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Reasons to adopt a “Big Box living wage” in Spokane Presented to Spokane City Council, July 10, 2006 Douglas V. Orr, Ph.D. Professor of Economics, Eastern Washington University I want to thank the Council for allowing me to discuss the need for a “Big Box living wage” in Spokane. There are several reasons why it make good sense to adopt a “living wage” in Spokane and why not adopting one is a mistake. By adopting this proposal, Spokane would be joining over 140 municipalities in the United States that have living wage ordinances. Ten of the nation's twenty largest cities have adopted living wage laws, and combining all cities with populations greater than 100,000, 40 percent of the population lives in cities with living wage laws. 1 Living wage laws are becoming very common. This is part of a nationwide trend of raising the floor under wage rates. In the 2006 elections, eleven states raised the state-wide minimum wage above the national rate. In total, 29 states have minimum wages set above the national rate. We should ask why this trend exists and is expanding. In October, 1995, the Pace Group issued a report on factors that help or hinder Spokane’s economic development. This report was used to justify plans to redevelop downtown Spokane, something, by the way, that I strongly support. One of the largest competitive weaknesses cited in the Pace report was the overly high levels of poverty in this region. The report noted that almost 45 percent of those employed in Spokane received wages in those jobs that were inadequate to lift a family of four out of poverty. The Spokane Economic Development Council has recognized that to prosper, just attracting more jobs to the region is not enough. Rather, we need to attract jobs that pay more than poverty level wages. The Economic Development Council of Northern Idaho has recently reached the same conclusion, and will only offer tax incentives to firms that will create jobs that pay wages of $12 per hour or higher. That wage is higher than that proposed by this ordinance. While the percentage of jobs paying poverty level wages has declined somewhat since 1996, we are still a long way from the goals presented in the Pace Report. The Pace report correctly noted that very high levels of income inequality inhibit economic growth. In order for a region to grow, someone has to buy the goods and services that are being produced in the region. High levels of poverty limit the demand for products. If the bottom falls out of the economy, it is not just those at the bottom who suffer. Everyone in the economy is hurt by the reduced level of economic growth. This is an economic lesson that was illustrated clearly in the 1920s. Almost everyone knows the story of Henry Ford. He was the first automobile manufacture to pays his workers $5 per day. By doing this, he was able to attract the most productive labor, which reduced his turn-over and training costs. Paying higher wages actually lowered his overall costs and raised his profitability. In addition, it helped to create a middle class customer base who could afford to purchase his cars. But fewer people are aware of Edward Filene, whose views speak directly to the issue confronting the City Council tonight. Edward Filene founded a chain of retail department stores that still exists today. He also helped to create the US Chamber of Commerce. He argued that true mass production was not the production of masses of goods, but rather production for masses of people. He believed that commercial success was ultimately determined by the average consumer's power to purchase and he supported the idea of a floor below which wages could not fall. The Federal government recognized this very basic fact in 1938 when they implemented the first minimum wage legislation. They recognized the need to hold up the bottom of the income distribution. They also correctly recognized how this must be accomplished; placing a minimum floor on wage levels. Why is this the correct approach? In a competitive economy, firms must often do things with which they are uncomfortable in order to compete. Let us say that all employers in the region have learned Edward Filene's lesson and recognize that they must pay their workers adequate wages in order to have a demand for their products. Now let a new firm enter the region and this firm pays its workers much lower wages. Since this one firm’s costs are lower, its profits are higher, and most importantly, it can potentially offer it’s products at a lower price, although there is no guarantee that it will. This one firm can also sell its products because the region’s income is still adequate. So far this looks good. Consumers get products at lower prices. But this is only the first step of the process. Economics teaches us that we must always look at the end result, and not just the first step. Since the existing firms have somewhat higher prices, they begin to lose customers to the newcomer. To avoid this outcome, they lower the wages they pay their workers as well. As more and more firms slash wages, regional incomes fall, and the population of the region can no longer afford to buy the region’s output and the regional economy stagnates.2 I don't want to focus on WalMart, but looking at them is instructive. Numerous researchers have analyzed the impacts that occur when WalMart enters a region. 3 One study by David Neumark, who is generally critical of living wage laws, found that as WalMart entered a region, average retail wages fell by 3.5 percent and total retail employment fell by from 2 to 4 percent. 4 Low wages hurt overall employment. Now the original firms already knew that cutting wages was not in the best interest of the region, but in order to survive in the face of the newcomer’s policies, they have no choice but to cut wages. What was a profitable policy for one firm is not profitable if all firms do it at the same time. Economists call this paradox the fallacy of composition: what is true for the individual is not true for the group. In my classes I often refer to this as the “parade principle.” If a bunch of people are sitting and watching a parade go by and just one person stands up, that person can see the parade better. If the first person sits down and a second stands up, that person can also see the parade better. In fact, if any one individual stands up, that person can see the parade better. But if they all stand up, not only do they NOT see the parade better, but some people’s view is worse than before. In our economic example, how do we allow the original firms, that wanted to do the right thing and pay their workers an adequate wage, to continue to pay that wage? The answer is simple: don’t allow the one firm to engage in the wage cutting behavior that is destructive to the regional economy. By placing a floor under wages, the living wage prevents this destructive outcome. It allows the firms, like Rosauers, Fred Meyers and others, that want to do the right thing to do so, without the fear of being undercut by cut-throat competition. Am I saying that all competition is bad? No. Often competition benefits everyone in society. Having more than one software company or more than one phone company for example! But saying that competition is usually beneficial is very different than blindly arguing that all competition is beneficial. A certain amount of rain is necessary to make crops grow, but too much destroys the crops. Maintaining a “livable” minimum wage benefits everyone in the region by facilitating regional economic development. Now you have probably heard many arguments against raising minimum wages, and it is very important to separate the theory from fact in these arguments. The most common argument is that raising the minimum wage will cause an increase in unemployment by reducing total employment. But this argument is just the fallacy of composition in reverse. If all we look only at is the increase in labor costs, it would appear to be obvious that the demand for labor would be reduced. But this ignores that wages are incomes and those at the bottom spend almost all of their income locally. As wages at the bottom rise, so does the demand for local goods and services. To provide these new outputs, local firms need more labor not less. While there are some studies that have demonstrated dis-employment effects, the majority of studies of the impacts of changes on minimum wages reach the same conclusion: unemployment is stable or is reduced. 5 If fact, many cities have experienced increases in total employment and decreases in unemployment. I have included citations to several studies on the impacts of living wage ordinances at the end of my talk, but one case will illustrate the point. The city of Santa Fe, NM implemented a city-wide minimum wage in 2003. Over the next year, gross receipts in the retail sector grew by 5.7 percent and employment in that sector grew by 200 jobs. This was in a city with a total population of just 67,000. Employment in the restaurant industry grew by 400 jobs. 6 A second argument is that raising the minimum wage will lead to inflation, which hurts the people it is meant to help. This argument is misleading for two reasons. First, lets look at the people who receive the increased wage. To keep the numbers simple let's assume we raise their wages by 20 percent, and that firms pass this entire increase along as price increases. If labor makes up half of the costs of the firm, then prices for these firms rise by 10 percent. If firms that pay minimum wages make up 30 percent of the regional economy, then the average price increase in the region is just 3 percent. 7 The incomes of those at the bottom have risen by 20 percent and the costs of what they buy has gone up by just 3 percent. Those we are trying to help have definitely benefited. But price increases of this magnitude are highly unlikely. According to a recent article in Business Week, at Target, "selling, general and administrative costs," which includes all labor costs, constitute just 24 percent of gross revenues. 8 So the assumption that labor makes up half of the costs of these firms is too high. Moreover, as Adam Smith, the father of free-market economics taught us more than 200 years ago, firms will always, every day, try to raise their prices. This is just good business. What keeps them from succeeding is competition in the market place. Burger King made the mistake of keeping the "sale" price of the Whopper at $.99 for too long, and customers got used to that price. Burger King has been trying to get the price of the Whopper back up to $1.99 for years, but the market won’t let them! The firms that would be affected by this ordinance are in relatively competitive markets. As much as they would like to, the market is not likely to allow them to pass all cost increases onto the customer as price increases. The cities that have adopted “livable wages” have seen minimal or no increase in their local inflation rates. Another argument that is raised against requiring firms to pay living wages is that if wage rates rise and output prices do not, the profitability of firms will be reduced. Yet there is considerable evidence that this is not the case. For example, Rosauers pays wages higher than would be required by this ordinance. Yet, that company is still profitable, and their stores function as anchors that help to build livable neighborhoods throughout the city. The big box stores that would be covered by this ordinance have even higher profit rates. According to the Department of Commerce, in the third quarter of 2005, the after tax rate of return on shareholder equity of retail firms with more than $50 million in assets was 15 percent. 9 This is a relatively high rate of return on assets. Even if profits were to decline slightly, the question facing the Spokane City Council is what is the correct response to this outcome? Research indicates that low income households tend to spend almost all of their income locally. 10 Every dollar spent locally creates about $2.00 in total regional income. Likewise, every dollar that is sent out of the region to corporate headquarters reduces regional income by $2.00. So each dollar that might be transferred from profits to wages could lead to a $4 increase in regional income. The specter of higher unemployment and higher inflation are usually raised to try to make it appear that all of us are affected equally, and negatively, by increases in minimum wages. But in fact, most of us benefit from these increases. Poverty level wages affect the Spokane region in ways other than reducing the level of economic growth. It also increases the cost of providing public assistance and other forms of government services, such as police and fire protection. No one has completed a study of the costs of low wage employment in Washington State, but that type of study was done recently in California. That study found that 53 percent of all families receiving public assistance have at least one member who works at least 45 weeks per year. For over half of those receiving assistance, their need is not caused by lack of work or even relying on part-time work, but rather working full-time at poverty level wages.11 The California study indicated that an increase in the minimum wage to $8.00 per hour would reduce the cost of public assistance to tax payers by 27 percent. Since public assistance is the second largest component of state and local government expenditures, after education, this reduction in the cost of public assistance would substantially benefit tax payers. A recent study indicates that poverty rates have been reduced in every city in California that has implemented a living wage ordinance. 12 Some might say that a minimum wage of $8.00 per hour would be unrealistic. But is that true? No one on either side of the living wage issue seems to tire at pointing out that WA State has the highest minimum wage in the country. I find this ironic, given that, adjusted for inflation, the national minimum wage in 1968 was almost $9.00 per hour (measured in 2005 dollars, see Figure 1). Washington State's minimum wage is still well below that amount. Moreover, from the end of World War II until the early-1970s, Congress attempted to keep the minimum wage at a level that was about half of the average wage for non-supervisory employees in the private sector. However, after 1973, Congress allowed the national minimum wage to be eroded by inflation, and by 2005 it is worth only 32 percent of the average private sector wage (Figure 2). Interestingly, as the commitment to maintaining a floor under wages eroded, so did the link between wages and labor productivity. Economic theory tells us that as someone contributes more to society, they should receive more, which used to be true for wages. From 1947 to 1973, as average labor productivity increased, so did average wages, but after 1973 this link was broken (Figure 3). As a result, the average real wage in 2005 is 8 percent lower than in 1973, despite a doubling of labor productivity. 13 Wage floors matter to everyone in society, not just those that make the minimum wage. It is sometimes argued that we should let "the market" decide social outcomes. But the market does not operate in a vacuum. Every existing and new government decision affects market outcomes. The new North-South freeway will not be built by the market, but it will have lasting impacts on the value of land, the distribution of housing and the profitability of businesses in different parts of the City. At one point, it appeared that the "market" had decided that downtown Spokane should continue to decline. But previous City Councils decided this market decision was unacceptable. They implemented policies that have lead to a renaissance for downtown Spokane and everyone in the city has benefited from those decisions. Very few would argue that this intervention in the market was a bad idea. As I mentioned, raising the wage floor does not necessarily create a reduction in profits for firms. In April 2004, Business Week did a comparison of Costco and Wal-Mart: two firms with which everyone in Spokane is familiar. The average wage at Costco is 39 percent higher than at Wal-Mart. Costco provides retirement and health care coverage for almost all of its employees, WalMart does not. Yet, the profit per employee for Costco is 24 percent higher than the profit per employee at Wal-Mart.14 Low wages do not guarantee high profits, but they do guarantee high levels of poverty and high costs for public assistance. It can be argued that Costco and WalMart function using very different business models, and this is in fact true. But society does not have to accept every business model that is imposed upon it by some large corporation. My uncle started to work in a coal mine when he was 7 years old. He died of black lung when he was 58. The business model of the coal industry included child labor and unsafe working conditions. At some point, society decided this was no longer acceptable. When we passed child labor laws and minimum wage laws in the late 1930s, the coal industry said it would destroy its existing business model. While that was true, it did not destroy the coal industry. There are two mutually exclusive and contradictory views of how economic growth and development occur. One is a "low wage, low productivity, short term growth" approach and the other is a "high wage, high productivity, long term growth" approach. Only the latter is viable in the long run. By setting a baseline standard for all of Spokane's large retailers, the living wage ordinance will encourage competition around how well businesses server their customers, not how little they pay their employees. Thank you for your patience and attention. Figure 1
 Figure 2
 Figure 3
 Source for all three figures: www.bls.gov Footnotes 1. Scott Adams and
David Neumark, "A Decade of Living Wages: What
Have We Learned?," (San Fransicso CA: Public Policy Institute of
California, July 2005)
2. Since wages are not the only costs a firm faces, if wages fall by 10 percent, prices will fall by less than 10 percent. Thus, for those living in the region, it is harder to afford the products created in the region. 3. Stephen J. Goetz and Hema Swaminthan, Wal-Mart and County-Wide Poverty, (University Park, PA: Pennsylvania State University, Department of Agricultural Economics and Rural Sociology, 2004 Staff Paper No. 371); Arindrajit Dube, Barry Eidlin, and Bill Lester, Impact of Wal-Mart Growth on Earnings throughout the Retail Sector in Urban and Rural Counties, (University of Caliifornia: Berkeley CA, Institute of Industrial Relations, 2005, Paper No. 126:05) 4. David Neumark, Junfu Zhang, and Stephen Ciccarella, The Effect of Wal-Mart on Local Labor Markets, National Bureau of Economic Research Working Paper 11782, November, 2005. 5. Adams and Neumark, find limited dis-employment effects; David Card and Alan Krueger, Myth and Measurement: The New Economics of the Minimum Wage, (Princeton, NJ: Princeton University Press), 1995 provide the most detailed study of minimum wages both nationally and locally and find very few dis-employment effects and generally find positive employment effects. 6. Lee A. Reynis, Myra Segal and Molly J. Bleecker, Preliminary Analysis of the Impacts of the $8.50 Minimum Wage on Sante Fe Businesses, Workers and the Sante Fe Economy (University of New Mexico, Bureau of Business and Economic Research, December 2005). 7. To do this calculation: 50 percent of 20 percent is 10 percent; 0.5 * 0.2 = 0.1. 30 percent of 10 percent is 3 percent; 0.3 * 0.1 = 0.03. 8. Stanley Holmes and Wendy Zellner, "The Costco Way: Higher Wages Mean Higher Profits. But Try to tell Wall Street." Business Week, April 12, 2004, PP. 76-77. 9. http://www.census.gov/csd/qfr/view/qfr_rt.html. 10. Ann Markusen, Jennifer Ebert and Martina Cameron, The Case for a Substantial Minimum Wage Hike for Minnesota (University of Minnesota, Humphrey Institute of Public Affairs, September 2003); Paul K Sonn, Citywide Minimum Wage Laws: A New Policy Tool for Local Governments (New York, NY: Brennan Center for Justice, May 2006); Arindrajit Dube, Suresh Naidu, and Michael Reich, The Economic Effects of Citywide Wage Mandates: Evidence form the 2004 San Francisco Minimum Wage Increase (University of Caliifornia: Berkeley CA, Institute of Industrial Relations, 2005, Paper No. 12x:05) . 11. Carol Zabin, Arindrajit Dube and Ken Jacobs, "The Hidden Public Costs of Low-Wage Jobs in California, " (Berkeley CA: Center for Labor Research and Education) May 2004. 12. Scott Adams and David Neumark, "A Decade of Living Wages: What Have We Learned?," (San Fransicso CA: Public Policy Institute of California, July 2005) 13. Adjusting all values to reflect 2005 prices, the average real wage for non-supervisory private sector employees was $9.99 in 1947, $17.33 in 1973 and only $15.92 in 2005. This decline is wage levels is much of the cause of the hollowing out of the U.S. middle class, and the very rapid increase in income inequality. 14. Stanley Holmes and Wendy Zellner, "The Costco Way: Higher Wages Mean Higher Profits. But Try to tell Wall Street." Business Week, April 12, 2004, PP. 76-77.
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