Economics 371
Economics of Work and Pay
Course Handouts
Spring 2010
Professor H.J. Schuetze
Topic 4.3 - Compensating Differentials
Professor H.J. Schuetze
Economics 370
Compensating Wage Differentials
Refers to the wage differentials that exist in equilibrium
to compensate workers for undesirable job
characteristics
Examples:
Unpleasant/unsafe working conditions
Desirable attributes like non-wage benefits
Long commute time
Thus, wages can also reflect compensation to
workers for undesirable jjob characteristics not jjust
productivity
Let’s work through the theory thinking about
compensating wages for the risk of injury that can
result from an unsafe or unhealthy work environment
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The Firm’s Iso-Profit Curve
The various combinations of wages and safety the firm
can provide while maintaining the same level of profit
Wage
Downward Sloping:
• Both wages and safety are
costly for the firm
• Firm can maintain profit and
increase safety only if it can pay
a lower wage
A
I0
I1
B
Safety
Concave:
• There is a diminishing marginal
rate of transformation between
wages and safety
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Concavity of Iso-Profit Curve
At A: little safety and high wages
With little safety the firm can increase safety
inexpensively
p
y
better lighting
signs
guard rails
The firm is at a stage of increasing returns with
respect to the provision of safety
The iso-profit
iso profit is relatively flat
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2
Concavity of Iso-Profit Curve
At B: lots of safety, low wage
The firm can only increase safety with more
sophisticated and costly safety procedures
Stage of diminishing returns in the provision of safety
The iso-profit is relatively steep
Left to right: The firm starts with the cheapest forms
of safety provision and moves to more expensive forms
I0 to I1: Implies a higher level of profits.
Iso-profit curves with both lower wages and safety
are higher because both are costly
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Different Firms/Safety Technology
Different firms can have different abilities to provide
safety at a given cost
Thus different firms can have differently shaped iso
Thus,
profit curves for the same level of profits
Wage
Firm 1 (High Safety Costs)
Firm 2 (Low Safety Costs)
Safety
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3
Different Firms/Safety Technology
Firm 1: Safety is costly
Can provide additional safety only if wages drop
rapidly to compensate for safety costs and maintain
profits
“rapidly diminishing returns to providing safety”
e.g. inherently dangerous sectors
„
mining
„
logging
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Different Firms/Safety Technology
Firm 2: Low safety costs
Can provide additional safety at a relatively cheaper
price
e.g. inherently safe industry
„
office manager
„
professor
Competition implies that in equilibrium both firms will
earn zero economic profits so that
I 1 = I2 = 0
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Employer’s Offer Curve
Wage
The maximum compensating wage that will be offered
in the market for the different levels of safety
Therefore it is the outer limits of the two iso profit
Therefore,
curves
Points “inside” the offer curve
Firm 1
will be dominated by points
“on” the offer curve
Example:
Worker can receive S* safety
g of W1 from Firm 1
Firm 2 and a wage
(Point A)
B
W*
W1
A
S*
Safety
Firm 2 can provide safety relatively cheaper and therefore can
offer W* > W1 wage along with the same amount of safety
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Individual’s Preferences
Workers have preferences for wages and safety
Can illustrate using indifference curves
Wage
A
U1
B
U0
• The level of utility is the same
along the indifference curve.
• Utility increases up and to the
right
• Convexity illustrates a
diminishing marginal rate of
substitution between wages and
safety
f t
Safety
A: willing to give up a lot of wages to get small increase in safety
(curve is steep)
B: not willing to give up wages for safety (curve is flat)
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Different Individuals (Risk Preferences)
Different workers may be more or less willing to give
up safety in return for higher wages (a risk premium)
Wage
The individual with preferences UL
is less risk averse while UM is more
risk averse
A
UL
UM
Safety
Person L requires less of a compensating wage increase
to give up safety at point A than person M
L’s indifference curve is flatter than M’s
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Equilibria
1. Single Firm, Single Individual:
Wage
W*
E
U0
S*
S
Safety
For a single type of firm and single type of worker
the equilibrium occurs at a point of tangency like E
This gives maximum utility given the firms ability to
trade safety for wages at perfectly competitive profit
=0
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Single Firm, Single Individual
To the left of E:
• Additional wage required by the worker to accept more risk (slope of IC) is greater than the firm is able to offer (slope iso‐
profit)
To the right:
• The worker is not willing to give up enough risk
• If the firm tries to reach a lower iso profit (higher profits) workers will go to another firm
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Equilibria
2. Single Worker, 2 Types of Firms:
Wage
WA
A
Firm 1
(Costly)
Firm 2
(Cheap)
With preferences as
drawn, maximum utility
with Firm 1 is UA
B
WB
UA
SA
SB
Safety
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Adjustment to Equilibrium
• Suppose that Firm 1 is able to raise the price of its product when the good becomes in short supply
Firm 1
Wage
A
• Now in equilibrium
• The homogeneous workers would
be indifferent between working at
either Firm 1 or Firm 2
B
Firm 2
Safety
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Equilibrium
• We could measure how much workers value safety if we could measure safety
• In a cross‐section of workers the various combinations of wages and safety traces out an indifference curve
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Equilibria
3. 1 Type of Firm, 2 Types of Workers:
Here, a cross-section
on wages and safety
traces out the isoprofit curve
tells us how firms are
able to trade wages
for safety
Wage
W
W
A
UL Less Risk
Averse
A
B
B
SA
SB
Safety
UM More Risk
Averse
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Different Individuals (Risk Preferences)
4. Many Firms and Individuals:
Wage
F1
F2
F3
UL Less Risk Averse
UA Average Risk Averse
UM More Risk Averse
Safety
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Wage‐Safety Locus
•
•
•
(i)
(ii)
•
The set of tangencies between iso‐profits and indifference curves (combination of wage and safety that will prevail in the market)
The wage‐safety locus can change depending upon:
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Wage‐Safety Locus
•
•
The wage premium paid for risk is often called a “shadow” price
This is because the price is embedded in the market wage rather than being attached explicitly to a job characteristic
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Effects of Safety Regulation
Might expect the effects of safety regulation to be “negative”
Workers and firms efficiently allocate themselves in terms of worker’s risk aversion and employers adopting cost‐effective safety standards
•
•
Single Firm, Single Worker
Wage
W0
• Suppose the competitive
equilibrium is at E0
E0
U0
S0
Safety
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Effects of Safety Regulation
Wage
W0
E0
U0
S0
Safety
Suppose regulatory board requires the level of safety
to increase to sr
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Effects of Safety Regulation
Suppose instead the firm is able to absorb the cost
‐
‐
•
Wage
E0
W0
U0
S0
Sr
Safety
In this case the firm is worse off
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Not All Firms Will Be Affected The Same
Wage
F1
F2
UL Less Risk
Averse
UA Average Risk Averse
F3
UM More Risk Averse
sa sr
Safety
For Firm 3 the safety regulation is redundant
Firm 2 could meet the standard only if workers are willing to
give up wages for safety or if the firm can absorb some costs
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Imperfect Information
The safety standard “weeds out” firms whose safety technology cannot meet the standard
•
At a cost to workers and firms
Imperfect Information:
•
Could be that firms have more information about risks than workers
e.g. •
•
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Imperfect Information
The worker perceives that she is
getting Sp safety and knows she gets
the actual wage (wa) (on Up)
Wage
Wa
Up (perceived)
E0
Ua (actual)
Sa
Sp
Safety
In fact, she is only getting Sa safety with the wage Wa (Ua)
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Why Safety Regulation?
Workers and firms are worse off so why?
1.
2.
3.
4.
5.
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Empirical Evidence
•
Difficult to estimate compensating differentials
(i) (ii) •
Can be explicit:
•
Can be implicit:
Studies have looked at premiums for:
•
risk of unemployment
•
mandatory overtime
•
commuting time
•
risk of injury and death (most)
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Problems
1. Increase wage due to increase risk may work the other way
•
•
•
2. “errors in variables”
•
3. Sample selection bias
•
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Results
1. •
risk of death pays more than risk of injury
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Topic 2 ‐ Human Capital
Professor H.J. Schuetze
Economics 371
Human Capital
•Under labor supply we emphasized the quantity of labor supplied but there is also a quality dimension
•In the section on compensating wages we talked about how negative job attributes like risk involved compensating wages to intice workers to those jobs
•This theory can also be applied to jobs that require workers to go through the costly process of acquiring human capital
•Thus, human capital can influence the quality of labor supplied to the economy as well as the wage that workers are paid
•We will look at two types of human capital
(1) Formal education
(2) Training
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Human Capital Theory
Investments are made in human resources to improve their productivity and their earnings
Why “investment”?
•Costs are incurred in the expectation of future benefits
•Like all investments we need to ask if it is economically worthwhile (i.e. benefits>costs)
Costs (2 components):
(i)
(ii)
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Human Capital Theory
• We must also distinguish between the consumption and investment components of human capital
Consumption:
Investment:
• Distinguish between private and social costs and benefits
Private:
Social:
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2
Human Capital Theory
•Distinguish between real and pecuniary costs and benefits
Pecuniary:
e.g. savings in UI that result from a retraining program
‐
‐
Real:
‐ should be included in social costs/benefits parties making the investment
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Formal Education
We can represent the education decision as follows:
Present Value
of Earnings
16 18
22
T
Age
A: did not complete high school (10 yrs ed. At age 16)
B: Completed high school (start at age 18)
C: University/College degree (start at age 22)
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Notes
(1) Earnings increase with age but at a decreasing rate
•
Adding more to productivity and earnings early in their careers and then diminishing returns set in late in their career
(2) Earnings of those with more years of education generally lie above those with fewer years of education
•
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Optimal Lifetime Income Stream?
First we need some simplifying assumptions
1. Individual receives no direct utility or disutility from education
2. Hours of work are fixed (includes hours in acquiring education)
3. Income streams are known with certainty
4. Can borrow/lend at real interest rate (r)
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Optimal Lifetime Income Stream?
Given these, choose the quantity of education to maximize the net present value of lifetime earnings
Costs and benefits:
(i) Attaining high‐school education
Opportunity Costs:
C
Present Value
of Earnings
B
A
16 18
T
22
Benefits:
Age
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Costs and Benefits
(ii) High School grad contemplating university
C
Present Value
of Earnings
f
B
e
b
a
Costs:
c
T
d
16
18
A
Age
22
Benefits:
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Example, Present Value Calculation
18 year old high school graduate considering university:
• Work until age T (retirement)
• Income at each age if she chooses high school is YH(age)
• Assuming she works now at age 18
If she goes to university income at each age is YU(age)>YH(age)
However, she will earn nothing for four years and will incur direct
costs of $D per year
We could compare PV(H) to PV(U) to determine whether or not
it is rational to obtain a university degree
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Example, Present Value Calculation
• These calculations can be tedious
• Instead, we might simply compare the PV of benefits to the PV of costs
This is precisely the same as comparing PV(H) to PV(U)
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Alternative Portrayal
P.V. of
MC/MB
MB declines with years of
education because:
1.
2.
MC rises with years of
education because
Years of Ed.
• The individual should increase years of education until the present value of benefits (year of ed.) equals the present value of the additional cost
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Problems
1. May not have this kind of detailed information
Models still might predict well
• Most people take into account at least some of the costs and benefits
2. Simplifying assumptions may not be realistic
(i)
(ii)
• We could relax these assumptions
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Education and Market Equilibrium
• The wages and education levels we observe are a result of the interaction between individuals and employers
• To understand this relationship we must look at the interaction between individuals and firms
•
•
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Workers’ Preferences for Education
• Suppose there are 2 types of workers
Type A: Strong preferences for education (could be because of ability or utility derived)
Type B: Dislikes education
Wage
Years of Ed.
Requires less of a wage increase to get A to increase
education than B while holding utility fixed
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Firms’ Iso‐Profit Curves
• Suppose there are 2 types of firms
Type 1: Values skilled workers highly
Type 2: Values skilled workers less
Wage
Positively sloped Iso-Profits
Higher wage can be paid to
higher educated workers
(greater productivity
Years of Ed.
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Firms’ Iso‐Profit Curves
Firm 1: Iso‐profit is steeper
•
Firm 2: Iso‐profit is flatter
•
Employers Offer Curve:
Maximum wage for each
level of education
I1
Wage
I2
Years of Ed.
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Equilibrium
UA
UB
EA
Wage
I2
EB
I1
Years of Ed.
The worker with more education receives a higher wage
(compensating differential)
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Empirical Evidence
Most include men only because of intermittent labor force participation of women
•
Basic idea is to run regressions with lots of things that should affect wages (occupation, industry, experience etc.) and see what effect education has
Results:
1. •
Income streams of the educated are above the less educated
2. •
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Problems
There are some problems with estimating the returns to education
1. Ability Bias
•
Difficult to control for ability
•
More able are inherently more productive and may also get more education
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Problems
2. Selectivity Bias
•
You may get the right education to prepare you for a job you simply have an aptitude for
e.g. 2 people and 2 occupation
Person A: mechanically inclined Person B: bean counter
Can choose to be either a mechanic or an accountant
•
Need college degree to be accountant
•
Both A and B could become an accountant
•
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Signalling/Screening Hypothesis
Higher education acts as a filter (screening the more able) rather than enhancing productivity
•
Workers signal unobserved ability and firms use education to screen workers
•
Bachelor’s diploma represents a “sheepskin”
Model Assumptions:
•
Asymmetric information
•
–
–
•
Employers do observe some characteristics of workers Professor Schuetze - Econ 371
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Signalling/Screening Hypothesis
Indices: –
–
Signals: –
Employers may form “beliefs” about the relationship between education and productivity
•
Perhaps based on past experience
Market Equilibrium:
•
•
Employers will offer higher wages to more educated workers if they believe there is a positive relationship
•
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Signalling ‐ Model
Suppose there are two types of workers
– Low ability (L)
– High ability (H)
•
•
•
Education (the signal) is acquired at a cost
•
Education is measured in years (y)
•
The costs are both financial and psychic
–
–
•
Could be that it takes able workers less time or that they simply dislike school less
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Signalling ‐ Beliefs
Suppose that the employer’s beliefs are as follows:
•
There is some critical value of education above which individuals are believed to be type H below which they are believed to be type L
Thus, the employer’s offered wage curve w(y) will be:
•
W, MPE
2
1
1
2
Education
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Signalling ‐ Equilibrium
•
•
•
•
Persons who choose y<y* will set y=0
•
We can add in the cost schedules to see if this is true (i.e. if this is an equilibrium)
Persons who choose y≥y* will set y=y*
W, MPE
w(y)
2
1
1
y*
2
Education
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Signalling ‐ Equilibrium
Type L will choose y=0
•
•
•
Type H will choose y=y*
•
•
Can show that the equilibrium requires y* to be between 1 and 2 years of education
•
•
•
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Notes on Signalling
1.
•
•
There are an infinite number of equilibrium values for y*
•
2.
The education level (y*) acts as an entrance requirement for the high‐salary job
•
•
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Notes on Signalling
3. The private and social rates of return will differ
Private Returns –
Social Returns –
•
•
Ignores the fact that signalling serves the useful role of sorting workers into the right jobs
–
•
Within the confines of the model there are more or less efficient ways of getting sorting
–
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Empirical Evidence
•
The few studies that test between human capital and signalling are based on the following notion
•
•
Example, Kang & Bishop (86) look at high‐school grads:
•
Diplomas are generally homogeneous to employers, but can be obtained taking easy or hard courses
•
Overall, these tests have not been conclusive
•
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Training
•
Form of human capital
Becker ‐ 2 types
1. General Training:
2. Specific Training:
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General Training
•
•
•
Firms can bid for general training by offering a wage that is higher by an amount equal to the value of the training
Therefore, the trainee would be willing to pay for the training as long as the benefits (higher earnings) exceed the costs
If the company paid for training they would still have to bid against other companies for the services of the trainee
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General Training
W, MRPE
W*=MRPE*
WA=MRPEA
MRPET
No training:
Time
Training:
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Who Pays for General Training?
Employee:
•
Could finance training if C<B and earn w* after training
Firm:
•
Could pay for training and reap the benefits
•
i.e. pay the worker wA before and after training
Problem?
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Specific Training
•
•
Other firms have no incentive to pay higher wages
•
W, MRPE
W*=MRPE*
WA=MRPEA
MRPET
Time
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Shared Investment?
•
•
•
The firm faces the risk that the worker will quit after the training (can get wA elsewhere)
Thus, the anticipated return (B) is eliminated
W, MRPE
MRPE*
WA=MRPEA
MRPET
Time
Thus, both the employer and employee incur costs
and reap benefits of training
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Shared Investment?
This also minimizes the risk that either party will terminate the employment relationship
Both earn rents after training:
Employer: •
Employee:
Note:
•
May not be easy to distinguish between general and specific training
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Role of Government
•
Are there situations when the private market does not provide a socially optimal amount of training?
1.
2.
3.
4.
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Topic 3 – Wage Structures Across Markets
Professor H.J. Schuetze
Economics 371
Wage Structures Across Markets Wages vary across a number of different markets (dimensions)
We’ve looked at how wages vary across skills (education) but there are a number of other interesting cases
•
•
–
–
–
–
–
–
–
Here, and in later topics we will examine and attempt to explain why wages vary across markets
•
–
Do such earnings differentials indicate that the labour market is not fully integrated?
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Earnings Function As we have shown, a simple way to summarize and isolate wage differences is through regression analysis
e.g. Earnings Function
(1) ln(w)=a + b*School + c*Exp + d*Exp2 + є
•
•
–
Estimation of this equation by OLS gives estimates of the returns to schooling and experience
Within this context we can allow wages to depend on other characteristics as well
•
•
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Earnings Function
(2) ln(w)=a + b*School + c*Exp + d*Exp2 + e*Occ + f*Ind + g*Prov + є
•
Equation 2 is estimated using the 1996 census to summarize differences in wages across these dimensions
Let’s start with the results looking across provinces
The table gives the percentage difference in wages across provinces “holding constant” education, experience, industry and occupation
•
•
•
–
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2
Results
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Results
•
•
The wage premia in this type of a regression are always relative to some base category
In this case, the base category is Ontario (largest group)
•
•
•
As we can see there is a great deal of variation in wages across provinces
Wages are significantly lower in the Atlantic Provinces
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Results
•
•
The base occupation is Trades
The highest paid occupation group is Managerial/Business Professional
•
•
•
•
Finally, the base industry is manufacturing
There is a large premium associated with “other primary” : 26.2 % higher than manufacturing controlling for region etc.
Accomodation/food/beverage industry groups have a large penalty
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Reasons for these Differences
Why do wages vary across these markets?
Š Clearly differences in educational requirements for the jobs matter
Š But differentials still exist even after controlling for schooling
Š There are a number of reasons we might consider that apply broadly to most cases
1. Š
Wages will be higher in unpleasant occupations
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Reasons for these Differences
2.
Immobility Across Sectors: e.g. ‐
‐
– Problematic because this suggests that the labour market is not integrated
3.
Short‐run Disequilibrium: 4.
Unobserved Heterogeneity: Š
With these in mind let’s examine each differential more closely
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Occupational Wage Structures
• The term occupation is used to refer to a number of
jobs that have “the same basic work content”
• These jobs may be found in different establishments
and industries
• Occupations can be broadly defined (e.g. clerical) or
very narrowly defined (e.g. typist)
•
• Otherwise workers at the margin will move from jobs
of low net advantage to ones of high net advantage
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Occupational Wage Structures
•
•
The net advantage includes non-pecuniary aspects
of the job, giving us our first reason
Occupational wage differentials may exist to
compensate workers for pleasantness, safety, fringe
benefits and stability of the job
I.
•
•
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A Simple Example
Unskilled Labourers
Skilled Welders
Wage
Ss
Wage
ws
Su
wu
Ds
Du
Employment
(skilled)
Employment
(unskilled)
• Upward sloping supply –
• May require costly skills, preferences for certain occupations
• Supply ranks workers according to reservation wages for that occupation
•
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Short‐run Adjustments
II. This example can illustrate how short-run adjustments
may also affect occupational wage structures
Unskilled Labourers
Skilled Welders
Wage
Ss
ws
Wage
Su
wu
Ds
skilled
Du
unskilled
• Suppose technological change induces an increase in demand for skilled labour
Supply schedule for skilled workers may be fairly inelastic
–
Wages will rise in the skilled sector in the short-run
In the long-run supply will increase in the skilled sector
(reducing the wage premium)
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Imperfect Competition
III. Finally, imperfect competition, which hinders
adjustment to the long-run equilibrium, will also
affect the occupational wage structure
Examples,
1. Occupational Licensing:
2. Unions:
3. Minimum wages and pay equity work directly on
wages and affect the wage structures of low-wage
and female dominated occupations
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Regional Wage Structures
• Once again, theory predicts equality of net advantage at the margin for identical jobs across regions
• Wage and non‐pecuniary aspects of the job must be the same otherwise workers would move to the region with higher “pay”
• Wages need not be the same, however, because of compensating differences, short‐run adjustments and non‐competitive factors
Compensating differences include:
–
–
–
–
–
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Regional Wage Structures
As before, short‐run wage differentials may exist as the labour market adjusts to long‐run equilibrium
•
Non‐competitive factors that hinder labour movement across regions will also impact the wage structure
Some examples are:
1. Occupational licensing – some provinces may not recognize training completed in other provinces or may have residency requirements
2. Unions –
•
3.
Social transfer programs –
e.g. EI benefits are an increasing function of the unemployment rate in a region
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8
The Migration Decision
• While we will discuss the migration decision in greater detail under immigration a simple treatment here will highlight some aspects of internal migration
• One can think of the migration decision in a similar manner as the human capital decision
•
Benefits?
•
•
Costs?
•
•
Professor Schuetze - Econ 371
17
The Migration Decision
•
i.
•
•
•
•
•
ii.
iii.
This framework has a number of implications which have been tested empirically – it implies:
Younger workers should be more mobile than older workers
Mobility should be from areas of high unemployment to areas of low unemployment
Mobility should increase at the “peak” of business cycles and decline in recessions
–
Professor Schuetze - Econ 371
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9
The Migration Decision
iv.
Mobility to and from Quebec is likely to be lower
–
v.
Distance should matter
–
vi.
•
•
Mobility to provinces with more generous social programs, lower taxes and higher expenditure on health and education should be higher
The empirical evidence to date appears to support these propositions
There is also evidence that regional wage disparities are eroding over time (as theory predicts)
–
–
Professor Schuetze - Econ 371
19
Evidence
U.S. – wage differential between the North and the South (controlling for the cost of living, human capital etc.) disappeared by the 1970’s
Canada – Interprovincial differences in per capita income levels are falling
• There is some debate about whether or not regional differences still exist but there has been some movement towards equalization
Professor Schuetze - Econ 371
20
10
Interindustry Wage Differentials
• The term “industry” refers to the principal kind or branch of economic activity of the establishment in which the individual works
• Industries can be broadly defined (e.g. non‐durable manufacturing) or narrowly defined (e.g. textiles)
• Because industry classification is based on the establishment, interindustry wage differentials reflect a variety of factors
–
–
–
• To get “pure” industry differentials we need to net these out
Professor Schuetze - Econ 371
21
Interindustry Wage Differentials
•
i.
•
•
ii.
iii.
•
•
•
•
These difference reflect, once again:
Compensating differentials: Some industries are safer than others
Some industries are characterized by seasonal employment (e.g. construction)
Short‐run adjustments to changes in demand
Non‐competitive factors
Professor Schuetze - Econ 371
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11
Interindustry Wage Differentials
•
Interindustry wage differentials likely also reflect a fourth factor; “Efficiency Wages”
•
•
•
They may do so in order to reduce shirking, improve morale, reduce turnover and absenteeism and to elicit effort from employees
The desirability of paying efficiency wages depends on the cost of shirking, turnover and absenteeism to the firm
•
•
Econometric results suggest that efficiency wages exist – pure interindustry wage differentials exist Professor Schuetze - Econ 371
23
Public‐Private Wage Differentials
•
•
Because the public sector is simply one industry, we might think of this differential as an interindustry wage differential
However, the public sector has a number of peculiarities that merit special attention
–
–
–
•
It is a very large sector
Wage determination is different
Outcomes in this sector impact all sectors
The public sector includes all sectors that are funded or owned by the government, including
–
–
–
–
Education Health
Government enterprises
Government employment (federal, provincial, municipal) Professor Schuetze - Econ 371
24
12
Public‐Private Wage Differentials
Many of the same reasons for wage differentials discussed earlier apply here
Compensating differentials:
•
•
•
•
These suggest that wages should be lower in the public sector, all else equal
Short‐run adjustments:
•
Recent contraction of the public sector may have lead to downward pressure on wages making it difficult for the government to recruit and retain employees •
Professor Schuetze - Econ 371
25
Public‐Private Wage Differentials
Non‐competitive factors:
•
It is perhaps here that the public sector deviates most from the private sector
•
We will discuss four peculiarities of the public sector under this heading
i.
Political rather than profit constraint
ii. Monopsony power of government
iii. An inelastic demand for labour
iv. A high degree of unionization
Political rather than profit constraint:
•
•
Political constraint is generally viewed as less binding
Professor Schuetze - Econ 371
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13
Public‐Private Wage Differentials
•
Future taxpayers have little or no representation in today’s political process
•
That said, working against public sector workers is the fact that even during a strike revenues come in
•
This isn’t true in the private sector
Monopsony:
•
•
•
There is some evidence with regard to teachers and nurses which suggests governments do utilize this power
Professor Schuetze - Econ 371
27
Public‐Private Wage Differentials
Inelastic demand for labour:
•
If demand is inelastic, unions can bargain for higher wages without having to worry about the effects on employment
•
•
Empirical evidence suggests that the demand for labour in the public sector is highly inelastic
Unionization:
•
•
Such non‐competition restricts the ability of wages to adjust
•
Professor Schuetze - Econ 371
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14
Public‐Private Wage Differentials
•
•
Most of the factors examined suggest that wages will be higher in the public sector than in the private sector
There is another reason to believe that wages will be higher in the public sector
•
•
The government would not be able to lower wages below those in other industries
–
•
Competitive forces do not preclude the government from paying wage that are higher, however
–
–
Professor Schuetze - Econ 371
29
Public‐Private Wage Differentials
•
The empirical evidence suggest that public sector worker in the 90’s earned a 9% premium over private sector workers
•
•
•
Professor Schuetze - Econ 371
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15
Topic 4 ‐ Immigration
Professor H.J. Schuetze
Economics 371
Immigration
•Immigration policy has been a hotly debated topic in Canada for some time
Some of the issues discussed are non‐economic:
•
–
Many of the issues are economic:
•
–
Some concern that immigration may be leading to higher unemployment and growing wage polarization
–
Wages tend to be lower than native born upon arrival
•
•
Professor Schuetze - Econ 371
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1
Some Facts About Immigration
•The importance of immigration in policy debates is not surprising given the flow of immigration to Canada and the increasing diversity
•Since the late 1980’s Canada has admitted over 200,000 immigrants per year
‐
‐
Professor Schuetze - Econ 371
3
Some Facts About Immigration
1960’s: 2004: Professor Schuetze - Econ 370
4
2
Some Facts About Immigration
•By 2001 18.3 percent of all Canadian residents were immigrants (born outside of Canada)
•Immigrant concentrations are highest in Toronto and Vancouver •Most new immigrants also reside in these cities
•
•
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5
Canadian Immigration Policy
•
•
•
•
•
In order to have effective immigration policy, policy makers must answer two questions
First, what are the impacts of immigration
Second, what “tools” are available to set appropriate policy in response to the first question
Let’s start by answering the second question and we will return the first later
Policy makers really have two mechanisms for controlling immigration
1)
2)
Professor Schuetze - Econ 371
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3
Canadian Immigration Policy
Prior to 1967 in Canada the focus was on the first of the two mechanisms (the number)
•
•
•
Prospective immigrants from other countries met a stiffer series of requirements for admission (Immigrants from China were not permitted)
Only the very sick, destitute and criminals were disallowed
•
•
Professor Schuetze - Econ 371
7
Canadian Immigration Policy
By the early 1960’s the influx of unskilled Europeans (particularly from the south) led to a shift in policy
The Point System:
•
In 1967 the point system was introduced
•
Potential immigrants to Canada are categorized based on motivation for immigration
Non‐assessed: •
‐ May also be for humanitarian reasons (escape political persecution or poverty)
•
Professor Schuetze - Econ 371
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4
Canadian Immigration Policy
Assessed: •
Such individuals are evaluated based on their likely success in the labour market
•
•
Relatively few immigrants are assessed
Professor Schuetze - Econ 371
9
The Immigration Decision How well immigrants perform in Canada depends, in part, on whether it is the most skilled or least skilled workers from other countries who migrate
•
To look at how potential immigrants make such a decision let’s work through the “Roy Model”
Roy Model:
•
For simplicity consider two countries
•
–
–
•
Assume that earnings in both countries depend on a single factor •
Professor Schuetze - Econ 371
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5
The Roy Model Let s denote the number of efficiency units (skills) embodied in a worker
The frequency distribution of skills may look much like the standard normal distribution
Assume, for now, that there are no costs to migration
•
•
•
•
There are a number of possible outcomes to this model – two of which we will illustrate
•
Professor Schuetze - Econ 371
11
Case 1: Positive Selection
$
S (Skills)
The wage-skill lines give the payoff to skills in Canada and the
source country
„
With no costs to migration a worker will migrate to Canada
whenever Canadian earnings exceed the source country
„
„
Professor Schuetze - Econ 371
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6
Case 2: Negative Selection
$
S (Skills)
Here the payoff to skills in the source country exceeds the
payoff in Canada
Professor Schuetze - Econ 371
13
Implications of the Roy Model
•
The key implication of the Roy Model is that:
•
Workers flow to markets where they can get the highest price
•
•
•
Changes in the base income levels do, however, affect the size of the flow
To see this consider the following example
Professor Schuetze - Econ 371
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7
Example: Change Income with Positive Selection
$
Canada
Source Country
SP
S (Skills)
Suppose there is a decrease in the base income in Canada
relative to the source country
Notice that we still get positive selection
„
However, the decrease in income reduces the size of the flow
„
Professor Schuetze - Econ 371
15
Adding in Migration Costs
•
•
•
•
The previous result allows us to relax the assumption that there are no costs to migration
Suppose it costs $20,000 to migrate to Canada from a given source country
And that these costs are the same regardless of the worker’s skills
These costs reduce the net income the worker can expect to receive in Canada
–
•
•
This is equivalent to a reduction in income in Canada
Professor Schuetze - Econ 371
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8
Evidence
•
The available data seems to suggest that income is more unequally distributed in Third‐World Countries (e.g. India, Mexico, etc.)
•
•
The “Brain Drain”
•
Canada has a relatively egalitarian income distribution compared to the US
–
•
Partly as a result of the tax and social system
Relative to the US we tax able workers and insure the unskilled against poor labour market outcomes
•
Professor Schuetze - Econ 371
17
The Brain Drain
•
•
Not surprisingly, this topic has received a great deal of media attention
However, data limitations have meant that very little research has been done on this topic
The work that has been done examines:
•
i)
ii)
Size of the brain drain:
•
It is difficult to estimate because the Canadian government does not collect data on those leaving Canada
•
There are, however, a number of indirect sources of data
Professor Schuetze - Econ 371
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9
Indirect Sources of Data
“Reverse Record Check”: Statistics Canada double checks the coverage of the Census
•
Establishes whether or not people have moved to the US
•
Gives no further information on immigrants
Tax Records: Can identify if tax‐filers switch from Canadian to US addresses
•
Again little demographic information
The Decennial US Census: Collects information on country of birth
•
This is only collected every 10 years
US Current Population Survey: contains lots of demographic information
•
The sample sizes tend to be small
US INS Administrative Data: Visa data
Professor Schuetze - Econ 371
19
The Brain Drain
•
•
Most alarming is that these migrants are disproportionately highly educated
Impact of the Brain Drain:
•
It is unlikely that an annual outflow of 25,000 workers will have much of an impact on the overall Canadian labour market
•
However, in more narrowly defined markets emigration may matter
–
Professor Schuetze - Econ 371
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10
Impact of The Brain Drain
•
•
Some have measured the impact by calculating the loss of goods and services produced by Canadians in the US
e.g. there are approximately 60,000 highly skilled Canadians living in the US (NAFTA Visas)
•
•
•
Of course, with this type of calculation it is easy to “cook the books”
Final Analysis:
•
•
We don’t seem to lose any sleep over this!
Professor Schuetze - Econ 371
21
The Impact of Immigrants
•
•
•
•
•
As we have already noted, effective policy requires information about the impact of immigrants
Of course, we will focus on the labour market impacts although there are certainly others
Let’s start by looking at what simple theory suggests and then move on to the evidence
Theory
The “simple” model assumes that immigrant and native workers are perfect substitutes in production
•
Professor Schuetze - Econ 371
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11
Impact When Workers are Substitutes
This case can be illustrated as follows:
w
S
As immigrants enter the
labour market the labour
supply curve shifts out
w0
D
N0
N
Wages fall from w0 to w1
Total employment increases from N0 to E1
Professor Schuetze - Econ 371
23
Impact When Workers are Compliments
• However, if immigrants and natives are complements, they do not compete in the same labour market
• For example, immigrants may be more adept at certain tasks than natives
• Immigration frees up the native workforce to perform tasks that they are better suited for
•
Professor Schuetze - Econ 371
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12
Impact When Workers are Compliments
This case can be illustrated by looking at the market for native workers:
w
An increase in immigration
raises the marginal product of
natives
S
w0
D
N0
N
Native workers who previously did not find it
profitable to work now see higher wages and enter the
labour market
Professor Schuetze - Econ 371
25
Other Considerations
1) Immigrants are often selected based on skills that are in short supply
•
2) Immigrants also consume goods and services
•
3) Importing labour may be a substitute for importing the goods produced by that labour in the country of origin
4) Immigrants may disproportionately invest in Canadian firms, creating employment
• Thus, the answer to the question “What is the impact of immigration?” is ambiguous and left to empirical studies
Professor Schuetze - Econ 371
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13
Empirical Studies on Impacts
Estimating the impact of immigration turns out to be quite difficult
Problems:
1. What is the relevant labour market?
•
• In any case, there are likely linkages
2. Result depends on whether immigrants are compliments or substitutes etc.
3. Immigrants do not arrive randomly to a market
•
•
Nevertheless there are a large number of studies that attempt to estimate the impacts
Professor Schuetze - Econ 371
27
Empirical Studies on Impacts
Most studies find that immigration has little impact on the labour market outcomes of natives
Approaches:
1. Exploit cross‐city variation in immigration
Example: compare Toronto to Montreal
•
This has been done using US data and the results suggest that there is little impact
Clearly there are some problems with this approach
•
•
–
•
There is still the endogeneity problem –
Professor Schuetze - Econ 371
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14
Empirical Studies on Impacts
2. “Natural experiments” to avoid endogeneity
• To get an exogenous change in immigration David Card looks at the impacts of the Mariel Boatlift on the Miami labour market
• Between May and September of 1980, 125 thousand Cubans were permitted to leave Mariel Cuba for the US.
• Many settled in Miami
• Again, however, there was little evidence of an adverse effect
•
Another “branch” of immigration research examines the labour market performance of immigrants
Professor Schuetze - Econ 371
29
Immigrant Assimilation
There is a general concern that immigrants do not succeed in the labour market and become a burden
This research examines whether or not these concerns are founded
We might expect the earnings profile of an immigrant and native worker to look as follows:
•
•
•
earnings
Native Born
20
65
(YSM=0)
(YSM=45)
Age
Controlling for hours worked
The workers are similar in
every aspect except origin
Assume the immigrant arrives
at age 20 and retires at age 65
YSM = years since migration
Professor Schuetze - Econ 371
30
15
Immigrant Assimilation
earnings
entry
effect
Immigrant
Native Born
{
20
(YSM=0)
T
65
Initially the immigrants
earnings may be below a
similar native-born worker.
Why?
Age
(YSM=45)
•
•
With age (experience) both workers’ earnings will rise
•
•
In this case wages catch up at age T but this age could exceed 65
If there is “positive selection” the earnings of immigrants may overtake those of comparable native born workers
•
Professor Schuetze - Econ 371
31
Empirical Findings
Need panel data to sort between cohort effects and assimilation
Men:
•
–
• The assimilation rate is very small; Bloom et al estimate it to be 0.25% per year –
Women:
•
•
Professor Schuetze - Econ 371
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16
Topic 5 ‐ Discrimination
Professor H.J. Schuetze
Economics 371
Discrimination
What is labour market discrimination?
•Occurs when participants in the marketplace take into account such factors as race and sex when making economic exchanges
•Even after accounting for the skills of workers and job characteristics race or sex influences decisions
•When thinking about wages could be discrimination in setting wages or in providing access to human capital or labour markets
What leads to discrimination in the labour market?
1.
•
Professor Schuetze - Econ 371
2
1
Discrimination
2.
•
•
3.
•
•
Could come from employee who underestimates his/her labour market capacity
Could come from employer who consistently underestimates value of group of workers
More likely to occur when information on individual workers is costly
–
–
e.g. employers judge pay decisions of a woman based on the turnover rate of all women Difficult to signal your true “type”
Professor Schuetze - Econ 371
3
Discrimination
4.
Š
One group of individuals may try to protect their high‐
wage jobs from low‐wage competition
–
Who discriminates?
•
Through wage, hiring and promotion policies
•
Through unions, apprenticeship systems etc.
•
Simply do not purchase goods from establishments that employ certain groups
Professor Schuetze - Econ 371
4
2
Labour Market Discrimination Theories
•We can classify theories of discrimination based upon whether the focus is on demand, supply or noncompetitive
aspects of the labour market
Demand Theories:
•The demand for labour of a group being discriminated against is reduced relative to other workers
Outcome Without Discrimination:
•Workers with different racial background or gender and similar skills are perfect substitutes
•q=f(NA, NB)
•
Professor Schuetze - Econ 371
5
Demand Theories of Discrimination
Thus, the marginal product of workers is the same as well
The firm’s hiring decision is simple:
Hire workers up to the point where MRPN equals the wage
If the wages of group A are less than group B hire only worker from group A With Discrimination (against group A):
•
The employer acts as if group A’s wage is not WA but WA(1+dA); dA is the “discrimination coefficient”
Employee discrimination: Consumer discrimination: •
•
•
•
Professor Schuetze - Econ 371
6
3
Demand Theories of Discrimination
•
•
•
•
•
•
The employer’s hiring decision is not based on a comparison of wages WA to WB
Instead, the employer compares the utility adjusted price The decision rule is:
Hire only group A workers if Hire only group B workers if Clearly, this will lower demand for those workers who are discriminated against and lead to segregation in the labour market
Professor Schuetze - Econ 371
7
Demand Discrimination Illustrated
w
w
Group A
Group B
wB
w(1+dA)
wA
MRPN
NDA
N*A
N
MRPN
N*B
N
Clearly, for both types of firms discrimination will not be profitable
Professor Schuetze - Econ 371
8
4
Supply Theories of Discrimination
1. Crowding Hypothesis
•
–
e.g. women into “pink‐collar” jobs
The relatively high supply in these sectors leads to low wages even though workers are paid their marginal product
2. Dual Labour Market
•
Suggests there are two distinct labour markets
Core labour market: Secondary market: •
Discrimination forces workers into the secondary market through the use of unions, barriers to education and training etc.
•
Professor Schuetze - Econ 371
9
Noncompetitive Theories of Discrimination
The predictions of the perfectly competitive model we reviewed lead to segregation not wage differentials
•
Competitive forces should lead to an equalization of wages yet we don’t observe this for some groups
1. Arrow (1973) suggests equalization might occur in the long‐run but the long‐run is a very long time
•
•
2. Queuing of workers, such as that caused by efficiency wages may allow firms to ration jobs on the basis of discrimination
Professor Schuetze - Econ 371
10
5
Noncompetitive Theories of Discrimination
3. Discrimination may occur in noncompetitive sectors 4. Historically determined practices
•
Professor Schuetze - Econ 371
11
Measuring Discrimination
•
•
•
•
•
•
In measuring discrimination you want to record evidence of unequal pay or promotion that is net of productivity differences
However, productivity is difficult to measure
It is easy to identify discrimination in cases where two individuals are doing the same job but are paid differently
There are likely relatively few cases like this and we rarely get this kind of data
Thus, most studies look at differences among groups and try to control for productivity
Any difference that can’t be accounted for by productivity is attributed to discrimination Professor Schuetze - Econ 371
12
6
Oaxaca Decomposition
• This procedure decomposes the overall difference in earnings between two groups into two parts
1. 2. • For example, suppose we wish to explain the earnings gap between men (M) and women (F)
Earnings gap = YM/YF or YF/YM • Using human capital models of earnings:
XF and XM are productivity characteristics
βF and βM are the rates of return to these characteristics
Professor Schuetze - Econ 371
13
Oaxaca Decomposition
• Taking logs we can rewrite the male‐female wage ratio as:
ln(YM/YF) = lnYM – lnYF = βM•XM ‐ βF•XF
Adding and subtracting βM•XF we get:
lnYM – lnYF = βM•XM ‐ βM•XF ‐ βF•XF + βM•XF
•
(Both men and women are paid at the men’s rate βM)
•
• This is usually labelled discrimination
Professor Schuetze - Econ 371
14
7
Graphical Illustration ‐ Oaxaca
lnY
lnYm
lnYf
lnYm=ßmXm
D
B
}
}
C
lnYf=ßfXf
A
Xf
X
Xm
Equations give the relationship between income and
characteristics for men and women, separately
Steeper male line suggests that men receive a higher return to
productive skills
Intercepts suggest men also receive a higher base pay
Professor Schuetze - Econ 371
15
Problems?
1) What are the appropriate X variables?
i) Education and experience?
•
ii) Industry and occupation?
•
iii) Demographic variables like marital status and number children?
•
2) What variables are missing?
•
Professor Schuetze - Econ 371
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8
Empirical Results Despite some of its problems the Oaxaca decomposition has been used to examine a number of earnings differentials
Male/Female Differentials:
• Lots of variation in the results; depending on approach and x‐variables included
Generally find:
1. Pure wage gap remains even after controlling for a number of wage‐determining characteristics
•
Baker et al. –
–
Kidd and Shannon
–
–
Professor Schuetze - Econ 371
17
Empirical Results 2. Potential discrimination outside the labour market is important
e.g. unequal division of labour with respect to childraising; affects hours worked, absenteeism, mobility, training, career interruption Kidd and Shannon (1997)
–
–
Hersch and Stratton (1997)
–
3. The occupational segregation of women into lower paying jobs does not explain much of the earnings differential
• Perhaps too coarse to measure segregation into low‐wage firms and industries
Professor Schuetze - Econ 371
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9
Empirical Results 4. The unexplained portion tends to be smaller in the union sector and in the public sector
Ethnic/White Differentials:
• Confounded by the fact that many nonwhites in Canada are also immigrants
–
•
•
Some compare earnings of whites in Canada to various ethnic groups born in Canada
The unexplained gap tends to vary by ethnic group
–
•
•
Unexplained gap is smaller in the US
Rankings are also different
Professor Schuetze - Econ 371
19
Policies to Combat Discrimination
1. Conventional Equal Pay Legislation
• Deals with wage discrimination within the same job in the same establishment
•
•
• Only minor differences are allowed especially when offset by other tasks
Example: equal work even if males must do heavy lifting especially when women do other tasks
• All Provinces and Territories in Canada are covered Professor Schuetze - Econ 371
20
10
Policies to Combat Discrimination
2. Pay Equity (Comparable Worth) Legislation:
• Recognizes that Conventional Equal Pay Legislation is limited in scope
•
•
Example: Male‐Female Procedure
• Compare jobs that are predominantly male to those that are predominantly female (say 70% or more)
• Points are allocated to job attributes such as skill required, effort, responsibility and work conditions Professor Schuetze - Econ 371
21
Pay Equity
•
•
The points are summed for each job and “female” jobs are compared to “male” jobs
Wages are then adjusted to reflect the “value” of the job done
•
•
•
•
•
It is felt that market forces reflect discrimination
The equal value concept is determined by the notion of value‐in‐use
Rationalized on grounds of being able to deal with both wage discrimination and Occ. segregation
Professor Schuetze - Econ 371
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11
Pay Equity
•
•
•
•
Who is covered by Pay Equity?
In Canada, all jurisdictions except Alberta and Saskatchewan
In most jurisdictions coverage is restricted to the public sector
Quebec and Ontario are the only two that require it to be applied to the private sector as well
Professor Schuetze - Econ 371
23
Policies to Combat Discrimination
3. Equal Opportunity Legislation:
• Designed to prevent discrimination in recruiting, hiring, promotion and dismissal
•
•
•
•
Hoped that this will increase demand for female employees and, in turn, increase wages
Likely to benefit new recruits and those changing jobs more than incumbent females
Professor Schuetze - Econ 371
24
12
Policies to Combat Discrimination
4. Employment Equity (Affirmative Action)
• Focuses not on providing equal opportunities for work but on results or quotas
•
•
Employment equity applies to four designated groups: •
Essentially, goals are set so that the internal representation of workers match their representation in the relevant external market
Employment equity covers only federal workers in Canada •
Professor Schuetze - Econ 371
25
Estimated Impacts of Policies
Conventional Equal Pay
• Most studies find equal pay for equal work policies have very little effect on wages
–
Pay Equity (Comparable Worth)
• A number of studies have examined the impact of comparable worth
• Typically examine its application in the public sector in Canada and the US
e.g. Public Service Alliance of Canada PSAC alleged that female clerical workers were paid lower wages than the male dominated Program Admin. Group
• Ended in a 3.6 billion dollar settlement
Professor Schuetze - Econ 371
26
13
Estimated Impacts of Pay Equity
•
The female/male earnings ratio in the overall public sector before comparable worth adjustments was around 0.78
•
•
Note that these studies don’t likely give a good indication of their likely impacts on the broader economy
–
•
Gap in public sector is just over half of that in the economy as a whole
Impact is likely to be smaller because the gap reflects the segregation of women into low‐wage firms and industries
–
Comparable worth doesn’t compare across firms and industries
Professor Schuetze - Econ 371
27
Estimated Impacts of Policies
•
•
Evidence of the impact of comparable worth in the wider labour market confirms this
e.g. Baker and Fortin (2000) examine the impact of Pay Equity in Ontario
•
•
Affirmative Action:
• Studied in the US by examining the impact of the US federal contract compliance of Executive Order 11246
• Minority groups targeted did benefit to a certain extent
• The effects were stronger during economic expansion than contraction in the overall economy
Professor Schuetze - Econ 371
28
14
Topic 6.1 ‐ Union Growth and Incidence
Professor H.J. Schuetze
Economics 371
Unions:
“Collective organizations whose primary objective is
to improve the well-being of their members”
Achieve this through “collective bargaining”
„
„
In “North America” bargaining is done primarily at
the firm level
Unions are also often involved in government
lobbying
In European countries the ties between unions and
political parties are particularly close
„
e.g. The Labour Party in the UK
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1
Unions in Canada
In Canada Unions have relatively close ties with the
New Democratic Party
There are two types of Unions in Canada
Craft Unions:
„
Industrial Unions:
„
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Union Membership in Canada
Professor Schuetze - Econ 371
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2
Union Membership in Canada
Professor Schuetze - Econ 371
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Union Membership in Canada
Unlike in the US, the percentage of workers covered
by a “collective agreement” in Canada has increased
(or stable) in recent years
Table 14.1 presents a number of different measures
of “union density”
Non-agricultural paid workers exclude a number of
individuals who are not eligible for unionization
„
e.g. self-employed and agricultural workers
In fact, these measures likely understate the fraction
of workers influenced by collective agreements
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3
Union Membership in Canada
First, there is a distinction between union
“membership” and union “coverage”
Once certified the union is the exclusive bargaining
representative for a bargaining unit
Thus, union coverage is likely even higher
Second, a unions influence may reach far beyond
those covered by a collective agreement
e.g. Steel industry in Hamilton – Stelco (unionized) while
Dofasco (not unionized)
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Legal Framework
The law with respect to collective bargaining in
Canada has passed through three main phases
Phase 1 (prior to confederation):
Phase 2 (Trade Unions Act of 1872):
Saw the removal of many of the restrictions on union
formation and collective action
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4
Legal Framework
Phase 3 (1944 National War Labour Order):
Modeled on the Wagner Act of 1935 in the US
Labour law facilitated the formation of unions
Established employees’ rights to union
representation and collective bargaining
Also established the certification process and limited
the interference of employers with union
establishment
Certification process:
The process by which unions come to represent
workers is somewhat complex and varies by province
(power is divided between federal and provincial
governments)
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Certification Process
Š
Š
Basically, an application is made by the union to the
province’s Labour Relations Board
Certification depends on the percentage of workers
who indicate their desire for organization by signing
union membership cards
Š
Š
In some provinces, even if this threshold is not met
an election may be held to determine if
representation is given to the union
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5
Determinants of Growth and Incidence
What explains the large variation in union density?
We have seen that union density in Canada varies
through time
The extent of unionization in Canada also varies by
industry, occupation, region and other characteristics
„
„
Union density and growth also varies by country
Most notable are the divergent trends in unionization
between Canada and the US. (Figure 14.1)
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Demand and Supply Framework
We can analyze the reasons for variation in union
density using a demand and supply framework
Demand for Union Representation:
Lies with the employees
Depends on the benefits and costs associated with
union representation
Benefits:
Costs:
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6
Demand and Supply Framework
Supply of Union Representation:
Lies with union leaders and their staff
Unions allocate their scarce resources to achieve the
unions objective
Administering contracts and organizing new
workplaces are obviously costly activities
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Determinants Thus, the extent of unionization depends on:
1. Demand –
Demand will be high in organizations where many
employees perceive the benefits of unionization to
be substantial
Depends on the actions of the employer and the
political, social and economic environment at any
point in time
2. Supply –
Supply will be high in organizations in which per
worker costs of organization/representation is low
Depends on the legal and political environment also
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7
Empirical Evidence The demand and supply framework has been used
as the basis for a number of empirical studies
Several factors suggested by the demand and supply
framework have been investigated using crosssectional data
These include:
i) Social Attitudes Towards Unions
The idea here is that the resistance to unionization
and the receptiveness of employees to union
representation are affected
The difficulty is measuring social attitudes
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Empirical Evidence Example: Ashenfelter and Pencavel (1969)
Find that the percent of Democrats is positively
correlated with union growth
This can’t help to explain Canada/US differences in
unionization as attitudes towards unions has become
increasingly unfavourable in both countries
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8
Empirical Evidence ii) Legislation Towards Unionization
This is somewhat related to the previous factor as
legislation is often influenced by social attitudes
„
Changes in the legislative framework in Canada have
been used to explain the growth in unionization
These changes led to decreases in the costs of
unionization for employees
Differences in legislation have also been used to
explain the divergent trends in unionization between
Canada and the US
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Empirical Evidence iii) Other Economic and Social Legislation
Legislation that raises employment standards can
narrow the gap between union and non-union
workers
„
iv) Aggregate Economic Conditions
The Business cycle may also influence the rate of
union growth
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9
Empirical Evidence Economic conditions work through:
The number and growth rate of employees who are
eligible for unionization
Its influence on the resistance of employers to union
formation
„
The unions ability to get wage increases
These suggest that union growth is procyclical
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Empirical Evidence v) Firm and Industry Characteristics
Studies find that union density is higher in industries
where
a)
It is more difficult for a single person to be heard in
a large firm
Likely that the need for work rules, grievance
procedures etc. is greater
Per worker cost of union organizing is lower
b)
Implies labour costs are a small fraction of total
costs
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10
Empirical Evidence c)
Barriers to entry may limit the threat of union
competition in the form of new entrants
Potentially greater benefits due to barriers to entry
Organizing costs may be lower
vi) Personal Characteristics
The characteristics of the individual affect the
demand for union representation
e.g. part-time workers are less likely to be unionized
The benefits are likely lower
Age, gender and the individuals earnings level have
also been found to influence the demand
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11
Topic 6.2 ‐ Unions:
Wage and Employment Determination
Professor H.J. Schuetze
Economics 371
Wage and Employment Determination
How do firms and unions interact in the setting of employment and wages?
•The view taken in the economic literature is that unions maximize an objective (utility) function subject to firm behaviour
Union Objectives:
What do unions want?
•“more” – Samuel Gompers, founder of the American Federation of Labor
•
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1
Union Objectives
•Note that the union’s objectives are not necessarily the same as those of the union members
•
•
•Nonetheless it is useful to think of the union acting as a single decision making unit in search of higher wages and employment
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The Union’s Indifference Curves
Thus, the union’s indifference curves have the usual shape
Real
Wage
(W/P)
U2
U1
U0
Wa/P
Downward Sloping:
• High wage is necessary to
compensate for low
employment
Convex:
• With a high wage and low
employment willing to give up a
lot of wages to increase E
•
Employment (E)
The worker’s alternative wage also matters
„
„
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2
Alternative Objective Functions
• Other union objective functions have also been suggested
1. Maximize the wage rate
• Place all the weight on wages and none on employment
• Utility increases “vertically”
only
Real
Wage
(W/P)
Wa/P
Employment (E)
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Alternative Objective Functions
2. Maximize employment
Real
Wage
(W/P)
• Utility increases
“horizontally”
Wa/P
Employment (E)
Recall that union membership matters to the
union because it increases union dues
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3
Alternative Objective Functions
3. Maximize the real wage bill (W/P•E)
• The real wage bill is just total labour income
• Here the union places weight on both wages and employment
• W/P•E =constant
•
Real
Wage
(W/P)
•
Wa/P
Employment (E)
Only makes sense if the income is shared between
employed and unemployed members
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Alternative Objective Functions
4. Maximize real economic rent (W/P‐ Wa/P )•E
• Similar to profit maximization for a monopolist
–
• The alternative wage represents the opportunity cost to each member
W/P•E = total revenue
Wa/P•E = total cost
Real
Wage
(W/P)
Wa/P
U0
U2
U1
• Indifference curves are
rectangular hyperbolas
•
Employment (E)
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4
Union Constraints
• The “choice” of wages and employment by the union is constrained by the firm’s behaviour
• Assume that the firm is dealing with a profit‐maximizing competitive firm
• Also assume (initially) that the determination of wages and employment is carried out in two stages
•
•
• The firm need only to look to its labour demand curve which specifies the profit maximizing employment level at each wage
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Union Constraints
In a sense, the firm’s labour demand curve can be viewed as a constraint on union behaviour
Real
Wage
(W/P)
• If the firm can not be induced
off of the demand curve
• Union utility maximization
occurs at a point of tangency
(a0)
Wa/P
DL
Employment (E)
a0 represents one of the possible outcomes from
collective bargaining in this model
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5
The Firm’s Preferred Outcome
• The firm prefers outcomes that yield higher profits
• Profits vary along the firm’s labour demand curve
Wage
d
•
W*
• To see this consider the firm’s
isoprofit curves
•
•a
•b
•
∏0
•c
Wa
∏1
∏2
DL
E
E*
Isoprofits lower on the demand curve are associated
with higher profits (preferred by the firm)
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Bargaining Range
• The range of wages along the demand curve over which bargaining can occur is constrained
1. The lowest possible wage the firm
can negotiate is Wa
-
Wage
W0
•
WU
Wf =Wa
•
∏0=0
U*
DL ∏*
2. The zero-profit isoprofit limits the
wage the union can ask for
-
E
As drawn the zero profit constraint is not binding
„
The union prefers a wage less than W0 (IU) because of
the negative employment effects of a higher wage
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6
Some Implications I. Elasticity of Demand:
• In the absence of the union the competitive wage is given by Wa
• Thus, if the union has any bargaining power wages will be higher and employment lower with the union
• Because of this the likelihood of a successful union drive and union utility increase when the labour demand curve is inelastic
–
–
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Some Implications • Not surprisingly, a number of union practices are aimed at making labour demand more inelastic
These include:
Reducing the number of substitutes for union labour
•
•
Reducing substitutes for union‐made products
•
•
•
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7
Some Implications II Labour Market Efficiency:
• The outcome implied by the model is inefficient because unions reduce the total value of labour’s contribution to national income
• If unions are able to raise wages (reduce employment) in union sectors employment increases in nonunion firms (if available etc.)
• The last worker hired by a nonunion firm would have greater productivity if she moved to the union sector
•
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Efficient Contracts
• The fact that the previous equilibrium is inefficient suggests there might be a “better” contract off of the demand curve Point A: represents the “ideal” union
outcome in previous model
Wage
W0
WU
Wa
A
•
B
•
U
UA A’’
Point B: Again there is a shaded
∏A
DL ∏
B
region in which both parties
benefit
E
When will all the gains from trade be exhausted?
No change can make one party better off without
making the other party worse off
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Efficient Contract (A’’) Wage
W0
WU
A
•
A’’
•
B
•
Wa
U
UA A’’
∏A
DL ∏
B
At A’’ all of the gains from
trade are exhausted
This occurs at a point of
tangency between the
union’s indifference curve
and the firm’s isoprofit curve
E
• A’’ is a “Pareto‐efficient” contract
•
•
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Contract Curve The locus of all of the relevant Pareto-efficient wageemployment contracts
Contract Curve = C - C’
The contract curve lies to
the right of DL
Wage
W0
•
•
Wa
•
DL
E
• Points up on C‐C’ are preferred by the union and those lower on C‐C’ are preferred by the firm
•Bargaining range is determined by zero economic profit and the workers’ alternative wage
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9
Implications 1. Featherbedding
• Outcomes on the contract curve contain higher levels of employment than the firm would choose on its own
• The firm is overstaffed
• The firm and the union will be forced to negotiate “make‐work” or featherbedding practices to share tasks
•
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Implications 2. Relationship between wages and employment
• The negative “ceteris paribus” relationship between wages and employment need not hold
•
3. “Efficiency”
• Although the term “efficient contract” is used for all contracts on the contract curve they may not be allocatively efficient
•
•
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10
Obstacles to Reaching Efficient Contracts
• There are obvious incentives for firms and unions to reach an agreement on the contract curve
• These agreements may, however, be difficult to reach
Why?
1. Imperfect Information
• May not realize that there are gains to be made if there is not full information about willingness/ability to trade
•
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Obstacles to Reaching Efficient Contracts
2. Difficult to enforce employment contracts
• The firm has an incentive to reduce employment at the negotiated wage (reach the demand curve)
•
•
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11
Bargaining Theory
The union models we have examined so far suggest
that there is a range of possible outcomes
Some of these outcomes are more preferred by the
firm and some are better for the union
Bargaining Theory is used to:
1.
2.
The basic idea is that the union and firm will engage
in strategic behaviour (like a card game or chess)
Both parties conjecture about the potential actions
of their collective bargaining partner
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The Basic Bargaining Problem
There is a set of characteristics that is common to all
bargaining situations
For the bargaining problem of a collective agreement
between a firm and a union the problem might be
illustrated as follows:
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12
Firm/Union Bargaining Problem
Union
Utility
d = disagreement or “threat
point”
A
C
B
d
Firm Utility
The area bounded by the curve represents the set of feasible
outcomes
„
Bounded by the firm’s profits
Points on the boundary are Pareto Efficient
To see this consider point C (inside the boundary)
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Firm/Union Bargaining Problem
Union
Utility
A
C
B
d
Firm Utility
Conflict arises because the set of Pareto Efficient outcomes
yield higher utility for one party at the cost of the other
Point B is also Pareto Efficient but yields higher utility to the
firm than A and lower utility to the union
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13
Bargaining Problem Solutions
There are two classes of solutions:
1.
Give a set of properties that describe the outcome
2.
Model the process of bargaining along with giving
predictions about the outcome
What follows are examples of each of these
The Nash Bargaining Solution:
Follows from the work of John Nash
Assumes perfect information about the possible
payoffs and preferences
„
Not about what the other party will do
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The Nash Bargaining Solution
1.
2.
Outlines four axioms that a solution to the
bargaining problem must obey
The outcome must be Pareto Efficient
If the bargaining set is “symmetric” the solution
must give equal utility increments to each party
Bargaining power depends on possible outcomes
With symmetry both parties have the same amount
of bargaining power
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14
The Nash Bargaining Solution
3.
The solution is not altered by a linear transformation
of either party’s utility function
The units that utility is measured in should not
matter
4.
Independence of Irrelevant Alternatives
The basic idea is as follows:
Suppose you “play the game” with all possible
outcomes and come to a solution
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The Nash Bargaining Solution
If we remove some of the possible outcomes (other
than the solution) we should get the exact same
outcome
Example: Deciding on how to get to school
Choose between: bus, car and bike
Suppose you choose to ride your bike
You find out that, in fact, the buses are not running
It is a little more complex in a two person situation
and it is an axiom that is often violated in
experiments
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15
Nash Equilibrium
It turns out that these four axioms imply a unique
solution to the bargaining problem
The “Nash Equilibrium” is such that the product of
the two parties’ utility increment is maximized
Union
Utility
In terms of the graph
N
UN
Ud
d
Fd
FN
Firm Utility
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Rubinstein’s Bargaining Theory
Rubinstein models the bargaining process
Clearly there are a number of different ways in
which firm’s and unions will interact
The interaction will depend, in part, on the “rules” of
the game
The rules in Rubinstein’s game are as follows
The bargainers take turns making offers
The offer is either accepted or rejected
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16
Assumptions
Perfect information
Each party cares only about the utility derived at the
end of the process
Each round in which an agreement is not reached is
costly to both parties
Potential profits from bargaining (boundary) decrease
„
U
First period bargaining
boundary = U1 – F1
Second period falls to U2 – F2
U1
U2
U3
d
U4
F3
F4
F
F2 F1
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Assumptions Each party acts rationally and can expect the other
party to do the same
„
Example: The union starts the bargaining by offering A
and only A in the following graph
U
i.e. otherwise end up at d
This is not a credible threat
A
U1
U2
U3
B
d
U4
F4
F3
F2 F1
F
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17
Equilibrium – Union Makes First Offer
U
U1
UR
U2
The equilibrium will occur at R if
the union moves first
i.e. the union will offer and the firm
will accept R
To see this we must use backward
induction
R
U3
d
U4
F3 FR
F4
F2 F1
F
Period 2: the firm moves, period 3: the union moves,
period 4: no decision to make
The best the firm can do in period 4 is F4
Period 3:
Professor Schuetze - Econ 371
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Equilibrium – Union Makes First Offer
U
U1
UR
U2
R
U3
d
U4
F4
Period 2:
F3 FR
F2 F1
F
The firm will offer (U3,FR)
Period 1: The same rational leads to the union offering
and getting (UR,FR)
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18
Delay Costs Notice that delay costs are important in that the
threat of these costs give the negotiators power
In fact, what really gives a party power in
negotiations is the relative delay costs
To see this consider the following diagram:
U
U1
U2
U3
The feasible set in period 1 is
the same as before
Delay costs to the firm are also
the same
d
U4
F3
F4
F2 F1
F
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Delay Costs U
U1
U2
U3
The relative delay costs for the
firm have increased
This decreases the bargaining
power of the firm and increases
that of the union
R
d
U4
F4
F3
F2 F1
F
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Some Final Words Clearly, Rubinstein’s model is overly simplistic
„
Captures the importance of relative delay costs in
determining the equilibrium outcome
Might help to explain why strikes or lockouts are
important in bargaining
„
Doesn’t help to explain why strikes actually occur
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Some Final Words The strike is irrational
The irrationality of strikes is known as the “Hicks
Paradox”
Most models that attempt to explain strikes assume
that there is asymmetric information
„
In such circumstances strikes may make sense
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20
More on Bargaining Power So far, we have thought of bargaining power as the
ability of one party to raise (lower) wages
„
However, union bargaining power is also related to
the elasticity of labour demand
Here the notion of bargaining power is associated
with the union’s willingness to raise wages
It is possible for a union to be powerful in one
respect but not in the other
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More on Bargaining Power w
wU
w
wU
A
wC
wa
B
wU=wC
wa
DL
E
DL
E
Of course, unions can be powerful or weak
according to both meanings as well
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21
Topic 6.3 ‐ Union Impacts
Professor H.J. Schuetze
Economics 371
Union Impact on Wages and Benefits A great deal of research has focused on estimating
the impact of Unions on wages
A simple approach to doing this is to compare the
average wages in the two sectors
Union –nonunion wage differential:
There are a number of problems with using this
simple method
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1
Problems/Difficulties 1.
The nonunion wage that prevails in the presence of
unions may differ from that which prevails in the
absence of unions (endogenous)
„
As we noted previously, the presence of unions may
also influence wages in the nonunion sector
a.
To illustrate, consider the following two-sector
general equilibrium model
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Two‐Sector General Equilibrium Model
w
A Union
SA
w0
w
B Non-Union
SB
w0
DA
NA0
DB
N
NB0
N
Both sectors employ the same type of labour
In the absence of unions the labour market is competitive with
equilibrium wage w0
Suppose unions enter and raise the wage in sector A to wU
Employment decreases to NA1
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2
Problems/Difficulties Notice that the estimated union-nonunion wage
differential is bigger than the true union impact
Other possibilities
b.
„
We need to distinguish between those that are
willing to pay higher wages and those that are not
Some may face very little threat of unionization.
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General Equilibrium With Threat Effects
SA w
B Threatened
wBN
w0
w0
NA1 NA0
a
b
}
DA
}
a
N
SB
S’B
w
w0
C Unthreatend
a
DB
NB1 NB0
N
SC
S’C
}
A Union
}
w
wU
DB
NC0
N
(wBN)
Sector B raises its wage to compete
Employment declines in sectors A and B
The average non-union wage can be higher or lower than the
previous case
However, the union-nonunion wage differential still doesn’t measure
the union impact on wages
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3
Vertical Contract Curve c.
w
It is possible that the firm and union will negotiate
off of the demand curve
An interesting case occurs when the contract curve
is vertical
A Union
C
SA
w
B Non-Union
SB
wU
w0
w0
DA
NA0
DB
N
NB0
Professor Schuetze - Econ 371
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7
Union Sector Queuing d.
Wages are higher in the union sector, thus, it may be
rational to wait
e.g. Here the increased supply of workers to the nonunion sector will be less than the reduction in
employment in the union sector
Wages in the nonunion sector won’t be depressed
quite as far
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4
Problems/Difficulties 2.
Selection Bias
What we want to do is compare differences in wages
controlling for other wage determining differences
Examples:
Unionized sector may utilize skilled workers more
than the nonunion sector
„
Unionized firms may be larger (have more capital)
than non-unionized firms
Some of these differences can be controlled for in a
regression setting because they are observable
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Problems/Difficulties The problem arises when the unobserved factors
that influence wages also influence selection into the
union sector
The estimated effect will be biased
Example:
This is likely to be the case if unions are able to
create queues of workers wanting higher wages
The solution is to use panel data
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5
Empirical Results Estimates of the union-nonunion differential vary
depending on statistical method and data used
Early studies, primarily using US aggregate data
estimate the union-nonunion differential to be
around 10-15 percent (Lewis 1963)
Because these studies are based on aggregate data
they are not very reliable
Studies based on individuals or individual firms
estimate the impact to be greater than 10-15
percent
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Empirical Results However, it has been argued that such studies may
overstate the true union wage impact
„
Recent studies attempt to deal with these issues
Account for the joint determination of union status
and the wage impact
These studies find the impacts to be smaller
Longitudinal studies have been used to control for
person-specific characteristics (not observed)
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6
Empirical Results US longitudinal studies find the union-nonunion
wage differential to be around 10 percent
Others have suggested that the lower estimates may
result from mismeasurement of union status in
longitudinal data
Variation in Impacts:
1. The differential tends to be higher the higher the
proportion of the industry/occupation organized
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Empirical Results 2.
The impact is larger the larger the firm
This is even more true in the non-union sector
Therefore, the wage differential declines with firm
size
3.
The union impact is higher for blue collar than white
collar workers
In general, the impact is larger at low skill levels and
smaller at high skill levels
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7
Empirical Results 4.
In Canada, it appears that women benefit more, in
terms of wages, than men from unionization
5.
The union impact tends to be smaller in the public
sector than in the private sector
The union wage impact varies countercyclically
Widening in recessions and narrowing in booms
6.
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Non‐Wage Impacts i)
Unions tend to have a larger impact on non-wage
benefits than they do on wages
ii)
Unions also tend to reduce worker “turnover”
Quit rates are lower in union firms even after
controlling for wage differentials
May reflect the fact that workers are reluctant to
leave these high wage jobs
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8
Non‐Wage Impacts iii)
Empirical studies find that unions may either
increase or decrease worker productivity
The overall impact depends on the magnitude of
various offsetting factors
It is important to distinguish between
a.
b.
Union firms will respond to an increase in the wage by:
1.
2.
3.
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Impacts on Productivity Thus, we might expect the union wage impact to
raise productivity
To get the underlying impact of unions, therefore,
we must control for capital, worker characteristics
and job characteristics
Through work stoppage and featherbedding we
might expect unions to have a negative impact on
productivity
On the other hand, reduced turnover and improved
worker morale may increase productivity among
union workers
Estimates of the impacts of unions have been both
positive and negative
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Impacts on Productivity The estimates depend on:
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10
Topic 7.1 Unemployment Measurement
Professor H.J. Schuetze
Economics 371
Unemployment
• In general, those not currently employed but who indicate that they want to work at the prevailing wages and working conditions.
• The most common measure is obtained from the monthly Labour Force Survey (LFS)
• In this survey people are asked about their labour market activities in the week prior to the survey
•
• The unemployed also includes those who were on temporary layoff or had a job starting within 4 weeks •
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1
Unemployment
Why is there unemployment?
• The Neoclassical model suggests that prices should adjust to reach an equilibrium in which all those wishing to work find employment.
• To see why some unemployment might be expected even with our simple supply and demand model let’s look at the different types of unemployment.
• However, we will need more than this to explain the existence and persistence of unemployment.
• We will examine some of the explanations proposed to explain persistent unemployment as well.
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Types of Unemployment:
(i) Frictional Unemployment:
•
Unemployment associated with normal turnover in the labour force.
•
Thus, unemployment would prevail even in a well functioning labour market.
•
New jobs open up, others disappear, workers return to school.
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2
Frictional Unemployment
•
Often associated with job search which takes time.
How much time? → “Optimal Search”
•
Job vacancies and job seekers exist because of imperfect information.
Costs:
•
•
Benefits:
•
•
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Optimal Search
•
Assume that individuals choose search activities to maximize expected utility
–
P.V.
C
total
C/B
Initially MC of search is low
„
P.V.
B
More costly methods will be
necessary as search continues
Search Time
MB likely declines with search
time
MC
MB
„
Equilibrium search time = Se
“expected” amount of search
Se
Search Time
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3
Frictional Unemployment
It may not be beneficial to reduce frictional unemployment.
•
•
•
Temporary layoffs due to
•
changes in product demand
•
weather
•
work stoppages
are part of frictional unemployment
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Types of Unemployment:
(ii) Structural Unemployment:
•
Results when the skills or location of the unemployed are not matched with the characteristics of job vacancies.
Like with frictional unemployment, unemployed
workers and job vacancies co-exist.
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4
Structural Unemployment
Here, successful matching requires more than the acquisition of information.
•
•
•
Solutions:
•
•
•
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Structural Unemployment
Whether frictional or structural depends on whether changes in demand are permanent or temporary.
Permanent →
Temporary →
•
Not always clear which is the case.
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5
Types of Unemployment:
(iii) Demand Deficient Unemployment:
•
When there is insufficient aggregate demand in the economy to generate sufficient job vacancies.
•
Doesn’t arise because of a lack of the correct skills or by being in the wrong labor market or because of search.
Supply =
Demand =
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Demand Deficient Unemployment
•
•
Usually associated with the business cycle “cyclical unemployment”.
Could be chronic as opposed to short‐term.
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Types of Unemployment:
(iv) Seasonal Unemployment:
•
Associated with insufficient demand in a particular season.
•
Different from demand deficient unemployment in that it is not a shortage of aggregate demand but rather a shortage in a particular season.
•
Usually predictable over the year and specific to particular industries.
e.g. Unemployment increases in the winter in:
•
•
•
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Seasonal Unemployment
Labour supply may also increase
Seasonal unemployment is analogous to temporary layoffs in several ways – often included in frictional unemployment.
Seasonally adjusted unemployment rate:
•
•
•
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Types of Unemployment:
(v) Involuntary Unemployment:
•
It is important to distinguish between voluntary and involuntary unemployment.
Involuntary unemployed:
Voluntary unemployed:
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Unemployment in Canada
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8
Unemployment in Canada
Canada’s unemployment rate fluctuated a great
deal during this period
Typically because of cyclical fluctuations
Great depression began in 1929 and the
unemployment rate soared up to almost 20%
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Unemployment in Canada
From the 1960’s on unemployment rates have
trended upward
This trend broke somewhat in recent years as
unemployment rates fell to levels not seen in
almost 30 years
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9
Hidden Unemployment (marginal labor force attachment)
Refers to situations in which individuals may be
without work yet desire to work but are not
classified as unemployed
Examples:
1. “discouraged worker” phenomenon:
Individual would work at the going wage but does
not seek work because he/she believes there is no
work available
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Examples of Hidden Unemployment
2. Those waiting for recall after 6 months of layoff
3. The underemployed
Those working fewer hours than they desire
There is evidence of significant hidden
unemployment
Some labour force surveys identify those who want
to work, are available but not seeking
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10
Should they be “unemployed”?
Yes:
No:
Note: the number of discouraged workers increases
during recessions
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Labour Force Dynamics
The measures we have discussed so far
provide a snapshot at a point in time
i.e. an estimate of the stock of persons in each
labour force state
However, even if the stocks remain constant it
could be a mistake to say that the labor force
hasn’t changed
Figure 17.2 gives the monthly flows between
three labor force states: employed,
unemployed and the non market sector
between 1976 and 1991
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11
Labour Force Dynamics
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Labour Force Dynamics
Even though the number of employed changes only
marginally from month to month, many of the
unemployed in one month are no longer
unemployed the next month
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12
Incidence and Duration
It is important to understand how stocks and flows
influence unemployment
Incidence of unemployment:
Duration of unemployment:
i.e. Incidence measures the probability of becoming
unemployed and duration the length of time the
individual can be expected to remain unemployed
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Incidence and Duration
The unemployment rate is affected by both
incidence and duration
In general, we find that those with the highest
incidence and low duration of unemployment have
the highest unemployment rates
e.g. high youth unemployment
low unemployment among older workers
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Topic 7.2 Unemployment Causes
Professor H.J. Schuetze
Economics 371
Why is there longer term unemployment?
We have shown that a certain amount of
frictional unemployment will exist
We have not offered any explanations for
longer-term unemployment
Let’s work through some explanations that
have been proposed
It’s important to note that no one explanation
is widely accepted
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1. Intertemporal Substitution Hypothesis
Suggests that some portion of cyclical
unemployment may be voluntary
Basic idea is that real wages rise during
economic expansion and fall when the
economy contracts (procyclical)
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Problems
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2
2. Sectoral Shifts Hypothesis
Helps to explain structural unemployment
Shifts in demand do not affect all sectors of the
economy equally
At any point in time some sectors of the economy
are growing while others are in decline
e.g. e-business and service sectors growing while
manufacturing is declining
This is likely the case
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Sectoral Shifts Hypothesis Continued
Can test this empirically by looking at the
relationship between aggregate unemployment
and the dispersion of growth rates across
industries
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3
3. Efficiency Wages
With shirking (high costs of monitoring) the firm
might be willing to offer higher wages to
encourage workers not to shirk
The wage/employment combination the firm is
willing to offer depends on the unemployment rate
(shirking cost)
High Unemployment
Low Unemployment
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Equilibrium
The equilibrium is given by the intersection of demand
and the no-shirking supply curve
Wage
NS
S
WNS
W*
D
ENS
E
Employment
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4
4. Implicit Contracts
Labour contracts often specify wages and the
number of hours of work given aggregate
economic conditions
Could be:
“fixed employment contract” -
“fixed wage contract” -
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Implicit Contracts
Helps to explain rigid wages and why firms tend to
adjust using layoffs instead of wages
The typical implicit contract is a fixed wage contract
(incomes are relatively stable)
Reflects risk-sharing between the employee and the
employer
„
„
Thus, workers prefer arrangements where they
receive a lower average wage with more certainty
The firm likes such contracts because average costs
are lower
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Implicit Contracts
Thus, the firm provides “insurance”
Why is insurance not provided privately?
1. Moral Hazard -- Insurance may affect the workers’
behaviour such that the likelihood of unemployment
increases
„
„
2. Adverse Selection -- Insurer doesn’t observe the
likelihood of unemployment for a particular worker
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Example
Suppose workers’ utility is a function of the wage only u(w)
There are N0 workers who sign a contract in period 1
There is uncertainty about the product market such that there
are two states, each occurring with equal probability
Wage
S
An unemployed worker
receives utility u(k)
k=value of leisure time
Da=MPN X Pa
Wb= k
Db=MPN X Pb
N0
Employment (N)
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Example
We know the outcome is “efficient”
However, if the firm is risk neutral and workers are
risk averse there are potentially Pareto improving
contracts that involve “risk sharing”
Pareto optimal contracts involve
1.
2.
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Example
S
Wage
w = expected wage with
Wa
Da=MPN X Pa
k
Db=MPN X Pb
Nb
N0
market clearing
= ½ wa + ½ k
W* is the contract wage
Nb* is the number of
workers hired in the bad
state under the contract
Employment (N)
Workers are better off
The firm may be better off
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Implications
As long as the savings are high enough in the good
state the firm is better off
Notice that the workers income is not fully
stabilized
The optimal contract represents a tradeoff between
risk-sharing and production efficiency
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Implications
Even though they would prefer to be working at the
going wage once laid off
Suggests that employment will fall during
recessions and rise during expansions
Weakness is that the model suggests that
unemployment with such wage contracts will be
less than if wages were allowed to adjust
However, models that allow for asymmetric
information (which is likely) give unemployment
that is greater than under market clearing
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Insider‐Outsider Model
Wage setting is determined through bargaining with
“insiders” – existing work force
The “outsiders” – unemployed – have little
influence on the outcome
Requires costs to the firm in order to replace
existing workers
„
These costs give the insiders bargaining power
Thus, the insiders are able to set wages above the
market clearing level
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9