Category Archives: Labour Market

Those left behind and the attacks on US Congress

Been reading an excellent book by Martin Sandbu (FT) entitled ‘The Economics of Belonging’. In it he addresses the problem that when an economy moves to more efficient ways of production new methods are established and old ones decline. For some who have been part of the old methods of doing things, the economic system has passed them by. He explains four ways how this has happened.

The plight of the uneducated. Economic value is now derived from cognitive skills and knowledge. The competitive nature of the global economy demands increased productivity which has streamlined production using technology and is cognitively demanding for the labour force. This results in the diminishing use of blue collar (manual) workers which tend to use little knowledge or initiative. As a result manual labour is not demanded like before and if there is any demand the wage is does not equate to what they received 10-20 years ago. As Sandbu states: If the world today offers much less than it once did to routine workers with only basic schooling or training, it is because they are less useful to the modern economy.

The triumph of cities. In most western economies poorer areas grew faster than richer ones therefore they were catching-up with the big cities. However at the start of the Thatcher and Reagan era the richer urban areas have pulled away from their rural counterparts. Deindustrialisation, especially in the UK, with the move from manufacturing to the service sector favouring urban areas where there is a concentration of people today’s most valuable skills and talent. If urban and rural areas go about different economic direction for long enough, inequality will increase as well as cultural separation which is turn leads to political separation. Sandbu points out that the strongest support of antiestablishment movements is found in the regions that have lost out in the competition to attract capital and skill.

The cost of staying put. If you stay in an area that is ‘the wrong side of the train tracks’ moving away from home will increase your chances of success. In the last 40 years those that have moved have reaped the benefits of higher incomes. One thinks about the UK and the North South divide with the migration flows south in search of opportunity. Regional inequality favours those who actually move, but also those capable of moving. Mobility reflects risk taking and a tolerance for what is new, different and uncomfortable whilst staying put comes with greater economic disadvantage than it did 40 years ago. From the 2016 US election: White Americans who still lived in the community where they were raised supported Donald Trump by 57% against only 31% for Hillary Clinton. Even those who lived two hours’ drive away preferred Trump. Among those who had moved further away, however, more supported Clinton.

Feminism is good for your wallet. The old blue collar work whether it be on production lines, oil rigs, truck driving, farming etc. were traditionally done by men. There was a macho image portrayed in these jobs but the new jobs were focused on the skills that create value in the new service and knowledge economy. It is estimated in the US that one in four jobs in the next decade are expected come in health care, social assistance, and education which tend to come with low status and lower pay. This means that more men (particularly unskilled) must be prepared to work in the service sector in jobs that are traditionally done by women. Soft skills are now increasingly rewarded and traditional manual work (mainly done by men) no longer attract much pay in the job market. Job roles must adapt in parallel with changing cultural expectations of gender roles in the home. Trump’s make America great again was a call to bring back the blue collar jobs but this was never going to happen with globalisation.

Sandbu points out that the one group which has been particularly effected by these four changes is low-skilled white men in small rural communities and subscribe to traditional cultural attitudes. Often blamed on globalisation, these consequences are the result of how we now produce output which has been driven by labour saving technology. Sandbu states that:

But we should recognise that much else of value was lost with jobs, and the dissatisfaction from these structural changes goes far beyond the financial.

It is only to be expected that these groups have become more visible within the populist insurgency and fresh in our memory is the attack on the US Congress on 6th January.

Source: The Economics of Belonging – Martin Sandbu 2020

Global Economic Data as of February 2021

I always encourage students to be aware of what is happening in the global economy as well as their own. Below are growth, unemployment and interest rates for the main economies. Note the high rates of quarterly economic growth which indicates a bounce back from the previous quarter when most of the world was in a serious lockdown. The unemployment rates you would expect to be a lot higher with COVID-19 and a 4.9% rate in NZ was a surprise. An area of employment growth in the December quarter was Construction, along with many government-dominated industry types. Monetary policy been very accommodative and although rates have been very low note that in Japan and the Euro zone areas it has been like this since 2016. These figures could be used for discussion purposes in you class.

Quarterly Economic Growth Rates

Unemployment %
Global Interest Rates

Source: Monthly Economic Review – February 2021 – NZ Parliamentary Service

US minimum wage increase – does it mean more job losses?

President Biden is pushing the US congress to gradually increase the federal minimum wage from $7.25 to $15 by 2025. The Economist video below talks about what economists have traditionally said – ‘increasing the minimum wage will mean that there will be job losses’. In most economics textbooks the labour market is shown with a simple graph of the supply of labour and the demand for labour and where they intersect the wage that employees receive for their service and the amount employed.

The minimum wage distorts the market equilibrium as there is now a wage floor – a level which the wage cannot fall below. If the minimum wage is below the equilibrium wage then there is no impact as the market will ensure that is reaches equilibrium. However a minimum wage above the equilibrium means that companies will hire fewer workers and therefore result in more unemployment. On the graph below a minimum wage of W1 means that the level of employment has fallen but those prepared to work but are involuntary unemployed has increased. However the people still employed are better off as they are paid more for the same work; their gain is exactly balanced by their employers’ loss. The jobs that someone would have been willing to do at less than the wage of We and for which some company would have been willing to pay more than We. Those jobs are now gone, as well as the goods and services they would have produced.

Real Impact of the Minimum Wage.

In reality the theory of the minimum wage explained above is not as simple as it is made out to be. From records in the USA there is no obvious relationship between the minimum wage and unemployment: adjusted for inflation, the federal minimum wage was highest from 1967 through 1969, when the unemployment rate was below 4%. One study in 1994 by David Card and Alan Krueger evaluated an increase in New Jersey’s minimum wage by comparing fast-food restaurants on both sides of the New Jersey – Pennsylvania border. They concluded, “contrary to the central prediction of the textbook model … we find no evidence that the rise in New Jersey’s minimum wage reduced employment at fast-food restaurants in the state.”

The idea that a higher minimum wage might not increase unemployment goes against the the theory in textbooks as if labour becomes more expensive firms will take on less employees. But there are several reason why this might not be the case:

  • The standard model states that firms will replace labour with machines if wages increase, but what happens if labour saving technologies are not available at a reasonable cost.
  • Some employers may not be able to maintain their business with fewer workers especially in service based industries. Therefore, some companies can’t lay off employees if the minimum wage is increased.
  • Small firms are traditionally labour intensive and can’t afford large capital investment. Therefore the minimum wage doesn’t have the impact of laying off workers.
  • If employers have significant market power that the theory of the supply and demand for labour doesn’t exist, then they can reduce the wage level by hiring fewer workers (only those willing to work for low pay), just as a monopolist can boost prices by cutting production (think of an oil cartel, for example, see graph Monopsony Labour Market). A minimum wage forces them to pay more, which eliminates the incentive to minimize their workforce.
  • Even though a higher minimum wage will raise labour costs many companies can recoup cost increases in the form of higher prices; because most of their customers are not poor, the net effect is to transfer money from higher-income to lower-income families. In addition, companies that pay more often benefit from higher employee productivity, offsetting the growth in labor costs.
  • Higher wages boost productivity as they motivate people to work harder, they attract higher-skilled workers, and they reduce employee turnover, lowering hiring and training costs, among other things. If fewer people quit their jobs, that also reduces the number of people who are out of work at any one time because they’re looking for something better. A higher minimum wage motivates more people to enter the labor force, raising both employment and output.
  • Higher pay increases workers’ buying power. Because poor people spend a relatively large proportion of their income, a higher minimum wage can boost overall economic activity and stimulate economic growth, creating more jobs.
Monopsony Labour Market

All the above add a range of variables that are not considered in the simple supply and demand model for labour. It maybe useful as a starting point in discussing the minimum wage but has its limitations in the more complex real world

Source: Economism by James Kwak

A2 Economics – Economic Rent and Transfer Earnings

Economic Rent and Transfer Earnings To most of us “rent” is defined as a periodical payment made for the use of a particular asset – usually a residential or commercial property. However, the concept is not limited to land or buildings because it can also be applied to the other factors of production. When a factor is earning more than its supply price, it is receiving a part of its income in the form of economic rent. This situation arises when demand increases and supply cannot fully respond to the increases in demand. For example, labour already employed will experience an increase in income so that they must be earning more than their supply prices.

Present Wages – Wages when initially employed = Economic Rent

The minimum payment required to prevent a person transferring to another employer or another occupation is know as transfer earnings. It is determined by what the factor could earn in its next best paid employment. Transfer earnings may be regarded as the opportunity cost of keeping an employee in their present job or it may be regarded as the employee’s supply price in their present occupation. For example, if the minimum weekly wage that would persuade someone to work as a shop attendant is $200 but he or she actually receives a wage of $250, then the transfer earnings amount is $200 and he or she is receiving $50 in the form of economic rent. Therefore, economic rent can be defined as any payment to a factor of production that is in excess of transfer earnings.

The graph below shows the demand and supply for labour. The equilibrium wage is $120 with a quantity of 50 units. Total earnings is equal to $120 x 50 units of labour = $6,000 and employees receive the same wage of $120. However, all workers except the last one taken into employment were prepared to offer their services at wages less than $120. Therefore, provided the supply of labour slopes upwards (i.e. it is less than perfectly inelastic) an increase in demand will give rise to rent payments to those factors that were already employed at the original wage of $120. The area of economic rent and transfer earnings is shown in the graph below. Only the last labour unit employed earns no economic rent because the wage of $120 is the supply price to that particular labour unit.

Inelastic and Elastic labour supply

The amount of economic rent and transfer earnings in the return to labour depends upon the elasticity of supply and the level of demand. The greater the occupational mobility of labour, the smaller the element of economic rent. If labour can do a variety of occupations then quite small changes in the wage rate will cause large movements of labour into an industry when wages rise, and out of that industry when wages fall.

Very specialised labour has an inelastic supply curve. This includes surgeons, top CEOs, scientists and jobs that require high skill levels or involve significant danger and skill, eg, deep sea divers. The relatively high rewards to this labour are due to the fact that they are in very scarce supply relative to the demands for their services. Their transfer earnings will be much less than their salary because the market values outside their own specialised professions are probably very low. A frequently quoted example of earnings that contain a large amount of economic rent are those of top sports people. Today these people can earn significant amounts of money in a short period of time. A footballer such as Christiano Ronaldo earns €326 923 per week because of his ability to attract big crowds, merchandise sales and sponsorship deals when he was at Real Madrid Football Club. His skill levels are unique and in very limited supply when considering other players. This reflects a very high marginal productivity leading to a higher wage.

Some other occupations that are held in high regard by society do not command such high salaries because of their low marginal productivity. This includes nurses, firefighters, teachers, etc. Furthermore, the supply of labour for these jobs tends to be elastic because there are many people to choose from, unlike their footballing counterparts who have unique skills.

Quasi rent

Where the supply of labour is less than perfectly elastic an increase in demand will lead to some workers receiving economic rent. This rent may be of a temporary nature, however, because the higher wage may lead to an increase in supply, which in turn, lowers the wage. Increased wages might entice other workers to undertake the necessary training. The economic rent that is earned during the period before supply can be increased is referred to as quasi rent. True economic rent refers to the remuneration of factors that are fixed in supply.

Read more at: elearn Economics – https://www.elearneconomics.com/

Covid19 and unemployment – BBC Podcast

BBC World Service - The Real Story, Newshour Extra: Welcome

Below is a link to a very good podcast from the BBC ‘The Real Story’. Dan Damon discuss what should be done about rising unemployment in the age of Covid-19? Contributors include Australian economist Steve Keen author of ‘Debunking Economics’. Topics of debate include:

  • Universal Basic Income
  • Modern Monetary Theory
  • How much debt can a government sustain in propping up an economy?
  • Should a government subsidise companies taking-on workers?

Also features a very good interview with Daniel Susskind – author of ‘A World Without Work: Technology, Automation and How We Should Respond’

It is 53 minutes long but can take your mind off the commute to work.

https://www.bbc.co.uk/programmes/w3cszcnf

A2 Worksheets – Perfect and Imperfect Labour Market

When covering Labour Markets with my A2 level classes I put together an exercise which tests them on calculating MCL, MRPL etc and also showing why MCL = MRPL is the number of workers a firm should employ. There is an exercise for both Perfect and Imperfect Labour markets – see ‘Word’ document. The excel document is a model answer showing the data in a table and a graphical format. Hope it is of use.

Imperfect Competition in the Labour Market
ACL MCL of Labour

Does CEO pay equal their marginal revenue product?

One reason for the increasing inequality in society is the stagnant wages for the lower and middle income groups – in the USA the top 0.1% have as much wealth as the bottom 90%. Labour compensation at the very top has increased dramatically since the 1970’s.

1970’s – the top 0.1% took home less than 3% of all income
2010 – the top 0.1% took home more than 10% of all income

In the USA the top CEO’s average compensation has grown since the late 1970’s by over 900% to around $15 million a year. In contrast the lower income groups have gone up by only 10%. However when you look at hedge fund and private equity fund managers the salaries are astounding. In 2014 which was seen as not a great year for the industry 25 fund managers made at least $175 million each, and 3 made more than $1 billion.

Are CEO’s worth every cent?

In theory the demand for labour is determined by their marginal revenue product – that is the value of revenue generating by employing an additional worker. Labour markets are imperfect and a monopsony occurs in the labour market when there is a single or dominant buyer of labour. The buyer therefore is able to determine the price at which is paid for services. The monopsonist will hire workers where:

Marginal Cost of labour (MCL) = Marginal Revenue product of labour (MRPL)

Therefore it will use labour up to level of Eq which is where MCL=MRPL. In order to entice workers to supply this amount of labour, the firm need pay only the wage Wq. (Remember that ACL is the supply of labour). You can see, therefore, that a profit-maximising monopsonist will use less labour, and pay a lower wage, than a firm operating under perfect competition.

So if Goldman Sach’s CEO, Lloyd Blankfein, made $24 million in 2014, that’s because he is worth $24 million to his company. In short, you make what you deserve based on your skills, effort, and productivity, in this fairest of all possible worlds.

However this theory has little to do with how the world actually works. The idea that good CEO’s are entitled to enormous rewards is based on the belief that success or failure of the company depends on one person. According to historian Nancy Koehn, business is a team sport: not only is it impossible to quantify a single leader’s marginal revenue product; it is hard even to describe it clearly. Ultimately a CEO can appoint friends and place them on the compensation committee which recommends the CEO salary. The committee invariably proposes to pay at least as much as the median comparable company, because no board wants to admit that its company has a below-average leader. CEO’s do have key performance indicators (KPI’s) but the CEO can encourage the committee to select metrics that will be easy to satisfy. John Kenneth Galbraith describes CEO pay very succinctly – “The salary of the chief executive of a large corporation is not a market reward for achievement. It is frequently in the nature of a warm personal gesture by the individual to himself.”

Luck plays an important role in CEO’s pay. Heads of oil companies were paid more when profits increased, even when the profits were not due to their decision making but simply by a rise in the price of oil. On the contrary it is argued that some boards actually do a good job in firing under-performing leaders and that in the end, high compensation is simply the result of the market for talent – supply and demand. The financial sector tend to use the marginal revenue product of labour theory in their awarding of compensation for CEO’s. Bonuses of traders and investment bankers’ are based on the profitability of their own deals but because bonuses can never be negative, individual employees can generate enormous payouts on bets that turn out well while sticking shareholders with the losses on bets that go bad. Furthermore even if bankers do make money by buying low and selling high in the securities markets there is no value generation as there is no tangible output that anyone can consume.

In aristocratic societies such as 18th century France or 19th century Russia, wealthy noblemen who owed their riches to the accident of birth had to worry about the prospect of violent rebellion by the have-nots. By contrast in the US today the wealthy are protected by the widespread belief that their extraordinary incomes – and the inequality that they generate – are simply the product of inescapable economic necessity.

Source: Economism by James Kwak

New Zealand’s unemployment and wages

In the September quarter New Zealand’s unemployment rate was 4.2% which was up 0.3% from the June quarter. Since the global financial crisis unemployment figures have been trending downwards since it peak of 6.7% in the September 2012. Despite the quarterly rise in unemployment, the underutilisation rate, which is a broader measure of spare capacity in the labour market, has fallen to the lowest level in over eleven years. The fall in underutilisation this quarter was driven by a drop in the number of underemployed people, those who work part time but are looking to work more hours.

Source: Economic Overview – Westpac November 2019

During 2019 the labour market appears to have tightened but it does appear to lag behind the growth cycle meaning that with the slowdown in growth in 2019 higher levels of unemployment will be apparent early this year. It is interesting to note that as labour becomes more scarce with lower levels of unemployment wage growth usually follows – see graph.

Annual wage growth is at its highest level since the 2008 global financial crisis, after which wage growth remained largely flat. The percentage of wages that increased is at its highest level since March 2015, at 59%. This shows there has been more broad-based wage growth across the Labour Cost Index* (LCI). Salary and wage rates for the public sector increased 3.0 percent annually, the highest rate since June 2009. This compares to a 2.2 percent increase in the year to the June 2019 quarter. Public sector wage rates have been driven by collective agreements for teachers, nurses, and police over the past year. With these three largest occupations excluded, public sector wages would have increased 1.8 percent annually.

*The labour cost index (LCI) measures changes in labour costs. These costs consist of base salary and ordinary-time wage rates, overtime wage rates, and non-wage labour-related costs. The index essentially covers all employees aged 15 years and over, in all occupations, and in all industries except domestic services.

Sources:
Department of Statistics NZ
Westpac Quarterly Overview – November 2019

A2 Economics – Labour Market – MRPL

Marginal Revenue Product refers to the amount of revenue generated by an additional worker. This is a theory of wages where workers are paid the value of their marginal revenue product to the firm and is based on the assumption of a perfectly competitive labour market. Therefore an employer will hire workers up to the point where the value of the marginal product of labour equals the wage that is being paid. The demand curve for labour can therefore be represented by the value of the marginal product curve – see graph below and a revision mindmap.

Adapted from: AS and A Level Economics Revision by Susan Grant