Current / Economics

Slight Statistical Shortsightedness

Something is rotten in the state of Denmark…

If American fast food workers were as well-paid as Danish fast food workers, they would enjoy much higher living standards — but about 65 percent of them might lose their jobs.

That is not the conclusion that I saw liberals drawing from yesterday’s New York times article about wages at McDonalds in Denmark by Liz Alderman and Steven Greenhouse. But it seems to be the conclusion that’s warranted by their reporting,  albeit with the crucial fact buried in the 29th paragraph of the article:

Measured in Big Macs, McDonald’s workers in Denmark earn the equivalent of 3.4 Big Macs an hour, while their American counterparts earn 1.8, according to a study by Orley C. Ashenfelter, a Princeton economics professor, and Stepan Jurajda, an economics professor at Charles University in Prague.

And the Danish restaurants are less profitable. With fast-food wages in the United States so much lower than in Denmark, and the price of Big Macs in the two countries similar, Mr. Ashenfelter said, “It must be that U.S. McDonald’s are far more profitable.” The higher wages and the higher menu prices help explain why there are 16 McDonald’s per million inhabitants in Denmark, but 45 McDonald’s per million in the United States, Mr. Jurajda said.

Obviously this is not a slam-dunk proof that forcing US McDonaldses to pay Danish wages would lead to the closure of two-thirds of the McDonalds restaurants in the country. But it’s certainly suggestive.

What’s suggestive?

Danish law does not require fast-food companies or their franchisees to adhere to the wages required by the agreement with the 3F union. But they do, because employees and unions pledge in exchange not to engage in strikes, demonstrations or boycotts. “What employers get is peace,” said Peter Lykke Nielsen, the 3F union’s chief negotiator with McDonald’s.

McDonald’s learned this the hard way. When it came to Denmark in the 1980s, it refused to join the employers association or adopt any collectively bargained agreements. Only after nearly a year of raucous, union-led protests did McDonald’s relent.

Perhaps this is suggestive that Mr. Yglesias does not read very carefully:

Denmark has no minimum-wage law. But Mr. Elofsson’s $20 an hour is the lowest the fast-food industry can pay under an agreement between Denmark’s 3F union, the nation’s largest, and the Danish employers group Horesta, which includes Burger King, McDonald’s, Starbucks and other restaurant and hotel companies.

(Emphasis added).

If the United States government were to mandate $20 an hour starting wages, it still wouldn’t be following the Denmark model.

Three Falsehoods: Lies, Damn Lies, and Statistics

Mr. Yglesias falls into another, much larger trap:

The good news about Denmark is that their unemployment rate is only very slightly higher than the USA’s and was lower in the recent past.

Is it?

Historical Data Chart

Historical Data Chart

The Danish unemployment rate appears to be nearly two full percentage points lower than the American rate.  Why the disparity?  Elementary error–Mr. Yglesias likely referred to Eurostat figures when comparing Denmark and the United States; figures that are more apples-to-apples when using the BLS U-6 measurement.  Statistics Denmark (the Danish equivalent of the BLS) releases measurements that closely approximate BLS U-3 (the “official” American rate of unemployment):

Net unemployed by sex and persons/pct. - Danmarks Statistik

Denmark has lower youth unemployment levels as well:

Historical Data ChartHistorical Data Chart

…while managing to maintain a higher overall labor force participation rate than the United States.  What lesson are Americans supposed to be taking away from this episode again?

Fast Food Franchises=Highway Robbery

I could leave well enough alone here, but Mr. Yglesias’s asks a question that needs to be answered:

The relevant question for the United States then becomes what would we have people do if half the fast food restaurants shut down?

Depends on which people we’re referring to.  Employees and franchise owners will lose jobs and investments.  The corporate offices, on the other hand, will simply resell the franchises:

In August, Larry and Kathryn Baerns and their son, Christopher, filed court papers charging that the two new Steak ’n Shake restaurants they had just opened in the Denver area were under siege. Suppliers refused to make deliveries. Their computer system went dark. Desperate, they bought old-school cash registers and took orders by hand while seeking a restraining order against the forces trying to shut them down.

The Baernses were up against Steak ’n Shake’s own national corporate offices, from whom they had bought their two Steak ’n Shake franchises. The franchisor was taking actions designed to “cut them off at the knees,” the Baernses alleged, over a dispute about whether their two restaurants had to offer a $4 value menu.

The Baernses claimed that they been misled about the profitability of Steak ’n Shake franchises, and that their business would fail if they sold items at the promotional price. In the middle of the legal battle, the two sides even turned to espionage: the chain sent an undercover operative into the franchisee’s stores to try to prove that they were not selling at approved prices. In response, the Baernses sent their own undercover agents to St. Louis to investigate prices at other Steak ’n Shake outlets.

Two weeks later, the Baernses lost their restaurants—and, with them, their investment. A court found them in breach of their contract with Steak ’n Shake. The restaurants closed in the first week of September, leaving behind only handwritten notes that read “Sorry closed.”

In Colorado, the legal battle rages on. The Baernses are still suing to recoup damages, while Steak ’n Shake has taken over the shuttered stores and plans to unveil new stores in the region.

Wait, what?

Franchisors often write very imbalanced contracts that squeeze individual franchisees at every turn, including charging high prices for supplies. Today, many franchisors earn high profits even as many of their franchisees are struggling or going out of business.

One of the major reasons such practices have spread is a big shift in how the courts interpret antitrust and contract law. For franchisees, 1997 marked a turning point on two fronts. In Queen City Pizza v. Domino’s Pizza, the owners of Queen City Pizza argued that they shouldn’t be bound by the language in their franchise agreement that required them to buy their pizza supplies exclusively from Domino’s. They argued that this language constituted a “tying arrangement,” and that the courts had long prevented franchisors from exercising such power over franchisees under antitrust laws. The 3rd Circuit Court of Appeals rejected this claim, however. Writing in the Franchise Law Journal, lawyer Andrew Selden notes that the Queen City Pizza decision “for all practical purposes sounded the death knell for tying claims in business-format franchises.” The decision left franchisors free to coerce franchisees into buying just about anything at any price so long as it was specified in their contract.

The same year, another ruling further limited the power of franchisees. The U.S. Supreme Court’s decision in State Oil Company v. Khan broke precedence by allowing franchisors to put ceilings on what franchisees could charge for specified items. This decision was affirmed in 2009 when Burger King franchisees sued the company for forcing them to be part of an unprofitable promotion. The franchisees argued that it was unfair to require them to sell double cheeseburgers, which cost more than $1 to make, for just $1. The courts ruled in favor of Burger King’s right to set maximum prices. Other court decisions have also limited the ability of franchisees to make their own decisions about cutting prices, giving franchisors near-total control over menu prices.

One might suppose that market forces would automatically correct any imbalance of power in franchising. It seems logical that franchisors would have an interest in seeing their franchisees do as well as possible. But that’s not necessarily true. The problem is that in a relationship of unequal power, reliance on contracts and the market has only made the imbalance of power between franchisors and franchisees worse. Bad franchisors have not gone out of business.

The sandwich shop chain Quiznos, for example, continued to sell new franchises even though its corporate management knew that 40 percent of the stores were failing and that they had oversaturated the market. In the most notorious case, one ruined franchise owner committed suicide and left a note that read, “Someone must do something about what Quiznos is doing to the trapped franchisees. I deeply regret getting into Quiznos. I wish I had never heard of them.”

More recently, the company has become entangled in a new round of lawsuits by franchisees who claim the company bilked them on the cost of food, paper, and other “mandated essential goods” that they were contractually obligated to buy from Quiznos. Meanwhile, 39 percent of its franchisees with Small Business Administration loans were in default in 2012. And Quiznos is not alone: the default rate for another well-known brand, Cold Stone Creamery, was more than 42 percent in 2012, costing the government millions and spelling financial ruin for franchisees.

The fact that there are, per capita, three times as many fast-food restaurants in the United States than in Denmark probably indicates the American market is oversaturated to the extreme.  Danish wages start at a level more than twice the average American fast food wage, yet Danish burgers are only 17% more expensive:

[A] Big Mac here costs more — $5.60, compared with $4.80 in the United States.

Okay…

Measured in Big Macs, McDonald’s workers in Denmark earn the equivalent of 3.4 Big Macs an hour, while their American counterparts earn 1.8, according to a study by Orley C. Ashenfelter, a Princeton economics professor, and Stepan Jurajda, an economics professor at Charles University in Prague.

And the Danish restaurants are less profitable. With fast-food wages in the United States so much lower than in Denmark, and the price of Big Macs in the two countries similar, Mr. Ashenfelter said, “It must be that U.S. McDonald’s are far more profitable.” The higher wages and the higher menu prices help explain why there are 16 McDonald’s per million inhabitants in Denmark, but 45 McDonald’s per million in the United States, Mr. Jurajda said.

McDonald’s declined requests for detailed financial data for its restaurants. But it said in a statement that the countries where it operates “have significantly different cost structures, economic environments and competitive frameworks.” The company added that it and its franchise operators “support paying valued employees fair wages aligned with a competitive marketplace.”

Beware of economics professors making assumptions.  American fast food franchises appear to be extremely low-profit, low-margin businesses, as least as far as the franchise “owners” are concerned (they sound more like serfs).  Low wages are a symptom, not a cause, of the disease.

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