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These Widespread Shortages Can’t Be Explained by Supply Constraints Alone

Poorer markets can still clear. So why won’t they?


All sorts of shortages are now popping up in our economy. At the head of the list is undoubtedly infant formula, but there are literally dozens of other items in short supply. There are so many of them that I feel constrained to mention them in alphabetical order, lest I inadvertently miss one or engage in double counting.

Here they are, as best I can list them: aluminum, avocado, bicycles, blood collection tubes, blood for transfusions, canned vegetables, cat food, chlorine, Christmas trees, coal, coins, commercial air tickets, computer chips, cream cheese, dye used in CT scans, eggs, fuel oil, garage doors, gasoline, girl scout cookies, hand sanitizer, home covid tests, infant formula, juice boxes, liquor, lithium, lumber, maple syrup, meat, motorcycles, natural gas, paper towels, pet food, potatoes, semiconductors, soap, soda, sunflower oil, toilet paper, tomato paste and wine. Peanut butter has not yet been mentioned in this regard but will soon, undoubtedly, be added prominently to this list.

I’m not kidding: each and every one of these items has been mentioned in this regard in the major media. What is going on here? Has the economy gone crazy, or what? According to several headlines, that is just about what is occurring. Here are a few of them: “The world is still short of everything; get used to it.” “America is running out of everything.” “Product shortages and soaring prices reveal fragility of U.S. supply chain.”

If the shortage list is long, the presumed causes of this economic malfunction are almost as large. For peanut butter, it will be a recall due to contamination; a salmonella outbreak. But this is an input into many other products, such as fudge, chocolates and peanut butter sandwiches, which will also soon be hard to find. For many items on the list the antecedent is the Coronavirus, which has led to supply chain problems. Paying workers to stay home and earn as much or more than their salaries, a few months ago, also contributed. Blame was also laid at a harsh winter. Imports from abroad have been subject to sudden border closures. Ships stuck at harbors on the west coast have been vulnerable to shortages of truck drivers and regulations. Computer chips have been susceptible to supply inelasticity; new offerings as a result of higher prices take a great amount of time to become forthcoming. Consumers have been castigated for hoarding. Staffing problems have been held responsible for commercial air travel disruptions. Drought, the bird flu and the Ukraine war have been held culpable.

But we have had all of these things before, war, pestilence, disease, bad weather, ill health, government regulations, before. However, massive shortages, not of everything under the sun, but almost pretty close, have never before disrupted the economy to anything like the degree we are presently experiencing (apart from the two world wars, of course).

Where is the much-vaunted free enterprise system in all of this? Nowhere, that is where. Has it succumbed to so-called “market failure?” Not a bit of it. Rather, the difficulty is that public policy has made capitalism operate with one arm tied behind its back, and it has not been able to function when hemmed in by a plethora of restrictions, limitations and regulations.

Basic introductory Economics 101 teaches us that a shortage occurs when demand for an item exceeds its supply. What invariably occurs then? Why, prices rise. When this takes place, businesses are incentivized to produce more, buyers to purchase less. Voila, the shortage ends. Why doesn’t this occur under the Biden Administration? Why do we have so many shortages?

One possibility not at all in the public eye is that business firms are afraid to raise prices lest they be charged with price gouging. And why in turn might this be the case? The Bidenites are not exactly friends of the free enterprise system. Yes, to be sure, prices have indeed been rising. But are they increasing fast enough so as to quell shortages? Evidently not. Why not? This is possibly due to fear of being accused of gouging, and being subject to antitrust attentions. Wages, too, are on the incline. But likely not sufficiently so as to overcome the supply inelasticity difficulty. Why not? Firms may well be leery of so doing, in case they have to be decreased later on, and will be accused of exploiting, or victimizing laborers, or some such.

Prices and wages are typically somewhat sticky; that is, they are not instantaneously and fully flexible. But an anti-business philosophy of the sort now prevailing in Washington D.C. makes them even less able to perform the tasks for which we need them, than would otherwise be the case.

AUTHOR

Walter Block

Walter Edward Block is an American economist and anarcho-capitalist theorist who holds the Harold E. Wirth Eminent Scholar Endowed Chair in Economics at the J. A. Butt School of Business at Loyola University New Orleans. He is a member of the FEE Faculty Network.

EDITORS NOTE: This FEE column is republished with permission. ©All rights reserved.

There Ain’t No Such Thing as a Cost-Plus Lunch! Who’s really to blame for rising prices?

Why are restaurants adding “inflation fees” to their checks?


A group of friends had just finished a meal at Romano’s Macaroni Grill in Honolulu when one of them noticed something odd about the check. As a local television news station reported in April, a “Temporary Inflation Fee” of $2.00  was nestled inconspicuously between the $4.50 Flavored Tea and the $14.00 Spinach & Artichoke Dip.

The restaurant chain’s website explained that the charge was added to “partially offset… operational cost increases” due to unusual economic conditions including “global supply chain shortages and ever-growing pressure from inflation.” The statement said, “we believe these burdens will eventually pass,” which is why they resorted to a temporary surcharge instead of simply raising the listed prices. An alternative explanation is that surcharges that show up on the check but not the menu are a sneaky way to try to raise prices without losing customers.

The Wall Street Journal recently cited this incident as part of a general trend:

“Lightspeed, a global developer of point-of-sale software, said fee revenue nearly doubled from April 2021 to April 2022, based on a sample of 6,000 U.S. restaurants that use its platform. The number of restaurants adding service fees increased by 36.4% over the same period.”

The Journal cited industry analysts who basically agreed with Romano’s, explaining that:

“…this wave of surcharges is mostly being driven by restaurants trying to cope with the impact of rising inflation and a tight labor market on their bottom lines.” (…)

“​​Inflation and the pandemic posed particular challenges for the restaurant industry. The average price of supplies for a restaurant operator increased by 17.5% since last year, according to NPD Group. By comparison, consumer spending at restaurants rose 5% during that time.

The increase in surcharges is a way for businesses to recoup at least some of those costs, said David Portalatin, a food-industry adviser with the group.”

In media coverage of today’s rising prices in general, this has become a prevailing narrative: “businesses are passing their rising costs onto consumers.”

While superficially plausible, this gets the economics of prices the wrong way round.

The explanation refers to “cost-plus pricing,” which is the business practice of setting prices by starting with your costs and then adding a markup.

Of course, nothing in economics says that a business owner cannot use this method to decide on a price to quote. Surely, some do exactly that. But it is only a heuristic and it is not what fundamentally drives price changes.

Just as “there ain’t no such thing as a free lunch” (TANSTAAFL), there ain’t no such thing as a cost-plus lunch.

To explain price increases as resulting from “passing costs on to the customer” is to implicitly embrace a “cost of production” theory of value and prices, which, in a nutshell, maintains that costs determine prices.

Of course, costs are prices, too. A business’s “costs” are the prices it pays for factors of production (land, labor, and capital goods). So, in a bigger nutshell, this theory posits that “factor prices determine product prices.”

But this is the exact opposite of how an economy actually works. As Murray Rothbard wrote in his economics treatise Power and Market, “Prices, however, are never determined by costs of production, but rather the reverse is true.” In other words, it is anticipated product prices that determine factor prices: prices that determine costs, not the other way around.

This insight was one of the great discoveries that resulted from the “Marginal Revolution” of economics in the 1860s and 70s. This was a literal “revolution” in the sense that it showed the old economic paradigm to be upside-down and then turned it right-side-up.

Before the Marginal Revolution, the “classical economists” largely subscribed to Adam Smith’s cost-of-production theory of value or David Ricardo’s labor theory of value. The latter, like the former, derived the value of products from the value of factors: specifically the factor of labor. (Incidentally, Karl Marx largely based his exploitation and class war theories on Ricardo’s labor theory of value.)

For example, classical economists might have traced the high value of a bottle of fine wine to the high real estate value of the vineyard and/or the amount of labor that went into producing the wine.

But the Marginal Revolutionaries—William Stanley Jevons, Leon Walras, and Carl Menger—upended that paradigm. They and their followers (especially the Austrian school of economics, founded by Menger) explained that the value of a good is based on its “marginal utility,” which is the usefulness for want-satisfaction of an additional unit of a good. And what’s useful about a factor of production is that it can help produce useful products.

For example, the utility of a wine vineyard is that it can yield wine grapes. The same goes for the utility of a vineyard worker’s labor. And the utility of wine grapes is their contribution toward producing enjoyable wine.

So Austrian economists do the opposite of what the classical economists did. Austrians trace the real estate price of the vineyard and the wages of the vineyard worker to the anticipated value of the wine at the end of the production line.

The insights of the Marginal Revolution made it clear that prices determine costs (product prices determine factor prices), not the other way around, and that ultimately consumer preferences determine all prices.

(Note: Alfred Marshall tried to reconcile the classical cost-of-production theory with marginal utility theory in a “neoclassical synthesis” that has influenced mainstream economics to this day. See here for Murray Rothbard’s Austrian critique of that attempt.)

So the “cost passing” explanation of rising prices is a retrogression to a long-overthrown economic paradigm: the economic equivalent of forgetting the heliocentric Copernican Revolution of astronomy and explaining planetary movements using the archaic geocentric model of Ptolemy. Just as the sun does not revolve around the earth, consumer prices do not revolve around producer costs: quite the opposite.

Many on the political left blame corporations for “price gouging” in order to fatten their profits. But blaming rising prices on profit-seeking is like blaming a plane crash on gravity.

Gravity is always pulling down on planes. To explain a plane crash, you have to explain what happened to the factors that had previously counteracted that downward pull. Why did gravity yank the plane down to earth when it did and not before?

Similarly, businesses are always seeking profit and are always ready to raise prices if that is what will maximize profits. To explain precipitous price hikes, you have to explain what happened to the factors that had previously put a lid on that upward price pressure. Why did profit-seeking propel prices skyward recently and not in 2019?

This question is also tricky for those (including some on the political right) who blame rising prices on rising costs. If businesses can preserve profits by raising prices now that their costs are higher, why wouldn’t they have increased profits by raising prices before when their costs were lower?

A business’s customers don’t care about that business’s costs. They care about value. Based on the value they expect from a product, there is a limited price range they’d be willing to pay for any given amount of it. That translates into the market demand for the product: the quantity of a good that would be bought at any given price point. The value of, and demand for, a product does not fluctuate with its production costs.

Even businesses don’t (or at least shouldn’t) really care about past costs when it comes to pricing. Past costs are sunk. Whatever was spent to produce it, at any given moment a business has a given inventory. Its best interest is to price that inventory so as to maximize revenue given current demand. Based on that definite demand, raising prices past a certain point will result in less revenue, regardless of past costs. If the most revenue they can hope for is less than their past expenditure, that’s just the way things turned out. They can learn from that error and from those losses by spending less and/or differently in the future. But they cannot change the past or defy the economic reality of the present.

As economist Jonathan Newman told FEE in an interview:

“There is no change in costs that directly affects the revenue-maximizing price. If the prevailing market price is one that maximizes revenue for the firm, then it is impossible for the firm to ‘pass on’ costs to the consumer by increasing prices, because this would result in less revenue.”

Newman reminds us that, “factors of production are valued because they help us make consumer goods, not the other way around. What consumers are willing to pay for consumption goods determines what entrepreneurs are willing to pay for land, labor, and capital goods.” He offers an extreme example to make this point:

“Suppose that tomorrow the government decides to tax the sale of ink for ballpoint pens at $1 billion per mL. Would pen makers be able to carry on as usual and pass this increased cost on to consumers? Would consumers be willing to pay $1,000,000,000.25 for a pen? Of course not. Anticipated consumer demand is a limit on what producers will pay for inputs. More expensive inputs does not mean consumers are ready to pay a higher price for outputs.”

So if “cost passing” isn’t what’s driving up prices, what is? Newman points to monetary expansion by central banks, especially the Federal Reserve:

“I suspect that many firms will be able to get away with increased prices because of this. Even if their stated intention is to ‘pass on’ or share costs with their customers, the increased demand from the trillions of dollars that have been injected into the economy over the past couple years is what really makes their price increases both necessary and feasible.”

It is important to note that monetary price inflation is also not “passed on” from suppliers to customers, as “inflation surcharges” might lead you to believe. Again, the reality is the reverse of that. Extra money enables customers to bid up the prices charged by their suppliers, who in turn use the extra money to bid up the prices charged by their suppliers, and so on. That is how new money raises prices across the board (although, unevenly) as it circulates through the economy.

Another contributing factor to rising prices, at least in many specific industries, is today’s supply chain crisis. To an extent, Romano’s and industry analysts are right to blame rising restaurant prices on supply constraints. But they are wrong to characterize it as a matter of “passing on” or “recouping” costs. Rather, it is a matter of greater scarcity translating into a higher marginal utility of certain goods and thus higher prices.

For example, a major factor in today’s high food prices is undoubtedly the war in Ukraine. Both Ukraine and Russia were major exporters of grain. But, owing to Russia’s blockade of Ukraine and the West’s sanctions on Russia, grain exports from both countries have been throttled.

As a result, food processors have less grain to produce foodstuffs like, for example, macaroni. And as a result of that, restaurants have less macaroni to produce macaroni dishes. And when there’s less of something, its price tends to go up. That is probably one of the reasons why the Honolulu diners at Romano’s Macaroni Grill discussed above paid $11.00 for “Signature Mac & Cheese Bites.”

This phenomenon is not “passing on costs.” It is the rippling repercussions of economic destruction and impoverishment. The word “passing” implies that consumers are impoverished while producers are not. But that is not the case. Diminished production and greater scarcity impoverish everyone involved.

It is also confusing to call that “inflation,” although both academia and the media tend to lump all price increases together under that term. For any given increase in prices, part of it may be caused by monetary expansion, and another might be due to supply constraints. Personally, I think it would be clearer to call only the former, and not the latter, “inflation.” Price increases due to an increasing abundance of money should be distinguished from price increases due to a declining abundance of goods and services, although the former very frequently causes the latter (especially by creating economic bubbles and crashes).

Especially since the advent of the Covid crisis in 2020, we have suffered plenty of both. Central banks have been driving up prices with money printing sprees undertaken to finance government spending sprees. Governments have also been driving up prices by sabotaging supply chains through lockdowns, business shutdowns, wars, trade restrictions, and other policies of mass economic destruction.

As prices continue to rise and living standards continue to drop, it is important to understand how it is happening, why it is happening, and who is truly to blame.

AUTHOR
Dan Sanchez

Dan Sanchez is the Director of Content at the Foundation for Economic Education (FEE) and the editor-in chief of FEE.org.

EDITORS NOTE: This FEE column is republished with permission. All rights reserved.

How CO2 Supply Chain Mayhem Almost Caused a Meat Shortage in Britain

In recent months, many of us have faced empty shelves, long lines, and frustrating delays as supply chains have seized up around the country, and indeed the world. Some have argued that the government should step in to fix these issues, blaming the problems on “corporate greed” and “the free market”. But while it may be tempting to blame private companies for our current woes and see the government as the savior, the reality is not that simple. Indeed, far from being the solution, government intervention in the market is arguably the primary cause of these problems in the first place.

A good case study for this issue is Great Britain. Back in September, the nation’s supply chain issues got so bad that they almost had major disruptions in their food supply. The UK government has been intervening in an attempt to fix the problems in the short run, but the situation is still extremely precarious.

So who is responsible for these issues? Well, let’s follow the supply chain link-by-link and see if it can lead us to the culprit.

The immediate problem that food producers are facing is a shortage of food-grade carbon dioxide (CO2). The meat industry is particularly affected by this shortage, since CO2 is used in many meat production processes. But aside from that, the gas also plays a key role in modified atmosphere packaging, which is used to prolong the shelf life of many food products. It’s also used in carbonated drinks (hence the name) like beer and soda, and in its solid form as dry ice it is used to keep fresh food cool during transportation.

Why is there a shortage of CO2? Well, most food-grade CO2 comes from fertilizer plants, because CO2 is a byproduct of the fertilizer manufacturing process. These plants, however, have been producing far less CO2 than normal. So to understand why there’s so little CO2, we need to investigate the fertilizer plants. This brings us to the next link in the chain.

Two of the biggest fertilizer plants in the UK are owned by a company called CF Industries. Together, they normally produce about 60 percent of the UK’s food-grade CO2. However, these plants were actually shut down for a large part of September, which drastically reduced the UK’s CO2 production.

The reason they were shut down is because natural gas, an essential part of the fertilizer process, has been very expensive in recent months. With the price of this key input so high, it was actually uneconomical for the plants to operate, so they decided to shut down temporarily in hopes of restarting their operations once the price of natural gas came back down. But why is natural gas suddenly so expensive? This brings us to the third link in the chain.

First, to say that natural gas prices are high in Britain is really quite the understatement. According to Industry group Oil & Gas UK, wholesale prices for gas in September were up 250 percent since January, and had increased 70 percent since August. As one UK energy CEO remarked, this is “the most extreme energy market in decades.”

So what’s causing the high prices? A number of factors. High global demand has played a role, especially since roughly 60 percent of the UK’s natural gas supply is imported. Lower solar and wind output have also been factors, as well as outages at some nuclear stations. The cold winter in 2020 also resulted in depleted stocks (since people use natural gas to heat their homes), and several gas platforms in the North Sea have closed to perform maintenance that was paused because of the COVID-19 lockdowns.

But one of the biggest sources of price volatility is the dearth of natural gas storage facilities in the UK.

“The UK currently has very modest amounts of storage, less than 6% of annual demand.” writes Michael Bradshaw, a Professor of Global Energy at the University of Warwick. “In Germany, France, and Italy, storage covers about 20% of annual demand,” he continues for context. Another report noted that the UK has enough storage to last for about 7 days, whereas Germany and France have roughly 90 days of storage.

While storage is far from the only factor affecting natural gas prices, it certainly plays a significant role. But why does Britain have so little storage capacity? This brings us to the final link in the chain.

One of the reasons for Britain’s low storage capacity is that a storage facility called Rough, which used to provide a significant percentage of the UKs natural gas storage, was decommissioned in 2017 as a result of age-related deterioration.

Industry leaders were concerned about the resulting lack of storage at the time, and have been warning about the issue ever since.

“Rough makes up an impressive 70% of the UK’s storage working gas volume,” Timera Energy noted back in 2017, when permanent closure was still being deliberated. “This can be contrasted with Rough’s contribution to the UK’s daily deliverability, at around 25%. And it is the deliverability that the UK market will miss most.”

They go on to explicitly discuss the likely impact of the closure on the price of natural gas. “The loss of deliverability should boost spot price volatility as it reduces the buffer of supply flexibility available to respond to swings in daily demand…The loss of working gas volume is likely to mean that supply shocks…have a sharper and more prolonged price impact.”

The need for more storage was reiterated in 2019 by another industry leader named InfraStrata Plc. “There is more demand in the market than we can satisfy,” said John Wood, the CEO of InfraStrata. “The market in the U.K. is sending out strong economic signals for additional gas storage capacity.”

So why wasn’t more storage built? Well, as it turns out, natural gas storage is taxed and regulated very heavily in the UK, much more so than other industries. Indeed, one of the largest gas storage operators in the country, called Storengy, explicitly called attention to these problems back in 2018, pointing out the “punitive” and “extortionate” tax levels that are applied to storage facilities as well as the numerous regulations that burden the industry.

As a result of these barriers, many potential storage projects have remained on the shelf, since they are prohibitively expensive in the current business environment. Thus, even though the demand is clearly there, the market has been unable to meet it, because taxes and regulations have severely crippled the industry.

This analysis is hardly exhaustive, of course. But at least with respect to the storage issue, it seems clear that government intervention in the market is the primary cause of the food supply chain disruptions.

One of the interesting things about this story is how it highlights the plethora of people, items, and systems that work together to keep our grocery shelves full. First, we discovered that food producers rely on CO2. That led us to investigate fertilizer plants and the crazy natural gas market, and then from there we explored natural gas storage and learned about the many ways that government intervention has been crippling that industry. Of course, most people wouldn’t intuitively connect gas storage regulations with food availability, but the rippling unintended consequences of these policies are very real nonetheless.

In his famous essay “I, Pencil,” Leonard Read similarly draws attention to the “innumerable antecedents” of everyday items, such as the seemingly simple lead pencil.

“Just as you cannot trace your family tree back very far, so is it impossible for me to name and explain all my antecedents,” Read wrote, speaking as the pencil. He goes on to discuss some of the many ancestors of the pencil, the people and things that went into producing it, and he points out how they all depend on one another. Indeed, you can’t mess with the trucking industry without impacting the production of pencils, just as you can’t mess with natural gas storage without impacting food supplies.

With that said, trucking and natural gas are not only ancestors of pencils and food. They are also ancestors of many other products, and this leads to an important insight. In reality, it’s actually somewhat misleading to speak of supply chains, as if the economy consisted of independent, linear processes. The economy is much more accurately characterized as one giant supply web, a multiplicity of interconnected processes that all depend on each other in various ways.

With this in mind, it quickly becomes apparent why interfering with the economy can be so dangerous. When the government breaks one part of the web, they aren’t just impacting one chain, they are creating countless unintended consequences, many of which are impossible to foresee.

If we’re lucky, those consequences will only lead to higher prices. If we’re not so lucky, empty grocery shelves await.

To address the looming crisis, the UK government ended up bailing out CF Industries, the company that owns the fertilizer plants. The deal, which was finalized on September 21, resulted in one of the two plants resuming operations, with the UK government providing “limited financial support,” which the Environment Secretary later clarified was “going to be into many millions, possibly the tens of millions [of euros].”

Since then, the government has brokered a deal between CF Industries and its CO2 buyers. Though the details are unclear, the government seems to be involved in setting the price of CO2, which would constitute even more intervention in the market.

But intervention is not the solution here. When governments intervene, they inevitably distort price signals, leading to increasingly inefficient outcomes. The real solution is for the government to stop causing the problem in the first place by removing the taxes and regulations that are standing in the way of the natural gas storage market.

Granted, it will take some time before the storage market can adjust, but even in the interim, the best way to address these problems is to let markets and prices do their thing.

COLUMN BY

Patrick Carroll

Patrick Carroll has a degree in Chemical Engineering from the University of Waterloo and is an Editorial Fellow at the Foundation for Economic Education.

EDITORS NOTE: This FEE column is republished with permission. ©All rights reserved.

“Restaurant Recession” Hits NYC Following $15 Minimum Wage

This will be a rough year for full-service NYC restaurants as they try to navigate a future with significant economic headwinds and significantly higher labor costs from the city’s $15 an hour minimum wage.

An article in the New York Eater (“Restaurateurs Are Scrambling to Cut Service and Raise Prices After Minimum Wage Hike“) highlights some of the suffering New York City’s full-service restaurants are experiencing following the December 31, 2018 hike in the city’s minimum wage to $15 an hour, which is 15.4% higher than the $13 minimum wage a year earlier and 36.4% higher than the $11 an hour two years ago. For example, Rosa Mexicana operates four restaurants in Manhattan and estimates the $15 mandated wage will increase their labor costs by $600,000 this year. Here’s a slice:

Now, across the city, restaurant owners and operators are reworking their budgets and operations to come up with those extra funds. Some restaurants, like Rosa Mexicano, are changing scheduling. Other restaurateurs are cutting hours and staffers, raising menu prices, and otherwise nixing costs wherever they can.

And though the new regulations are intended to benefit employees, some restaurateurs and staffers say that take home pay ends up being less due to fewer hours — or that employees face more work because there are fewer staffers per shift. “The bottom line is, we have to reduce the number of hours we spend,” says Chris Westcott, Rosa Mexicano’s president and CEO. “And unfortunately that means that, in many cases, employees are earning less even though they’re making more.”

In a survey conducted by New York City Hospitality Alliance late last year, about 75% of the more than 300 respondents operating full-service restaurants reported they’ll reduce employee hours this year because of the new wage increases, while 47% said they’ll eliminate jobs in 2019.

Note also that the survey also reported that “76.50% of respondents report reducing employee hours and 36.30% eliminated jobs in 2018 in response to mandated wage increases.” Those staff reductions are showing up in the NYC full-service restaurant employee series from the BLS, see chart above. December 2018 restaurant jobs were down by almost 3,000 (and by 1.64%) from the previous December, and the 2.5% annual decline in March 2018 was the worst annual decline since the sharp collapse in restaurant jobs following 9/11 in 2001.

As the chart shows, it usually takes an economic recession to cause year-over-year job losses at NYC’s full-service restaurants, so it’s likely that this is a “restaurant recession” tied to the annual series of minimum wage hikes that brought the city’s minimum wage to $15 an hour at the end of last year. And the NYC restaurant recession is happening even as the national economy hums along in the 117th month of the second-longest economic expansion in history and just short of the 120-month record expansion from March 1991 to March 2001.

Here’s more of the article:

“There’s a lot of concern and anxiety happening within the city’s restaurant industry,” says Andrew Rigie, executive director of the restaurant advocacy group. Most restaurant owners want to pay employees more, he says, but are challenged by “the financial realities of running a restaurant in New York City.” Merelyn Bucio, a server at a restaurant in Soho that she declined to name, says her hours were cut and her workload increased when wage rates rose. Server assistants and bussers now work fewer shifts, so she and other servers take on side work like polishing silverware and glasses. “We have large sections, and there are large groups, so it’s more difficult,” she says. “You need your server assistant in order to give guests a better experience.”

At Lalito, a small restaurant in Chinatown, they used to roster two servers on the floor, but post wage increases, there’s only one, who is armed with a handheld POS (point of sale) system, according to co-owner Mateusz Lilpop. Having fewer people working was the only way for him to reduce costs, he says. Since the hike, labor costs at Lalito have risen about 10 percent — from 30 to 35 percent to 40 to 45 percent of sales, he says.

These changes get passed onto the diner, some restaurateurs argue. Service can suffer due to fewer people on the floor, or more and more restaurateurs will explore the fast-casual format over full-service ones. Some restaurants are also raising prices for customers. According to the NYC Hospitality Alliance’s survey, close to 90 percent of respondents expect to raise menu prices this year. Lalito’s menu prices have increased by 10 to 15 percent. Lilpop says, and it’s not just the cost of paying his staff driving prices up — it’s a ripple effect from New York-based food purveyors’ own labor cost increases.

“If you have a farmer that has employees that are picking fruit, he has to increase his labor costs, which means he has to increase his fruit prices,” Lilpop says. “I have to buy that fruit from him at a higher rate, and it goes down the chain.”

A few economic lessons here.

  1. A reduction in restaurant staffing that results in a decline in customer service (e.g., longer wait times, less attentive wait staff, etc.) is equivalent to a price increase for customers.
  2. The increases in the city minimum wage to $15 an hour, in addition to directly increasing labor costs for restaurants, also affects the labor costs of companies that supply food, liquor, restaurant supplies, menus, etc. and causes a ripple effect of indirect higher operational costs throughout the entire restaurant supply chain as described above.
  3. Even for workers who keep their jobs, a higher minimum wage per hour doesn’t necessarily translate into higher weekly earnings, if the reduction in hours is greater than the increase in hourly wages. For example, 40 hours per week at $13 an hour generates higher weekly pre-tax earnings ($520) than 33 hours per week at the higher $15 an hour ($495).

Prediction: This will be a rough year for full-service NYC restaurants as they try to navigate a future with significant economic headwinds and significantly higher labor costs from the city’s $15 an hour minimum wage.

This article was reprinted from the American Enterprise Institute.

COLUMN BY

Mark J. Perry

Mark J. Perry

Mark J. Perry is a scholar at the American Enterprise Institute and a professor of economics and finance at the University of Michigan’s Flint campus.

EDITORS NOTE: This FEE column with images is republished with permission. Image Credit: Wikimedia Commons | CC BY 2.0