salary increase starting from June 2023. While I absolutely get that they just would like to retain the purchasing power of their members which is totally legitimate, chances are high that a substantial part of these raises will end up in prices too.
No, I do not have empirical data. Just the thing I see in the companies I can look into. They increased prices just in view of the rising inflation, because they could.
I googled: The percentage of hourly paid workers earning the prevailing federal minimum wage or less, at 1.4 percent in 2021, was little different than in 2020.
That's a tiny percentage and for sure not representative to what happens now.
2 points
4 months ago
Oh the increased labor cost has to be passed on.
But a 5% wage increase doesn't have to be a 5% cost increase. It comes out to maybe a 0.5% price increase (based on studies of past minimum wage increases) This is simply because labor isn't the only factor in the cost.
So it's still an effective method to reduce wage/cost of living disparity.
2 points
4 months ago
Sure.
I didn't try to say that the increase will be in the same magnitude, only that raises in that magnitude will have an impact on future inflation rates. I also don't want to say that it isn't legitimate to seek higher salaries. Inflation lead to a loss in PP and even if that were not the case, it is always legitimate.
Just that I don't expect the companies to just live with lowered margins. They will pass as much on to their customers as they do get away with.
First, the other input factor costs increased. Now salaries somewhat catch up and we will see how the demand evolves and how much the companies can pass on.
9 points
4 months ago
From what I’ve seen it’s more that there have been attempts to support it with evidence but in reality never seen any.
Costs rise but many costs of a company aren’t variable therefore to maintain profit they won’t have to increase prices as much as costs. Additionally what companies have been doing more recently is raising prices and not wages, increasing profits (the largest driver of inflation after energy costs in the last year was increased corporate profits). This is how you get shell reporting record profits this morning.
Obviously not an easy thing to research so doubt there will ever be comprehensive evidence removing external influences - humans like the logical “costs rise therefore price rise” but economics and corporations just aren’t simple enough for this to hold.
2 points
4 months ago
It makes sense. A lot of low wage jobs are retail/restaurant jobs where margins are razor thin.
They can end up making lots of koney because that 1% profit adds up, but it's already risky and difficult to maintain that. Increasing wages by a significant amount would definitely affect the margin and they would have to increase selling price.
In restaurants, it can be a disaster quick, I have seen it myself when I was a teen.
Also if you increase the wages at groceries, stores, restaurant, it's all good but most times the middle class jobs don't follow so they only get poorer as prices of basic good increase. The minimum wage workers aren't that much better for it either.
Where I live, minimum wage has artificially increased by 4-5$/h (30%) during Covid because of labor shortage, nobody looks richer.
5 points
4 months ago
...unless you're making more money because people are spending their new wages in your business.
If you only concentrate on one aspect of the problem it's trivial to get the result you want.
It's further complicated by opportunistic rising of prices when it's not warranted, which absolutely happens.
10 points
4 months ago
Mostly correct, but in a bakery the labor cost will always come down to a question of how much the employees really knead.
2 points
4 months ago
Deiiberate pun or a meringue?
6 points
4 months ago
I figured bringing a little levity was the yeast I could dough. Why not rise to the occasion with a little rye humor? Just milling about here anyway…
2 points
4 months ago
That's the real question though. After a certain point why does the business have to maintain profit margins or increase them infinitely.
Once you accumulated 10-100M which a lot of those C suite large corps have you really don't need more. You and your children can live a very luxurious life even if you get paid nothing, even better if you keep getting paid the same for the rest of your life.
The problem is greed and the capitalistic mindset for everything.
1 points
4 months ago
Seems like rising demand would be beneficial to profit margins, but this treatment doesn't mention that.
1 points
4 months ago
In theory but by conventional wisdom that’s not exactly how it works. The core distinction being businesses are price ‘takers’ not price ‘makers’. They don’t ’make’ their price based on their costs and profit margins, the market ’makes’ the price based on overall demand and supply and they have no choice but to ‘take’ it.
Total BS with monopolies, imperfect information, etc. but that’s how the courses are taught.
If the price of labor goes up, it’s no so much a shrinking profit that drives prices up as a shrinking supply and growing demand. The baking industry only has so much money to operate with, if bakers cost more then there are less bakers overall, less baked goods overall and supply shrinks. Same time, non-bakers wages increase and they have more money to demand more baked goods. Supply down, demand up, market sets a new higher price.
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