Labor, Employment

1
Labor, Employment And Wages
Samuel Bowles Santa Fe Institute University of
Siena
Diego Rivera, The Ford Plant River Rouge
2
Employment what is the principal agent problem?

• e 0 0,1 effort per hour of work (e.g. of
  time on)
• Per period output is
• y y(he) µ , with y'gt0 and y" lt0
• where h is the number of worker "hours" hired
• µ is a mean zero disturbance term.
• the employer selects
• i) termination probability t(e,m)00,1
  (telt0 and tmgt0
• ii) a wage rate, w, and
• iii) monitoring expenditure per hour of
  labor hired, m
• the worker selects e to max his present value
  of utility
• the worker is paid, and is renewed or
  terminated, the latter occurring with probability
  t(e,m).

3
The Workers Best Response

• Per period utility (experienced at the end of the
  period) u u(w,e)
• Fallback asset Z what is it?
• Present value of the job (game is stationary)
  
• V u(w,e)(1-t(e,m))Vt(e,m)Z'(1i)
• V u(w,e)-iZ'(it(e,m) Z
• The worker selects e so as to set Ve 0
• which requires ue te(V-Z)
• Interpretation of the foc?
• Given that P knows As brf, he also knows the
  resulting e. Why then is there a P-A problem?

4
The Workers Fallback Position

• At the end of each period there is a probability
  ? that the unemployed worker will find work,
  exiting the unemployment pool, so the expected
  duration of unemployment is 1/?.
• Thus
• Z u(b,0)?V(1-?)Z'(1i) u(b,0)?V'(i ?)

5
Employees best response function ue te(V-Z)

• slope of iso-v?
• e , w?

6
Profit Maximizing

• p y(he(w,mZ)) - (wm)h
• ph y'e - (wm) 0
• pw y'hew - h 0
• pm y'hem - h 0
• which requires that
• ew e/(wm) em
• y' (wm)/e
• Meaning of the second foc?

7
The Solow condition ew e/(wm) em

• What does it mean?
• Show that a Walrasian equilibrium is a special
  case of this model.
• What does it require of the nature of work and
  the scarcity of goods?

8
Comparative Statics

• Let (wm)/e / µ the cost of a unit effort
• dµ/dZ gt 0 and
• dp/dZ lt 0
• What is the economic meaning of these results?

9
General Equilibrium

• The zero profit condition p - d 0
• ? varies with the level of aggregate employment
  (nhH), so
• ? ?(H, ...) with ?gt 0
• Z Z(H, ..) with Z gt 0
• Recall that (wm)/e / µ the cost of a unit
  effort and dµ/dZ gt 0 and dp/dZ lt 0
• Because these relationships are all monotonic,
  there is a unique µ0 and hence a unique Z0 and H0
  that satisfies the zpc.
• Thus the level of unemployment, employment,
  number of firms are determined. Why is Hlt1?
• No reference to aggregate demand?

10
e, wis Pareto-inefficient. Why? How to show
this?

• Ve 0 but pe gt 0 and
• Vw gt 0 but pw 0
• thus there exists some (arbitrarily small) values
  (?e,?w) such that
• V(e?e,w?w)gtV(e,w) and
• p(e?e,w?w,...)gtp(e,w)
• Where is the efficient contract locus in the
  figure?

11
Why is w, m technically inefficient?
In what sense is m unproductive labor?
12
Pareto sub-optimal workplace amenities

• Suppose the employee's utility function is
  expanded to include a measure of work amenities
  provided (per hour of work), t
• u(w,t,e)
• with ut gt 0 over the relevant range, and that
  amenities cost pt for the employer to provide.
• a new present value V(e,w,t)
• a new best response function e(w,m,tz)
• an additional first order condition for the
  employer
• pt y'et - pt 0
• Q Why will t be P-suboptimal?
• A for the same reason that the wage suboptimal
  more amenities and more effort are a pareto
  improvement

13
Can trade union bargaining implement a
P-improvement over w,e?
The Employers and Unions Bargaining Problem
Per Period Payoffs (right figure) Note the
bargaining set is the area bounded by the payoffs
in the non cooperative interaction and the
efficient contract locus. If the strategies
available were unconditional w and w for the
employer and e and e for the employee, the game
is a prisoners dilemma. Point a is the
equilibrium of the uncooperative game (indicated
by point a in the left figure) while point b is a
point on the efficient contract locus (indicated
by point b in figure 1).
14
Given that job rents are huge, firms could sell
jobs. What problem would the firm solve to
calculate the optimal fee?

• Let B a one time job fee.
• The employer varies h, w, and B to maximize
  p y(he(w)) -hw iBh
• subject to V(e(w), w-iB) Z
• where i is the rate of return and V(.) is the
  ex ante present value of the job with fee B.
• w-iB is the net wage taking account of the
  opportunity cost to the employee of foregoing
  returns iB on the employees wealth.

15

• Results
• P-efficient?
• Labor market clearing?
• P has power over A?

Optimal job fees. The employer identifies point a
as the solution of max e/(mw-iB), the effort
elicited from the employee per unit cost. The
employer then offers w (the employee responds
with e) with a fee of B.
16
Why do firms not sell jobs (charge an optimal
fee)? Some possible answers

• Firms search costs are reduced by job rationing
• Morale, reciprocity reasons
• Perhaps they do (by very low initial wages, etc)

17
Macroeconomic applications

• w(h) the labor market equilibrium (workers and
  firms foc with respect to labor discipline) h is
  total employment
• h(w) the locus of w,h s.t. excess demand for
  goods i b s 0
• Upward shift in w(h) increases h saving
  depends strongly on profit share

Bowles, Samuel and Robert Boyer. 1988. "Labor
Discipline and Aggregate Demand A Macroeconomic
Model." American Economic Review, 782, pp.
395-400.
18
Two ways of closing the model zpc or aggregate
demand

• h (w) could be the h for a given w that
  satisfies zpc (necessarily downwards sloping) or
• the level of employment that clears the product
  market.

19
Evidence

• Labor effort appears to be quite variable and is
  rarely subject to contract (Laffont, Lazear,
  Rosenzweig et al)
• Employers devote substantial personnel (Gordon)
  and other resources (Baker) to monitoring their
  employees effort.
• Substantial employment rents in most jobs (
  primary /secondary labor market distinction)
  (Weisskopf and Green)
• Real wages tend to vary with the level of
  employment (Blanchflower and Oswald, Bowles,
  BER)
• Econometric evidence on effort (Schor), labor
  productivity (BGW), and profits (BGW) (high
  employment profit squeeze)
• Experimental evidence (Fehr et al)
• Footnote how BGW came to do this work.

20
Presentations of discussion questions (with .ppt
or handouts)

• Apartheid as labor discipline (22.3)
• The distribution of gains from freer North South
  trade (22.2)
• An employment subsidy with endogenous effort (23)
• An incentive compatible BIG (unconditional basic
  income grant) (24)
• Husbands and wives/Principals and agents (29)

A more extensive review of the evidence, if youd
like Next credit and wealth, read chapter 9.
21
Additional readings

• Bowles, Samuel, Herbert Gintis, and Melissa
  Osborne. 2001. "Incentive-Enhancing Preferences."
  American Economic Review, 912, pp. 155-58
• Heckman, James and Yona Rubinstein. 2001. "The
  importance of non-cognitive skills lessons from
  the GED testing progam." American Economic
  Review, 912, pp. 145-49
• Bowles, Samuel, Herbert Gintis, and Melissa
  Osborne. 2001. "The Determinants of Earnings A
  Behavioral Approach." Journal of Economic
  Literature, XXXIX(December), pp. 1137-76.

22

• After NAFTA. A country (South) with a large
  traditional grain growing sector protected by
  tariffs and subsidies shares a border with a
  country (North) with ideal grain growing
  conditions and a highly productive agricultural
  sector. The reservation position for wage workers
  in the South is to return to working on their
  family's farm in the traditional agricultural
  sector. An international trade economist proposes
  a free trade area for the two countries, removing
  tariffs and subsidies, showing that substantial
  gains from trade will result for both countries,
  and claiming that employees in the South will
  enjoy higher (real) wages as a result. A worker
  asks you if the claim is correct. The trade
  economist is certainly right about the gains from
  trade but what about the wage increases? Show
  that i) using the no shirking condition as the
  model of wage determination, the trade economist
  is wrong and ii) assuming that wages and effort
  are determined by a Nash bargain between
  employees and employers he could be right, but
  need not be.

23

• The apartheid system in South Africa gave
  non-white workers restricted access to the labor
  market of the modern sector of the economy.
  According to the infamous pass laws, those
  working in the urban areas required a pass, which
  was revoked if their job was terminated, and they
  were required to return to close to subsistence
  living in one of the so- called bantustans. South
  African scholars have debated whether this system
  lowered profits (by restricting the supply of
  labor) or raised profits (by providing businesses
  with a favorable labor discipline environment).
  Use the labor discipline model (the no shirking
  condition, or the more general model in the text)
  to develop the latter argument. What additional
  information would you need to determine which
  position is more nearly correct?

24

• A wage subsidy. Employment subsidies are a
  widely discussed means of increasing employment
  in labor surplus economies, or among less skilled
  workers in the advanced countries. Suppose that n
  identical firms each hire h hours of identical
  labor, varying both h and w, the hourly wage, to
  maximize profits, which depend on total labor
  effor which is the product of hours hired and
  effort per hour, e. Consider two types of subsidy
  paid to owners of each firm i) an employment
  subsidy the subsidy s is a fixed amount, paid
  per hour of labor hired, or ii) a wage subsidy,
  F, the subsidy is a fixed fraction of the wages
  paid. You may assume that the taxes supporting
  this subsidy have no effects on this problem.
  Using the zero subsidy case as a benchmark,
  indicate the effects of the two types of subsidy
  on the equilibrium wage, effort, and employment
  levels, assuming a) that z, the fallback position
  of each worker, is exogenous, and b) that z
  varies with the level of total employment, nh

25

• The BIG idea. (8) Assume all employed work for
  an hour. A linear tax (meaning with a flat rate,
  J) is levied on every employed worker, the
  proceeds being distributed unconditionally to all
  members of the population (for simplicity, assume
  that half of those in the population are
  employed, a quarter are unemployed and a quarter
  are not in the labor force). Because profits are
  not taxed and because all workers (including
  those not working) are identical, we assume this
  proposal has no effect on the demand for labor so
  the expected duration of a spell of unemployment
  is unaffected. You may also abstract from any
  changes in labor supply. Assume that the
  implementation of the BIG is accompanied by the
  elimination of unemployment insurance (define
  this as b), the replacement income a worker
  receives if unemployed) and that the net effect
  of the tax, the BIG, and the elimination of
  unemployment insurance on the government budget
  is zero. If the employment relationship is
  governed by the contingent renewal model in the
  text, with ww, ee with b w/2 what is the
  maximum tax that can be levied without reducing
  the equilibrium level of effort and what is the
  resulting per person grant? Check to see that a
  family composed of two employed workers, one
  unemployed person and one out of the labor force,
  experiences no change in income or total effort
  provided, while those with relatively more
  non-employed members gain.

26

• Domestic labor. (10) Consider the determination
  of domestic work and the sharing of income by a
  husband and wife (the amount of domestic work
  done is not costlessly observable by the other
  adult, as much of it is bestowed on the children,
  and the results of this are only evident in the
  very long run). Consider only the two adults, one
  of whom works for pay and other works in their
  home. Extend the model in chapter 8 to determine
  the share of the paid worker's income received by
  the home worker (w) and the amount of domestic
  work done (e). Contrast this domestic labor
  discipline model with a transactions cost
  approach to this problem. What are the relevant
  transaction specific investments? What are the
  similarities and key differences?