Minimum Wage Hikes Drive (Lousy) Restaurants Out of Business

 
 
Do minimum wage increases harm businesses? Evidence from Yelp-inspired research by Michael and Dara Lee Luca suggests the popularity of the business has a lot to do with it.
 
 
by Dina Gerdeman
Minimum wage hikes can drive poor-quality restaurants out of business. (Source: AndresCalle)

A hike in the minimum wage can push restaurants out of business—but mainly the less desirable establishments already suffering from poor reputations, recent research shows.

The research results reveal that restaurants awarded five stars on the popular Yelp review service managed to carry on business as usual, despite a $1 increase in the minimum wage. But restaurants with a mediocre 3.5-star rating didn’t fare as well; the same $1 wage increase led to a 14 percent greater chance that these establishments would go under.

“We see that lower-rated restaurants generally go out of business at higher rates, so they already tend to be living closer to the edge,” says Michael Luca, an assistant professor at Harvard Business School, who conducted the research with his wife, Dara Lee Luca, an economist at Mathematica Policy Research. “Increases to the minimum wage then disproportionately push them over the edge.”

The research brings more insight into the continuing argument over whether raising the minimum wage hurts businesses. The findings were reported in the April 2017 paper Survival of the Fittest: The Impact of the Minimum Wage on Firm Exit.

One lesson is clear: Businesses that provide higher-quality service and maintain a solid reputation can become more insulated from market shocks, such as increases in fixed costs.

The minimum wage debate rages on

The issue of whether to raise the minimum wage remains intense.

Advocates for higher wages for the country’s lowest-paid workers argue that businesses should provide a livable wage for their employees. Activists have pushed to increase the minimum pay to as much as $15 an hour, more than twice the current federal mandate of $7.25, which was last raised in 2009. Twenty-nine states and 41 cities have increased the minimum wage above that federal level.

“The minimum wage is a big issue, and this is one piece of the puzzle”

Opponents counter that government-mandated pay hikes not only hurt businesses, but also ultimately lead to fewer jobs.

Luca doesn’t see the study results as a definitive case for or against minimum wage increases. Instead, the findings help us understand how the minimum wage affects markets—in other words, which types of businesses are affected by pay hikes and which aren’t.

“The minimum wage is a big issue, and this is one piece of the puzzle,” Luca says. “Our hope is to add nuance and a little more context for other economists and policymakers researching and making decisions about the minimum wage.”

Case in point: the San Francisco Bay Area

The Lucas, who spend a lot of time in the San Francisco Bay Area, found that the region could be a perfect laboratory for their research given that cities there had different minimum wages. Between 2008 and 2016, there had been 21 minimum wage increases throughout the Bay Area, making it a compelling setting.

They studied restaurants not only because they are the largest employer of minimum wage workers but also because they have a fairly high turnover rate—about 5 percent of restaurants go out of business each year.

Using data obtained from Yelp, the researchers looked at reviews of about 35,000 restaurants and compared them with the timing of minimum wage increases in local communities, as well as subsequent restaurant closure rates.

In addition to the results on restaurants closures, the research showed that minimum wage increases can stifle new businesses thinking about entering the market.

These effects held after controlling for the cost of eating at the restaurant, suggesting that a restaurant’s reputation was far more important than menu prices in determining ultimate survival. (On Yelp, the correlation between price and reputation is also limited.)

The study didn’t address the issue of whether minimum wage hikes create more unemployment. Luca believes that given the high amount of churn in the restaurant industry, it’s quite possible that employees who are left jobless from one restaurant that shuts down often find work at other places.

“While there’s still more to learn, previous research has suggested that increases to the minimum wage have a limited effect on overall employment,” Luca says.

Crowdsourced consumer data

This study differs from others done on wage-floor increases in that it uses crowdsourced data instead of government data to more quickly measure the impact.

Relying on government data has its drawbacks. It is often not as granular as researchers would like; for example, it may provide data by county, rather than by city or at the business level, and it may not include all the variables researchers are interested in, such as quality and price. Plus, the lag time between the collection of data and its release can be quite long, with some government data taking up to two years before it can be viewed.

“You can look at Yelp data to get metrics that aren’t in government datasets, and you can look at data more quickly. It’s all sitting right there on the platform,” says Luca, who has teamed with Yelp on a number of research projects, ranging from pinpointing restaurants with hygiene issues to finding ways to make Yelp itself more accurate.

Improving policy analyses with new data sources

Beyond the findings on the minimum wage, the research results provide a broader lesson about data that economists and policymakers can use to understand the world.

“Data from platforms like Yelp can add to our understanding of the economy,” says Luca, who works closely with companies and cities to help them better use data. “We can learn a lot by stepping outside of the standard datasets and giving platforms with interesting data a seat at the table in discussions about the economy.”

He believes that many companies are sitting on data that can provide valuable insights for society. Just as Yelp is informative about businesses, Zillow and Trulia might be able to provide insight into housing policy, and Glassdoor and Indeed could inform us about labor markets.

Related Reading

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Your Insight Needed!

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About the Author

Dina Gerdeman is a senior writer for Harvard Business School Working Knowledge

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