Which Restaurants Will Suffer the Most Under a Higher Minimum Wage?

"We don’t want our paper to serve as a mouthpiece for or against raising the minimum wage."

Jul 29 2017, 4:00pm

All photos by author.

The debate over the minimum wage is dividing America in unprecedented ways, and how that question continues to be answered throughout the United States will undoubtedly be felt most acutely in the food services and restaurant industry—the segment of our economy with the most minimum-wage workers. As more and more states raise their legal minimum wage, the fight between those who are for the increase and those against it has greatly intensified. The stakes are even higher when you consider the massive labor shortage the industry continues to face—one that Saru Jayaraman, co-founder and co-director of the Restaurant Opportunities Centers United, calls "the worst labor shortage in the history of our industry."

Dara Lee and Michael Luca—a husband and wife team of economic researchers—found out just how politicized and divisive the issue is when they posted their paper regarding the impact of raising the minimum wage on restaurant closures—and Breitbart picked it up. About the study, Breitbart misleadingly wrote that its findings proved raising the minimum "put(s) non-elite restaurants out of business."

Nowhere in the 33-page paper—which is part of an ongoing economic research initiative between the Harvard Business School and Yelp—did the Lucas mention "elite" restaurants or even rely on a rating matrix that could be construed as such, like Michelin stars. Needless to say, their findings were far more nuanced and complicated than the Breitbart summary would suggest. Given the vital importance of this topic to restaurants and diners alike, we spoke to Dara Lee Luca in the hopes of finding out exactly what does happen to restaurants when the minimum wage in their area goes up.

MUNCHIES: Hi, Dara. Can you explain for us what your most recent study looks at?
Dara Lee Luca: We looked at over 35,000 restaurants in the Bay Area and examined how 21 minimum wage hikes in the area between 2008 and 20016 have affected restaurant exit rates over time by using data from Yelp.

And what were the overall findings of the study?
We found that lower-rated restaurants are driven to exit [in other words, close] by increases to the minimum wage, whereas high-rated restaurants tended to be more insulated from these shocks.

So the variable you used to quantify the quality of the restaurants was their Yelp rating not prices, or "elitism," or ratings by restaurant critics?
The framework we used in this analysis controls for a lot of other factors. We asked: Within each restaurant, after the minimum wage goes up, does it increase the likelihood of restaurant closure compared to other restaurants that are similar, in all sorts of characteristics such as the type of restaurant, the cuisine, the dollar value?

Are the Yelp ratings generally a proxy for pricing, or did you come across lower-cost restaurants that were rated higher than more costly equivalents?
We've been asked a lot about whether this is just driven by the fact that lower-rated restaurants are often cheaper, or that there's some kind of relationship between price and quality. That's actually not true. There's a very low raw correlation between price and quality. We do control for that, and we don't see any correlation between price and the minimum wage. In layman's terms, this is not driven by price; it's driven by quality, and there's very little correlation between quality and price.

I know there has been a Harvard Business School study that previously looked into the prevalence of fake Yelp reviews. Was that a concern for you as you were gathering data?
That's actually my husband's old paper. We don't use any reviews that are deemed untrustworthy by Yelp, so we actually weed out those reviews. That said, even when we do include those reviews, the results are about the same.

Do you think that your findings translate to other major cities that have seen significant increases in the minimum wage, like Portland?
We focus on the Bay Area because it has been a testbed for minimum wage increases, which allows us to cleanly identify the impact of minimum wage on local businesses. I think the main takeaway does generalize to other areas and settings, i.e., firms with stronger reputations or of higher quality will be more insulated from minimum wage increases. We'll probably look at other cities in downstream work.

As you note in your study, California doesn't have a tip credit. In areas where tips are credited towards wages, do you think an increase in minimum wage will have less of an impact on business closures?
It's possible. In previously existing work that looked at restaurants and employment, most haven't found much of an effect on employment. It also depends on how large the minimum wage increases have been. In the Bay Area, we're seeing more than average increases, so it could be a multitude of reasons why we could potentially see more binding effects than in other places. It's really an empirical question to know what the effects are going to be on other cities.

You write in your paper that lower-quality restaurants are closer to the margin of exit than higher-quality restaurants, irrespective of minimum wage raises. You also note that an increase in minimum wage and increased restaurant closure is not necessarily a causal relationship. How did you go about separating these variables?
Restaurants that are lower-rated are associated with higher levels of exit; it doesn't have to be causal. All we're seeing is that lower-rated restaurants are already closer to the margin of exit, and this could be because they are already doing poorly or it could be that Yelp ratings do affect their likelihood of exit.

San Francisco is set for another minimum wage increase in about a year. Based on your work, do you think there will be a rash of restaurant closures following the move, and is there anything you think restaurants can do to avoid that?
Well, I would qualify that the analysis in our paper should be considered as short-term impact, because a lot of these minimum wage changes have been fairly new. Once we have more data, we want to find out if these effects are sustained and if we will continually see restaurants closing, or if this is just a short-term adjustment after which we won't see a continuation of restaurants closing. As far as what restaurants can do, I think one thing we learned from this study is that a restaurant's reputation does matter. Anticipating that there is going to be change and thinking about how to create higher demand would be helpful, as well as figuring out how to adjust to higher labor costs.

Your paper is almost certainly going to be cited by opponents of raising the minimum wage as proof that doing so is detrimental to business. On the other hand, advocates of raising the minimum wage may read it and argue that perhaps low-rated restaurants should just go out of business, instead of barely eking by through the use of a labor pool that isn't being paid a livable wage. What do you think about these arguments?
We don't want our paper to serve as a mouthpiece for or against raising the minimum wage. We're just trying to show that restaurants with lower ratings—which are already closer to the margin of exit—are being disproportionately affected by minimum wage increases. This is a useful piece of information for policymakers to understand the potential tradeoffs of raising the minimum wage. At the end of the day, there are going to be effects of raising the minimum wage.

Thanks for speaking with us, Dara.

This interview has been edited for clarity and length.

This article originally appeared on MUNCHIES in May 2017.