Axel Schmiegelow

Labor Costs and Service Prices in the US economy: hidden flexibility?

Travelling through the US once again and hearing comments about the recession every day, I was struck by the elasticity of US business once again. As much as the business climate is intoxicating to the point of being hectic in boom times, as seen in 1999/2000 and once again in 2007, in bear times everything gets very gloomy.

I was riding in a cab in Las Vegas headed to CES and for once in the habit of European cab fares I forgot to tip the cab driver. He commented “You Europeans never tip, do you?”. After paying the due tip, I reflected on how dependent employees in all services industries were on tips for their regular income. I also noticed that tipping behavior on the part of Americans differed strongly from what I had experienced just 6 months ago on my last extended trip to California. People now, out of need or out of fashion, were downright stingy. Given that such large portions of the US economy are service based, I could not help but wonder how that had the same effect as a wage cut in many of these industries. At the very least, it shows that employers, who deflect part of the necessity of paying market wages to the culture of tipping and its encouragement in the policies of their businesses, thereby have an instrument to reduce and flexibilize their labor cost. In boom times employees earn more from tips and in bust times they earn less without the employer having to enforce wage cuts. This benefits the employer because he remains at his (low) wage cost basis, keeps his prices stable and lets the customer reduce tips if he feels he needs to. Since tips are part of the price structure of using a service, this means that lower tipping amounts to a deflation of service prices from the point of the customer. Thus, in a way, the business owner is leaving part of the pricing to the customer who can deflate the price he pays at will if his pockets are tied – as is the case in a recession.

Now while this, from a European perspective, could be perceived as an unfair advantage the business owner has in his relation to employees and customers, it could also be described as an “entrepreneurial risk” of the employee. Employees that commit particularly well to the service they are a part of and endear themselves to customers will invariably in good or bad times reap better tips from the customers. An employee who does well will probably convince a business owner to give him the responsibilities (assigned tables, assigned services) that will have the highest likelihood of earning him tips. One can already observe that some businesses compete on a labor market by installing policies that encourage tips.

A hamburger chain called Fat Burger places a small tip box next to a big tip box at the cash register and each time a larger tip is paid into the so called “fat tip box” the cashier yells out “FAT TIP!” and all other employees chime in yelling “FAT TIP!” as well.

As ludicrous as a discussion of the macroeconomic effect of tipping might seem at first glance, the impact on the US economy must be sizable. Considering the service industry is a 10s of billions of dollars segment of the economy and that average tipping is between 10 and 20 % of a purchase, tipping could well amount to several billion dollars in the economy. Adding or subtracting billions of dollars of volume to the price structure of the service industry could in turn have stronger than imagined effects on inflation and deflation, as well as on purchasing power in low income segments of the population.

As I am not an economist, I will leave the discussion at that, but I sure would find it interesting to know if this has ever been explored academically.

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