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McDonalds and America’s new low-wage economy explained

FORTUNE – This week, more than 2,000 fast food workers and activists picketed outside McDonald’s (MCD) annual shareholder meeting to protest low wages.

The demonstrations in Oak Brook, Ill. are a reminder of the growing economic inequality in America. At McDonald’s, workers making the federal minimum wage earn $7.25 an hour, while those in Illinois take in $8.25 at the state’s minimum wage. By contrast, McDonald’s CEO Don Thompson made approximately $9.5 million last year, which means it would take a minimum wage worker more than a million hours of work to earn Thompson’s annual salary.

We could blame greedy corporate executives for the pay gap, but that would be too simplistic. It doesn’t capture the changing corporate structures central to understanding the rise of low-wage work at some of America’s biggest companies.

McDonald’s, for instance, doesn’t actually employ most of its workers; instead, they work for individual franchise restaurants that operate as independent businesses and pay fees to use the company’s brand and sell its products – from which buns they buy to how signs are displayed. Beyond that, however, the individual franchise owner is technically the employer and therefore responsible for setting and paying workers’ wages.

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It’s important to highlight the business structure of franchising because it raises more questions than a simple case of an employer hiring an employee. In the case of McDonald’s, who exactly is the employer? Is it the national corporation, which collects fees from franchise owners and dictates the look, feel and operations of the restaurants? Or is it the individual franchisees, who are legally responsible for hiring the workers?

These ambiguities lie at the heart of wage disparities at McDonald’s and at other companies beyond the fast-food industry. Companies separate out direct employment to other parties, such as independent contractors, franchise owners, or logistics coordinators along the supply chain. New technologies and a more favorable legal environment have allowed companies to maintain their ability to enforce the standards they want for a brand even if they are no longer the direct employer of most of their workforce. As more employment relationships begin to “fissure,” as Boston University economist David Weil calls it, they upend the way we understand typical work arrangements.

This trend is clear across low-wage workplaces. Besides McDonald’s, janitorial companies like Coverall are organized as either franchises or independent subcontractors. Trucking companies classify workers as owner-operators, which exempts the companies from paying for worker’s compensation or unemployment insurance. Even football cheerleaders are often classified as independent contractors rather than employees, which have prompted five NFL squads from the Cincinnati Ben-Gals to the New York Jets Flight Crew to sue their teams. The separation of employment can also span many levels: In a 2006 AT&T cell tower incident in Talladega, Ala., the telecom company hired a management firm, who subcontracted a tower company, who subcontracted another tower company to actually do the work.

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By shifting employment outward, companies no longer have to deal with setting wages, providing benefits, or meeting the requirements of labor laws. As a result, many of the risks and costs associated with a standard employment arrangement are off the company’s books. This has increased profitability, particularly in the eyes of shareholders: Companies can boost their net earnings by drastically reducing their costs.

These changes have not eliminated the risks, however. They have shifted it onto other businesses and workers. Sub-providers have lower profit margins, which make it more difficult to raise worker wages. One fast food industry analyst estimated that up to one in four McDonald’s actually loses money and is only propped up by more profitable “sister” franchises with the same owner. It also increases the likelihood of unfair work conditions: A 2012 study by Weil and Min Woong Ji found that franchise-owned stores were 24% more likely to violate laws and owed 50% more in back wages per employee. In sum, Weil writes, “Shifting work outward allows redistribution of gains upward.”

Thus, the protestors outside of McDonald’s headquarters face an impasse. On the one hand, workers cannot make ends meet for themselves or their families on low wages, no benefits, and unstable jobs. On the other, unless the structure of the “fissured workplace” is altered, there is little room for improvement in industries where the direct employers are themselves also squeezed. Franchisees are already frustrated with low margins and high costs for upgrades, which they have to pay for themselves. A recent survey by Janney Capital Markets found that McDonald’s franchisees rated their relationship with corporate management a 1.73 on a scale from one to five.

Addressing the new story of economic insecurity in America requires fixing the underlying causes of our low wage economy. Small fixes like raising the minimum wage or more aggressively pursuing labor violators are important, but they alone will fall short of altering the trajectory toward a low-wage economy in which costs are rising faster than incomes. And helping low-wage workers through tax subsidies might alleviate some pain in the short term, but it will do nothing to address the structural issues in these new employment relationships that drive down wages and make work more tenuous than in the past.

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Instead, we need to rethink the entire way we understand the workplace in the modern economy. Policies to connect the bottom and the top – rather than just the bottom with the next level up – will ensure that the companies more equally share the risks and costs of work. Current legal structures do very little to cover the imbalances in these workplaces: despite the historic recent settlement between Wal-Mart (WMT) and workers employed by its largest subcontractor, Schneider Logistics, most courts have not held companies responsible for work issues arising within franchises, subcontractors, or along the supply chain.

As long as McDonald’s can claim that they bear no responsibility for the plight of the workers who are toasting the buns, shareholders at the meeting in Oak Brook will benefit from the changing workplace that shifts risks onto workers and franchisees. But low-wage workers everywhere will be left with a huge bill.

Josh Freedman is a policy analyst in the economic growth program at the New America Foundation, where he writes and researches about U.S. economic and social policy.