Businesses can thrive with a higher minimum wage, and government can help

A great deal of research shows that higher minimum wages benefit workers by adding to their income while causing little unemployment, as this report and this report show. Employers can adjust to paying higher wages in three ways: (1) increasing prices, (2) accepting reduced profits, or (3) offsetting higher-wage costs with increased ability by adopting “high-road” practices.

In this blog post, I argue that insufficient attention has been paid to this third channel, and that government efforts to help firms “take the high road” could ease firms’ transition to higher wages in a way that also benefits workers and consumers.

Much research documents the ways that firms can utilize high-road policies or good-jobs strategies to tap the knowledge of all their workers to create innovative products and processes. In retail, for example, firms such as Costco and Trader Joe’s pay far above minimum wage, yet remain profitable, as MIT’s Zeynep Ton has shown. The key to their success is a mix of complementary practices in marketing (reducing the number of products and promotion so that stores can manage inventory efficiently), human resources (cross-training workers so they can respond to a variety of demands), and operations (avoiding unneeded steps, in part by soliciting feedback from employees).

In manufacturing, one successful high-road strategy is “agile production,” in which firms design, set up, and produce a variety of products quickly. Because the product mix changes constantly, a fixed division of labor is not practical. As Helper and Martins show, this strategy is especially effective when firms also consistently perform preventive maintenance (so machines are ready when needed); have employees participate in quality circles (to debug new products and processes quickly); and have a higher percentage of sales from products designed by the firm (to generate a steady stream of products that need such debugging).

In sum, many high-road firms thrive while paying higher wages than their competitors do because their highly skilled workers help these firms achieve high rates of innovation and quality and can enable a fast response to unexpected situations. The resulting high productivity allows these firms both to pay high wages and still make acceptable profits.

The high-road literature usually assumes that firms are paying higher wages than are their competitors. An increase in the legal minimum wage is a slightly different scenario, but has many similar effects. A higher minimum wage makes high-road practices easier to adopt, since a firm with only local competition doesn’t have to worry about being undercut by rivals paying less. A minimum wage increase can improve the productivity of a given firm’s workforce because higher wages reduce turnover. In fact, there is strong empirical evidence that higher minimum wages lead to more stable and experienced workforces. (The reason is that the higher minimum compresses the wage distribution from below so that the gains that a worker can expect from job search will fall for a worker earning near the new minimum wage.) In addition, firms can reap the benefits of employees who can focus more on work and are less distracted by the cognitive demands of poverty, like whether their car might break down before they can afford to fix it.

However, firms that would like to choose the high road often find it difficult to immediately shift from their current high-turnover, low-productivity strategy. As noted above, adopting a high-road strategy requires not just changes in labor practices, but also changes in marketing, product development, and information technology to take advantage of the higher-skilled (but also higher-cost) labor entailed by the new policies. The need to adopt complementary changes all at once and the need to vary the recipe when employers face different contexts that indicate slightly different payoffs to investments in training, task richness, schedule stability, and complex feedback from customer demand all raise the degree of difficulty.

Improving management practices thus has much in common with developing and adopting new technology. Like technology, management practices are a key determinant of productivity, they are complex and difficult to adopt, and their adoption has many social spillovers. In the case of high-road practices, these benefits to society include both better jobs for workers (better career paths and richer tasks) and better customer service.

Some firms can figure out these new recipes, but others struggle. For example, Luca and Luca find that restaurants with low ratings on Yelp responded to a minimum wage increase both by raising prices and by exiting the business. In contrast, firms with 5-star ratings raised prices significantly less, and saw no increase in the probability of exit.

The federal government should help to develop and diffuse these high-road practices, since these practices deliver social, as well as private, benefits. In manufacturing, some nascent institutions exist in the U.S. The Manufacturing Extension Partnership does excellent work diffusing management techniques such as lean production and effective new product development to small firms, but does not develop new techniques, and sees firm owners, not workers, as its constituents. Manufacturing USA institutes develop new technologies and helps transition them from lab to market–but these are technologies as traditionally defined (e.g., new equipment and new materials), not new ways of organizing.

To build on these institutions, the federal government could fund the development and implementation of high-road management practices either through a consortium of universities or via a pilot project focused on manufacturing that could be established in the Manufacturing USA network. A new institute or consortium dedicated to managing a sustainable manufacturing ecosystem could collaborate with the Manufacturing Extension Partnership. The institute could develop and diffuse methods for managing high-road labor practices, establishing collaborative supplier relationships, and developing worker capabilities to participate in discussions of innovation. Such an institute or consortium would be particularly valuable in helping small firms adjust to increased worker power.

In the service sector, there are some local models to build on, such as the Culinary Academy of Las Vegas, the Los Angeles Hospitality Training Academy, and programs by the Service Employees International Union (SEIU) in Washington state to increase the skills (and income) of home health aides. A similar new institution could help spread these models to other industries and across the country.

Experience with minimum wage increases has shown that some struggling firms are replaced with firms better positioned to operate under higher wage standards and also that workers are reallocated to more productive firms. However, programs such as those described above could achieve these productivity benefits both more broadly and with less disruption to the lives of workers and business owners.

The voluminous economic research on the impacts of the minimum wage shows that raising the federal minimum wage would have benefits for workers and the economy that far outweigh its costs. Helping firms to adjust by adopting high-road management strategies would increase these benefits even more.

Susan Helper is Carlton Professor of Economics at the Weatherhead School of Management, Case Western Reserve University. She is former Chief Economist of the U.S. Department of Commerce, and a member of the EPI board.