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Pivoting off Karl’s recent posts, I want to throw my two cents in on the minimum wage. Actually, I’ll make that one cent, because I’ve already written about my take on the empirical evidence plenty before and there’s no sense in rehashing that. What I do want to draw attention to is a smart post by Robert Waldmann from 2009 that illustrates why now in particular is a bad time for the minimum wage:
Empirical estimates of the effect of the minimum wage on employment suggest that the effect is very small. One famous study by Card and Krueger showed a positive effect of an increase in the minimum wage. The logic used by Card and Krueger to understand how this could happen suggests that things are different now.
Their logic is basically that firms can choose to pay a low wage and have a high quit rate and take a long time to fill vacancies or pay a high wage and have fewer quits and fill vacancies more quickly. If they are forced to pay the higher wage, their desired level of employment will be lower, but that level is the sum of employment plus vacant jobs. A binding minimum wage can reduce the number of vacant jobs by more than it reduces the sum of employment plus vacant jobs. Thus more employment.
I think this is not relevant to the current situation. There are very few vacant jobs. Quit rates are low. According to their logic, the effect of the minimum wage on employment depends on the unemployment rate. The evidence of a small effect is almost all from periods of unemployment far below 10%. I don’t think it is relevant to the current situation.
As you can see in this graph quits are still quite low, and so Robert’s logic still holds.
It’s always worth noting that when basic laws of supply and demand don’t seem to hold it’s not because of some universal and eternal forcefield simply protecting a market from these laws, but for reasons typically explained by some usually more complicated economic theory. Either that or it’s a mystery, and maybe the exception to the rule is simply due to some irreducible complexity economists will never grasp. But if this is the case it should make you worry even more: since you don’t know where the exception is coming from, you have no idea what will cause it to give way.
When the laws of supply and demand seem violated, it’s probably for a reason, and that reason may not hold in all circumstances. “When and under what circumstances will the result you believe continue to hold?” is an important question to ask yourself. Take the minimum wage. I don’t know any economist who believes that the minimum wage won’t definitely cause unemployment at some level. Maybe it’s a $10 minimum wage, maybe it’s $8, and just maybe it varies a lot by location, industry, and job. That some studies in the past have failed to show a significant unemployment effect of the minimum wage should not lead you to toss aside the concepts of supply and demand and conclude that they are meaningless or disproven in this context.
This is the second part of a series of posts responding to Matt Steinglass at the Economist, who put forward some common progressive arguments in favor of more unionization recently. To understand the big picture problem with the argument for more unions, it’s useful to look at the reasons why unions have died out in the first place. One common explanation is that the most highly unionized industries, like manufacturing, have shrunk, and that unionization was simply taken along for the ride. This is not the case however. As Barry Hirsch details, while overall manufacturing employment fell from 20.1 million from 1973 to 15.6 million in 2006, nonunion manufacturing employment rose by 1.5 million. A similar patter persisted in the other main union industries of construction, and transportation/communication/utilities: union employment fell while nonunion employment rose. The graphs below, from Hirsch, tell the story pretty clearly:
If declining industries is not the cause then what? Hirsh identifies 3 main explanations for the decline of unionism: competitive, structural, and institutional. Ultimately, he provides a convincing argument that the fall of unionism is due to a more competitive and dynamic economy. Part of the problem, he argues, is that collective bargaining slows firms down:
“Were changes in the economic environment very gradual and competitive pressures weak, a formal and highly deliberate union governance structure might pose few problems. The costs of deliberate or sluggish union governance, however, increase with the speed of change and the degree of competition. New information is constantly coming to a firm and its workers and it is prohibitively costly. to have explicit contract terms for every possible contingency. Revising formal contractual terms is costly. Although many collective bargaining agreements have broad management rights clauses, formalized contractual governance limits flexibility and managerial discretion in union companies. “
A related problem is that by cartelizing labor, unions raise wages above the competitive level. The more competitive a firm’s market, the less they will be able to raise price in response to higher wages, and the more costly unionization is in terms of lost employment. For both reasons it is difficult more difficult for unionization to exist in a competitive and dynamic economy.
A common counterargument to this, which Matt makes, is to point to the high employment and unionization of the 50s and 60s as evidence that they can co-exist. But the economy was much less dynamic and competitive than it was today. As detailed by Brink Lindsay in Nostalgianomics, labor market competition in that time period was limited by discrimination against minorities and women, and strict immigration restrictions. Goods market competition was limited by government policy like tariffs and price controls, and a much lower level of global competition than you have today. Despite this, strong economic growth was possible due to lots of long-hanging productivity fruit and innovation.
Today low unemployment can’t co-exist with high unionization of the kind we have in the U.S. because the world, and especially the U.S., is more competitive and dynamic. I think an implicit argument made by some, although not necessarily Matt, is that we should be willing to give up the dynamic and competitive economy in exchange for more unionization. But aside from being good for all the reasons detailed in Nostalgianomics (free trade, less discrimination, and more immigration are good things), a competitive and dynamic economy is extremely important. As Tyler Cowen argues in The Great Stagnation, we’re out of low-hanging fruit like we used to have, and so we can’t afford to give up the economic growth we do have by attempting to decrease labor market and goods market competition enough that unions can thrive again.
Matt Steinglass at the Economist has replied to my recent piece on how liberals often ignore labor markets by outlining how we can have more unionization without less employment. His argument goes like this: unions capture profits and increase the labor share of national income. This increases aggregate demand, which fuels growth and leads to higher employment. I’m going to address this argument in two posts, since the reply will be lengthy.
The first question I want to address is “if unions increase wages by capturing profits, would it increase economic growth?” I think this argument suffers from what I’d like to call the fallacy of permanent Keynesianism. It’s true that there is slack in the economy right now, and that increasing consumption and therefore aggregate demand will increase economic growth. But the level of unionization in the economy is a long-term structural and institutional issue, not a short-term countercyclical one. Attempting to increase consumption like this will come at the expense of savings, which in the long-run means lower investment, a lower capital stock, and therefore lower economic growth. In short, more consupmtion does not necessarily mean more economic growth. Consider, as a simple example, the Golden Rule of savings in a Solow growth model.
In fact, in a symposium commemorating the 25th anniversary review of his celebrated book “What do unions do?”, labor economist and union defender Richard Freeman makes the complete opposite argument as Steinglass. He argues that the negative direct impact of of unions on economic growth (which, as discussed below, he acknowledges) may be offset by an increase in workers’ savings that result from labor contracts with larger pensions.
But even if it were true that more consumption always meant more economic growth, I do not agree with Matt’s contention that unionization would increase the labor share of national income. The following graph shows the ratio of labor compensation to corporate profit from the BEA’s NIPA tables. While Matt is right that this ratio is at a historical low, notice that the pattern bears no relationship to the level of unionization in the economy, shown in the graph below it.
Labor’s share of national income actually fares much better when you use the definition used by Robert Gordon and Ian Dew-Becker in their paper on inequality.
Here the denominator is GNP minus consumption of fixed capital, minus indirect business taxes. While the number has fallen recently, it is well above historical lows, and well above what it was during the heydey of unionism. Again, the important thing is there is nothing to indicate that the decline in unionization has affected labor’s share. Gordon and Dew-Becker conclude in their paper:
“Thus,to a first approximation, we conclude that the increase in American inequality after the mid-1960s has little to do with labor’s share in domestic income. What has happened is a sharp increase in skewness within labor compensation.”
However, even if unionization doesn’t allow labor to capture profits in the aggregate, the empirical evidence (some of which is summarized usefully here by Barry Hirsch, more can be found in the symposium discussed above) does suggest that it happens within unionized firms. But is this a good thing as Matt believes? The problem is that measured profits, when they are rents that unions can potentially capture at all, can be either pure rents or they can be quasi-rents. In the long-run, competition eats away at pure rents, and quasi-rents that represent normal returns to long-lived physical and non-tangible capital are necessary and important. Allowing unions to ex-post grab quasi-rents to long-lived capital incentivizes firms away from making those investments in the first place. In fact the empirical evidence on this topic shows that unionized firms have less profit, less investment, and less R&D spending.
While Matt seems to disagree, the notion that unionized firms suffer from lower employment is actually not a very controvertial claim among labor economists. For instance, in his aforementioned book, Richard Freeman agrees that union firms not only have lower rates of R&D, investment, as discussed above, but that they have lower employment growth. He argues that this may not negatively impact economic growth if the decreases in union firms are offset by increased investment, R&D, and employment growth by non-union firms. But this is exactly the problem with arguing for a more unionized economy: the only way it isn’t damaging is if there are nonunion firms to take up the slack and grow. In the long-run, this suggests a steady decline of unionization is inevitable.
There is another major disconnect between the way liberal writers like Matt and liberal labor economists like Freeman write about unions. Typically, the former praise the so-called “monopoloy face” of unions, whereas the latter usually recognize that unions ability to raise wages above market level is a downside of unions. Labor economists who support unions tend to do so for what economists call the “voice face” of unionism. Indeed, I think this positive aspect of unions, whereby they communicate with owners and managers the desires of the workers, is underestimated by many conservative writers. The “voice face” of unions can lead unionization to have a positive impact on firm productivity. Granted, there are a lot of issues here, like the possibility of alternative ways of providing workers voice that don’t risk a “monopoly face”, and the fact that the empirical impact of unions on productivity is ambiguous whereas the wage impact is not. But suffice it to say that the aspect of unions liberal writers praise is often recognized by prominant liberal labor economists as a problem.
Next I’ll discuss why unionization has fallen in the first place, why high unions could co-exist with low unemployment in the 50s and 60s, and why both of these things tell us that high unionization is undesirable today.
Felix Salmon has a post about occupational licensing where he says a lot that I want to disagree with. First, he claims that licensing probably decreases inequality:
…broadly speaking, the more constraints you have on a profession, the less likely you are to see massive inequality within that profession. If you got rid of licensing for profession X, you’d see many more low-paid Xs than you do right now, and you’d also see a significant uptick in earnings at the very top of the X profession. It’s a second-order effect, to be sure, but I’m pretty sure that at the margin, licensing helps to reduce inequality.
Yes, licensing may reduce inequality within a particular occupation, but it’s just as likely that it increases inequality overall. Licensing creates an up front cost to enter a profession. This means that those who will be pushed out of the profession by these laws are those who are least able to say, take 6 months to go without working while undergoing training and pay for requisite classes, which are of course are going to be individuals with less economic resources overall. So you’re taxing those who are credit constrained, those who need to work full-time to support their family, single-parent families, etc. in order to benefit those who can overcome such constraints and thus have more economic resources at their disposal. Do you think this will increase or decrease inequality?
In addition, everyone pushed out of a skilled job with a license is pushed into a lower wage job, increasing the supply of workers and driving down wages. The woman who can’t get a job as a masseuse because she’s a single mother -with a knack for massage- instead has to work as a hotel maid, which drives down wages of hotel maids. These laws systematically push people out of more skilled jobs into lower skilled ones, decreasing the labor supply in the former and increasing it in the latter.
To use a more broad and likely more common example, the higher than necessary levels of education required by licensing boards to become health professionals make it more expensive to enter these professions and pushes out those most responsive to these prices, which are again going to be the worst off economically.
Felix also argues the following:
But at the same time I think they are, in a sense, a form of worker protection which is acceptable to Republicans — think of them as unions for people who hate unions. And that’s not entirely a bad thing.
But licensing is just as likely to be a cudgel that one group of workers uses against another, and in particular they are likely to be used to help a higher paid, more educated group at the expense of a against a lower paid, less educated group. Take dentists and dental hygienists. Felix has complained this issue lacks data, so let me bring some by quoting myself:
…many states have regulations preventing dental hygienists from practicing without the supervision of a dentist. Dentists have an average of six years more schooling than a hygienists, who on average have 2.6 years of post high-school education. In addition, dentists make on average $100 an hour, and are 80% male, whereas hygiensts are 97% female and make around $37 an hour. Kleiner and Park find that these regulations transfer $1.5 billion dollars a year from hygiensts to dentists. This is a highly regressive transfer to a male dominated, higher educated, higher paid job from a female dominated, lower educated, lower paid job. In a very similar vein with likely similar impacts, many states restrict the ability of nurses to practice without the supervision of doctors. In fact these regulations are currently growing as regulators rush to restrict the number nurses working in retail health clinics in a variety of ways to prevent them from competing with doctors.
Hardly sounds like a law that you’d want to characterize as providing “worker protection”.
Felix also wonders whether the increasing percent of jobs licensed over time is just a result of the shift of the economy from manufacturing into services, likewise Kevin Drum wonders if we can chalk it up to more workers in health care. No doubt this explains a greater opportunity for occupations to be licensed, but it does not explain the amount that have been licensed. This can be seen clearly in state by state variations in licensing. According to Morris Kleiner 30% of California’s workforce is licensed, while Indiana’s is at around 11%. Is this about more workers in healthcare and education in California? No, according to BLS data health and education services account for 12.8% of the non-farm workforce in California and 15.1% in Indiana. Overall services jobs account for 87% of employment in California, and 80% in Indiana; not nearly enough to account for having almost triple the percent of jobs licensed. It’s about regulatory capture, not sectoral shift.
State by state variation also provides a useful rebuttal to occupational licensing defenses that appeal to our desire to have quality services. Do you really think of Indiana as a laissez-faire, low quality free-for-all where you can’t tell whether your dentist is illiterate and your heart surgeon is a legally blind imbecile who works a night shift at White Castle? No, you don’t, and it’s likely that if California adopted the much lower licensing regulations of Indiana they wouldn’t become one either.
Now that’s not to say licensing doesn’t increase quality sometimes. If you mandated that every masseuse had a Ph.D in massage therapy and 10,000 hours of training, then yes, the quality of legal massages consumed would skyrocket. But you’d also push a lot of massages into the black market, where the lack of transparency and legality makes it difficult for non-license quality monitoring institutions to evolve. This means that for those pushed out of the market quality will go down.
Black market massages probably aren’t a big deal, but what does this mean for something like electricians? People priced out of the market by licensing may either choose to forgo repairs or do them by themselves. This turns the public safety rationale on it’s head: the more important the public safety rationale the more we should be concerned about people either foregoing the service or being pushed out of the market. This is particularly important with respect to laws that restrict who can offer primary care services. As an institution licensing just does not work very well. It pushes up prices too high, which pushes too many people out of the market, and if it evolves at all it evolves towards more and more protectionism because of the inherent public choice problem. Just because we want something done well doesn’t mean we want it licensed.
Now there are times when licensing is probably the best way to handle things. This is when you have a clear public safety interest, a minimal set of standards that are easy to agree upon, low price elasticity of demand, unlikely chance of a black market, and the economic forces interested in limiting licensing are as strong as those pushing for more of it. Airplane pilots come to mind here. But huge state by state variation in licensing without concomitant state by state variation in quality shows that we have a lot of licenses we can get rid of without any hugely negative consequences. In the meantime, the most disadvantaged workers and consumers are being hurt.
Jonathan Chait has been having a back and forth with Will Wilkinson over the extent and insurmountability of regulatory capture. In his last reply, Chait summed up his position like this:
If [Will] has access to some study showing that regulation usually, as a rule rather than the exception, become s a weapon of the powers it was intended to regulate and winds up serving the opposite of its intended purpose, then I’m willing to listen. But if his only argument is “look at all of Tim Carney’s articles,” then no, I’m not persuaded, and and not many people outside the economic libertarian world are going to be, either.
Given the varieties and scope of regulation this would be a difficult question to answer with a particular study, or even with a handful of studies. Another problem is defining the challenge as showing that regulations end up “serving the opposite of its intended purpose”. Shouldn’t it be enough to show that regulations don’t serve their intended purpose at all but instead simply raise prices?
To focus on one class of regulations in particular, consider occupational licensing. In his book“Licensing Occupations: Ensuring Quality or Restricting Competition?”, Morris Kleiner surveys the literature on occupational licensing and finds a lot of evidence that it does nothing to improve quality. From teachers to interior designers to medical professionals. Now here, at the mention of medical professionals, is where alarm bells start going off in everybody’s heads except libertarians. I’m not arguing that any regulation of medical professionals represents inefficient capture in-and-of-itself, but that on the margin the restrictions put into place on medical professionals represent attempts to control competition rather than quality.
For instance, there are studies showing that the wide state-by-state variations in these regulations do not affect outcomes. In medicine there are studies showing that malpractice insurance premiums aren’t lower in states with occupational licensing, which you would expect if licensing was increasing service quality. There is evidence that nurses provide providing primary care services as effectively as doctors. There are the studies showing that licensing and certification for teachers do not improve outcomes. This is unsurprising given that in most cases how one qualifies for a license is strongly influenced by or even directly set by some group representing the interests of the industry.
In some cases it can even worsen outcomes by driving people priced out of the market into the black market, where quality is very low due to informational problems caused by regulation pushing these markets into the shadows. It’s difficult to develop a good or bad reputation when having any reputation whatsoever risks attracting law enforcement.
So I don’t know if this quite represents an answer to Chait’s challenge. But the balance of the evidence shows that on the margin occupational licensing does not improve quality. How important is that margin? Well there is a huge variety in the level of occupational licensing in states. Indiana has around 11% of it’s workforce licensed, while California has 30%. If all states moved towards regulatings more like Indiana, based on the evidence it seems unlikely that quality would be impacted despite cutting the number of licensed occupations down to nearly a third of the current level for some states.
There’s obviously a lot of regulation other than occupational licensing, so this doesn’t rebut Chait’s wider point. But it is a very important and widespread class of regulation. At the very least I would hope Chait would agree that regulatory capture is decidedly more than an exception to the rule when it comes to occupational licensing.
Finally, I’d also like to answer the challenge that libertarians aren’t interested in making these laws work better, and are only in abolishing them. Yes, because regulatory capture here has proven fairly intractiable, so just getting rid of many occupational licenses will be a huge improvement. But I am also interested in improving occupational regulations.
One thing that states can do is write these laws with sunset provisions that force legislators to reexamine them at some point. This was a suggestion by the Cato Institute in a paper I can’t find. Another thing that states can do is have mandatory registration for certain occupations, which is what Pennsylvania does for contractors. This help solves informational problems by ensuring that contractors can’t lie about who they are and then rip you off, and allows sites like Angie’s List to work better by ensuring that someone can’t dodge bad reviews by using fake names. States should also look at other states and see what works for them, given the wide variety of licensing there is a lot of improvement states can make by following their neighbors. The last suggestion is to give Matt Yglesias millions of dollars to start a think tank dedicated to identifying and calling attention to bad occupational licenses, and identifying good examples of occupational regulation.
Via Mark Thoma comes an interview with economist Arindrajit Dube about his research on the minimum wage:
In an interview with The Real News, Arindrajit Dube, labor economist and Assistant Professor of Economics at University of Massachusetts, said that increasing the minimum wage in some areas has not reduced jobs as expected by the conventional theory.
Dube said the conventional wisdom surrounding minimum wage comes from research done before the early ‘90s. … Dube told TRNN that around the early to mid ‘90s some economists realized these studies were badly flawed, and began looking at local evidence instead of just national evidence. The famous work of labor economists David Card and Alan Kruger looked at the border of New Jersey and Pennsylvania when New Jersey raised its minimum wage. Within a year, he said, not only had employment in New Jersey not decreased, it had actually risen in some groups.
He said the report received strong criticism from the economic community, but Dube’s studies apply this technique across borders of all the states, over a twenty year period to track the effects in many cases, and for a much longer period.
Dube sort of creates the impression here that the current conventional wisdom is based on outdated research, which is not the case. While the conventional wisdom may have been founded on research from before the 90s, the majority of post Card and Kruger research, what has been called “the new minimum wage research”, supports the notion that minimum wages decreases employment. For instance, a 2006 paper from David Neumark and William Wascher summarizes the new minimum wage research like this:
The studies surveyed in this paper lead to 91 entries in our summary tables (in some cases covering more than one paper). Of these, by our reckoning nearly two-thirds give a relatively consistent (although by no means always statistically significant) indication of negative employment effects of minimum wages—where we sometimes focus on results for the least-skilled—and fewer than 10 give a relatively consistent indication of positive employment effects. In addition, we have highlighted in the tables 20 studies that we view as providing more credible evidence, and 16 (80 percent) of these point to negative employment effects. Correspondingly, we have indicated in our narrative review that, in our view, many of the studies that find zero or positive effects suffer from various shortcomings.
This is consistent with their 2008 book, Minimum Wages, which I don’t have on me at the moment.
In any case, I have not read Dube’s paper but it looks like an interesting extension of Card and Kruger. In the meantime, the majority of the new minimum wage research supports the hypothesis that the minimum wage increases unemployment.