The secret to Costco's high-wage success

The folks on the editorial board at the New York Times have made another argument for raising the minimum wage, namely that it's good for business.

This is not entirely a crazy argument.  The "efficiency wage" theory of labor economics suggests that paying workers a bit more than the going rate makes them happy and pays off in terms of increased loyalty, lower turnover, etc.  Probably 95% of labor economics textbooks will accompany discussion of this subject with a sidebar about Henry Ford and the $5 day.  Ford famously paid more than any other carmaker in the industry and enjoyed the same type of low turnover -- even in back-breaking, physically demanding assembly line jobs -- touted in the NYT editorial.

Think about this another way, though, and the argument is that basically business owners are too dumb to figure out that paying higher wages will make them more profitable, so the government needs to save them from themselves.  I don't mean to dismiss that argument out of hand; certainly H.L. Mencken wouldn't.  But any time somebody asks you to believe that, it's worth considering alternative hypotheses.

The NYT talking point that Wal-Mart wants a higher minimum wage is a bit disingenuous, since their average wages exceed the minimum they are basically just asking the government to make their competitors pay more.

The Gap has voluntarily agreed to increase worker pay for the majority of its workforce (albeit to a level that's still below the proposed $10.10 minimum wage).  Bear in mind that the Gap sells self-branded clothing, and consumer willingness-to-pay for Gap jeans depends largely on how much they value the brand.  So chalk that one up as a shrewd marketing maneuver.  Expect Abercrombie & Fitch to follow suit quickly.  The model doesn't work so well for businesses that sell things like grapefruit and cat food -- identically packaged and marketed items sold by competing retailers.

And Costco, the subject of a Harvard Business Review article back in 2006, has a dirty little secret about its famously high wages that is patently obvious if you just read the article with calculator in hand.  Compared to Sam's Club, Costco logs 16% more in sales while employing 38% fewer workers.  Put these two ratios together and you discover that Sam's employs 87% more workers per dollar of sales than Costco does.  Costco has clearly traded higher wages for fewer jobs.

So is that what we want?  Higher paying jobs but many fewer of them?  That might end up working for some businesses, but what is it going to do for the people we intend to help?

I'll say it again: the EITC, backstopped by the existing minimum wage, is the way to efficiently and progressively ensure that no full-time worker lives in poverty. 

 

Comments

[Mattia]

Hello Jake, I hope you are doing well.

I am a bit puzzled by your comments on CostCo. The only thing one can say based on those numbers is that they are a more productive company that pays higher wages. If you want to make that a point of criticism, you should explain (1) how do you know that they "traded" wages for jobs, and (2) how do you know it's a bad thing.

Maybe they just train their employees better, or have more efficient processes - so it's good news. Or maybe they just hire more productive employees, or they outsource low-paying jobs, or they have fewer customers who buy bigger boxes - so it's no news at all but just sample selection. Or maybe, they employ more capital per unit of labor - so they literally traded, and it might be bad news, if you are a Luddite; or good news, if you are a turbo-capitalist like me, because I'd rather have three CostCos than two Sams in my economy :)

I have never been at Sam's so I can't really say, but I always thought CostCo was a good company. I always joked that CostCo is the proof that the Soviet system would work, if it were run by Americans. (Because you have really little choice of brands, but there are never shortages, and you wind up satisfied).

[Jake Vigdor]

Thanks for your comment, Mattia...

I don't mean to say that Costco's business plan is a bad thing. I'm a Costco member myself and am happy that the store exists. Whatever their business model is, it works well for our family.

Facile comparisons between Costco wages and Sam's Club wages, however, are implicitly making the argument that Sam's could raise their wages to Costco levels and still earn a profit.

The truth is that if Sam's replicated the Costco business model, part of the shift would involve laying off nearly half their workforce. As you suggest, Costco's model is relatively more capital-intensive and less labor-intensive, which naturally raises labor productivity on the margin.

So, yes, more businesses could be like Costco and pay fewer employees higher wages, but the consequence would be a dramatic loss of jobs. This is nothing more than an Economics 101-level insight.