The Role of Search Frictions and Monopsony Power in Shaping the Effects of Tipped Minimum Wage Policy in the U.S. Restaurant Industry

Abstract

In the U.S. restaurant industry, tipped workers receive a large share of their earnings from customers rather than from their employers, and tip credit provisions allow restaurants to pay cash wages below the standard minimum wage. This paper examines why this compensation structure persists and how raising the tipped minimum wage affects wages, employment, and firm behavior. Based on the literature on modern monopsony power and existing evidence on minimum wage policies, labor market concentration, and tipping, this paper develops a search-friction framework in which job-switching costs give individual restaurants wage-setting power even in markets with many employers. The results indicate that restaurants' wage-setting power enables them to maintain wages below competitive levels, implying that a moderate increase in the tipped minimum wage can improve worker earnings and reduce turnover without generating a proportionate loss in employment. However, restaurants respond through multiple channels, including raising menu prices, adjusting service charges and compensation structures, slowing hiring, reducing working hours, and, for low-margin firms, exiting the market. The effects of tipped minimum wage policies therefore rely on the magnitude of the wage increase, restaurant characteristics, and local labor market conditions.