Compensating Wage Differentials

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Compensating Wage Differentials
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Not All Jobs Are Created Equal

• Risk of death or injury on the job.
• Location.
• Flexibility of hours.
• Health benefits.
• Pension plans.
• Repetitiveness of tasks.
• Weeks of vacation.

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Compensating Wage Differentials

• Worker heterogeneity.
• Workers may value different job attributes
  differently.
• Firm heterogeneity.
• Some firms may find it more costly to provide
  on-the-job benefits than others.
• In equilibrium
• Wages will compensate workers for job
  attributes.
• Firms and workers will match with each other so
  that firms that find it easy to provide amenities
  will match with workers who value those
  amenities the most highly.

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Fatality Rate by Industry, 1998
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San Diego, CA vs. Tallahassee, FL
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The Market for Risky Jobs

• Two types of jobs risk of injury0 or risk of
  injury1
• Workers have complete information about risks.
• Utilityf(w, risk)

Worker prefers risky job
w1
w1
Wage that makes worker indifferent
w1
Worker prefers safe job
w0
?ww1-w0
Probability of Injury
0
1
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The Market for Risky Jobs

• Can think of ?w as a reservation price.
• Amount you have to bribe someone to take the
  risky job.
• Workers differ in terms of ?w.
• As ?w grows, the supply of workers to the risky
  job will increase.
• Firms differ in how costly it is for them to
  reduce risk.
• Firms balance the cost of reducing the risk
  against ?w.
• As ?w grows, more firms will find it worthwhile
  to incur the cost of reducing the risk on the
  job.
• Thus, as ?w grows, the demand for workers in the
  risky job will go down.

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The Market for Risky Jobs
w1-w0
S
Equilibrium wage differential greater than
workers reservation wage
(w1-w0)
D
Number of Workers in Risky Jobs
E
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Underlying Assumptions

• Compensating wage differentials reflect the value
  of non-wage job attributes if
• Workers maximize utility, not income
• Workers have perfect information about all job
  characteristics.
• Sufficient labor mobility exists.
• You can also think about favorable non-wage job
  attributes.

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Hedonic Wage Theory

• Suppose there are many types of jobs, a risky job
  and a safe job.
• Firms and workers observe those characteristics
  and know their value.
• We only observe the wage (and not the price of
  other job characteristics).
• But we would like to know the value of the
  characteristics.
• I.e. We want to know much do we have to pay for
  health benefits, coffee and donuts in the
  morning, etc. in the form of lower wages.

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Individuals
Indifference Curves

• Positive relationship between risk and wages.
• Implicit in graph marginal disutility of risk
  is increasing.

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Individual Heterogeneity
w
More risk averse
Less risk averse
Risk
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Firms

• Firms differ along two dimension
• Wages
• Level of risk
• Firms attract workers by
• Reducing risk.
• Raising wages.
• Both actions result lower profits.

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Isoprofits

• Isoprofits the combinations of wages and risk
  levels that result in a fixed level of profits.

• Positive relationship between wages and risk.
• Implicit in graph marginal cost of reducing risk
  is increasing.
• p0 in long run.

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Firm Heterogeneity
w
p0 High cost of reducing risk
p0 Low cost of reducing risk
Risk
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The More Risk Averse Worker
Wage
More risk averse
p 0 High cost of reducing risk
p 0 Low cost of reducing risk
Risk
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The More Less Averse Worker
Wage
Less risk averse
p 0 High cost of reducing risk
p 0 Low cost of reducing risk
Risk
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Equilibrium
Less risk averse
Wage
More risk averse
p 0 High cost of reducing risk
w2
p 0 Low cost of reducing risk
w1
R1
R2
Risk
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MatchingMany Types
Wage

Tells you the relationship between wages and risk
in equilibrium. Slope is positive

Risk
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Empirical Evidence on Compensating Wage
Differentials

• In general, there is weak empirical evidence that
  compensating wage differentials exist.
• This doesnt necessarily mean that they are not
  there, it may just means that our statistical
  techniques have failed to uncover them.
• However, one very prominent study found that
  mandated maternity benefits for women resulted in
  lower wages for women.
• Still an active area of research.

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Mandated Safety and Health Regulations

• Occupational Safety and Health Act of 1970 (OSHA)
• Charged the U.S. Department of Labor with
  protecting health and safety of American labor
  force.
• OSHA sets safety and health standards in the
  workplace.
• Restrictions on dust and asbestos in air.
• Fall protection at construction sites.
• Noise control regulations.
• ENORMOUSLY wide range of regulations.

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Are These Safety Regulations a Good Idea?

• Despite the ideal that employees should face the
  minimum possible risk on the job, health and
  safety regulations are not necessarily in the
  best interest of workers.
• Why regulations may be bad . . .
• Why regulations may be good . . .

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Why Regulations May Be Bad
wage
IC1
IC2
Simple case with only 1 kind of firm. Regulation
caps the risk level at Rmax. New wage of Wmax.
Worker utility decreases. Intuition
p0
wmax
Risk
Rmax
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Why Regulations May Be Good
wage
ICPERCEIVED
Economic efficiency assumes that people have
perfect information. People may not understand
the full implications of health risks. OSHA
standards can increase utility.
ICTRUE
p0
w
Risk
RPERCEIVED
RTRUE
RMAX
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Bigger Lesson About Regulation

• If the following three conditions hold
• Markets are perfectly competitive
• Information is perfect
• There are no externalities
• then economic theory predicts that government
  regulation is inefficient.
• BUT there are many cases in which 1.-3. do not
  hold.