, , , , , , , , , , , , , , , , ,


Buyer beware: various memes promoting a higher minimum wage, or a mandated “living wage” of $15, cite Costco as “proof” that a higher wage floor does not imply that product prices must rise. In fact, Costco pays relatively high wages to its hourly workers and it is a discount retailer, but it is highly misleading to treat these facts in isolation or to suggest that they imply anything about cost-price causality and the consequences of changes in costs. A higher wage floor would add cost pressure to any business employing low-skilled labor and even some employing more skilled workers like Costco. Many of these firms would have to raise prices to remain viable.

Costco says that it pays an average wage of $17 plus benefits. A quick glance at Glassdoor.com shows starting pay rates well below that average, which is no surprise. Costco recently increased its lowest pay rates for the first time in eight years, to $13 and $13.50 an hour from $11.50 and $12. However, there may be some slight-of-hand used to support other quotes of Costco’s average wage. It’s been claimed elsewhere that the company pays an average wage of $20, and President Obama asserted that Costco’s average wage is $21. Typically, quotes of hourly wages do not include the value of benefits. One blogger suggests that these higher figures may have been calculated by averaging across job classifications, rather than dividing the company’s total hourly wage bill by the number of worker-hours. One other qualification is that roughly 10% of the workers in a typical Costco warehouse store dispense free samples but are not employed by Costco. The average hourly wage of “workers at Costco” would likely be lower than $17 if they were included.

Nevertheless, it’s true that Costco pays a relatively high wage rate to its hourly workers. How can they afford to do so? As it happens, Costco has relatively few workers relative to other retail operations, and its average revenue per transaction is high. According to Megan McArdle at Bloomberg, in 2013, Costco’s average square-feet of floor space per employee was almost twice WalMart’s; according to MarketWatch, Costco’s average revenue per employee is now nearly three times the comparable figure for WalMart (enter COST and WMT). Obviously, Costco employees are highly productive in terms of revenue, and that is closely associated with higher wages.

The high productivity at Costco is not an accident. While a good wage is certainly a motivating factor, the productivity of Costco’s work force starts with screening during the hiring process, where the company is known to prefer significant retail experience. They also emphasize the demanding physical requirements of certain jobs, and given their thin staffing, a relatively high level of responsibility for a retail worker. Newcomers are said to be under a watchful eye, and effective performers are rewarded. It takes four to five years to reach the top of the wage scale in a job category. Many of those categories involve specialized skills, such as licensed opticians, butchers, cake decorators, forklift drivers, licensed hearing aid dispensers, and registered pharmacists (these categories drive up the average wage). The company provides training opportunities in various areas, and average employee turnover is low, which reduces costs. The Costco warehouse stores are without typical retail amenities; they are bare-bones with goods sitting on pallets rather than displayed on shelves. This also lowers costs, giving the company additional leeway in shaping its generous wage policy.

Returning to the question of pricing, Costco’s example cannot be generalized. First, it might not be such a good example of price restraint in the face of higher wages to begin with. To bolster earnings, Costco is expected to raise its membership fees by about 9% in 2017; undoubtedly there is also room for retail margins to increase. Time will tell. Second, again, Costco’s wage policy works fairly well because its business model rests largely on high labor productivity. Basic economics teaches us that higher productivity drives higher wages. Workers who earn less than Costco wages are, in general, less productive. This is a consequence of more limited skill sets, less experience, and sometimes weak desire. Those earning at the minimum wage are handicapped by an inability to contribute at high levels, or an inability to demonstrate that they can at their hiring date. Thus, they work in jobs that do not require developed skills. For their employers, higher wages are not a path to profitability.

Mandating an increase in the wage floor is not possible without other market adjustments. First, like anything else, the demand curve for low-skilled labor slopes downward, so a higher wage floor reduces the desired labor input. Job losses befall the least skilled in such a scenario. This consequence has greater breadth in a world in which opportunities for automation are plentiful. Another possible adjustment is an increase in the price charged to customers, which might be a reflexive response among business operators. However, they must compromise when confronted with the competitive effects of passing along an increase in costs. There could be other cost-reducing changes in job structure, benefits, break times, and any number of other conditions and circumstances of employment. Finally, some business owners might accept a lower level of profitability, depending on their disposition and the competitive tenor of the markets in which they operate. Some Costco shareholders believe that might be the case, as the company’s earnings have softened recently.

The final outcome is likely to be a combination of the adjustments described above. Unfortunately for proponents of a higher wage floor, the economy cannot and will not transform itself into a community of Costco clones. With limited skills, the motivational power of higher wages goes only so far. All price floors create excess supply, in this context unemployment. Excess supplies tend to consist of the most marginal units, in this case, the least productive workers. Perhaps sheer ignorance causes agitators for wage mandates to overlook this inevitable marginalization. The real minimum wage is zero.

A note on the cartoon above: It reminded me of an amusing passage in Margaret Mitchell’s “Gone With The Wind” when Rhett Butler, in a sardonic moment, suggests to Scarlett O’Hara that she change the name of Kennedy’s General Store in Atlanta to “Caveat Emptorium, assuring her that it would be a title most in keeping with the type of goods sold in the store. She thought it had an imposing sound and even went so far as to have the sign painted….” Later, Rhett learns that she actually had the sign made, but an embarrassed Ashley Wilkes clued her in to the meaning. She is furious, and Rhett laughs hysterically.