Efficiency wages, monopsony and labor demand
Again Krugman writes about something I know something about. This time I enthusiastically agree (yeah I know big surprise there).
he noted that, in efficiency wage models, it can be relatively easy to convince firms to raise wages. His presentation is (as usual) extremely, brief, clear, unwonkish and excellent.
Then he linked to Arindrajit Dube who notes that the same is true if there is monopsony (like monopoly but with one big agent on the demand side — in this case a firm big enough to affect the prevailing wage in its local labor market).
As usual, I stress that your time is much better spent by clicking the links and reading Krugman (and in this case Dube) than by reading on. In any case, even if you insist on reading this post, for some reason, you shourd read Krugman first.
I note that the two stories actually become the same if the local area market is very local (that is if each firm including even each McDonald’s franchise has its own “local market” of people who look for a job at that particular firm”. Quits which decrease gradually as a function of the wage can be seen as just another form of labor supply which decreases gradually. So the two models are the same. Now in the real world, the cost of a quit is mostly not the brief period when the job is vacant (pretty consistently about 1 month on average in the USA) but the cost of training a new worker. But a model of turnover costs can be made to work even without training costs so long as it takes a while to fill a vacancy. This point is barely worth making.
But with much more enthusiasm, I call on George Borjas in support of Krugman and Dube (and yes I did enjoy typing that) .
The reason is that there are two litartures with results which appear contradictory if one assumes no monopsony and no efficiency wages.
It is alleged that increases in the minimum wage have a small to tiny effect on employment. This corresponds to a very steep almost vertical demand curve for labor (similar L and very different wages — by convention labor demand is on the x axis). On the other hand, it is also alleged that immigration has a small effect on wages. This fits an almost flat demand curve for labor with very different labor demand at similar wages.
Borjas says the literatures are contradictory (because he insists on assuming perfect competition with no efficiency wage effect). But both results are consistent with some models of efficiency wages.
1) turnover depends on the wage and the local unemployment rate (and not on local employment). A higher wage causes lower turnover which can imply only a slight reduction in employment (or even an increase in employment). Immigrants arriving imply the same unemployment rate for higher employment. Employment can increase (if the no turnover labor demand curve is close to flat) provided unemployment stays high enough to keep people from quiting. The turnover model reconciles the two apparently contradictory results.
This also works in a work/shirk that is moral hazard efficiency wage model in which high wages are needed so that workers are sufficiently afraid of being fired that they actually work even if the boss isn’t always watching. The wage required to make workers actually word depends on the local unemployment rate (and not on employment) an increase in labor supply (due say to immigration) means higher employment is consistent with the same wage and sufficient fear to make workers work. Again if the no shirking problem demand for labor demand curve is almowst flat, a helicopter drop of workers (with parachutes so they can work after being dropped) has a small effect on wages.
In both cases, an increase in the minimum wage can have a small effect on employment.
With monopsony, labor demand can increase one for one with labor supply (if the firm has constant returns to scale and no market power in the goods market — that is if the no monopsony labor demand curve is flat). The wage depends on the elasticity of labor supply, not the level of labor supply so a doubling of the number of workers with each reservation wage causes employment to double.
In such models a minimum wage can actually cause higher employment.
The alleged results that the arrival immigrants has a small effect on wages and that increases in the minimum wage have a small effect on employment together suggest that efficiency wages and/or monopsony are important.
I found this from Krugman fascinating:
“Efficiency wage theory is the idea that for any of a number of reasons, employers get more out of their workers when they pay more. It could be effort, it could be morale, it could be turnover. The causes of the efficiency gain could lie in psychology, or simply in the fact that workers are less willing to risk better-paying jobs with bad behavior. ”
Because for me it seems to miss the mark. But I can only address this off the top of my head and certainly will be leaving things out. And what is missing is the workers own evaluation of what his labor is worth at normal output across the worker’s understanding of comparable wages.
To keep this schematic suppose I am fully qualified to be a team lead for a given set of tasks and by applying my normal level of work effort can provide an acceptable and/or standard amount of output for that position as measured across “the industry”. And suppose I am then paid scale. Okay that is fair, an honest hours work for an honest wage.
But suppose that in my next job in the same industry I am hired to be on the team and NOT the lead. And because of my higher order skills achieved as a lead in the last job can produce an acceptable and/or standard amount of output for that position as measured across “the industry” at less than my previous normal level of work effort. Am I somehow obligated to outperform my fellow team members just because I CAN or is it reasonable to just deliver an honest hours WORTH of work for that lower pay. And I would say no, not unless I am bucking for a promotion back to lead, which I may or may not want.
On the flip side suppose I am a lead that is promoted to supervisor at a higher rate of pay. Then it is perfectly reasonable for my employers to expect me to ramp up my effort beyond my old norm in order to (once again) produce an acceptable and/or standard amount of output.
Which if I apply it back to Krugman gives me perhaps a partial match for “effort” but one that I see as indirect. Because what the employer is paying me for in most real world hiring situations is output within a standard range for the job. And that what makes me a good worker is not necessarily my level of effort as that relates to my innate abilities (because I may not have revealed that) but instead my level of output as against standard.
Right now I am out of work and am applying for entry level jobs that would require a fraction of the mental input I put into some of my past jobs. And if hired I expect to perform at the upper end of the standard range of output for the given job. That is I expect to deliver value for money. But other than wanting to put myself in a position for advancement I don’t see any moral claim on my mental effort other than what the employer is paying for. If my new employer pays me to monitor a security screen I have no obligation to offer to do some web design or data analytics just because I could dual task.
I’ll leave it at that because I don’t know that this is making sense. It just seems that the framework Krugman is working seems to treat the labor input unit as if it had no real agency and instead just reacted to input as if wages were the simple equivalent of voltage that amped up output.
If there is any deep theory behind the ramblings above it is probably derived from what I think is a very important work by an early Soviet era agricultural economist. A.V. Chayanov The Theory of Peasant Economy
What he found in a study of the peasant economy in late pre-revolutionary times is that peasant work effort was pegged to particular output levels which in turn were determined by a combination of rent and target consumption. What this meant was a ramping up and down of work effort levels over the work life of the family and in particular peasant parents worked hardest when their children were young and then progressively less as the children were old enough to participate in production rather than maintaining the same level of production throughout to maximize accumulation. In effect they worked just hard enough to pay themselves a living wage for the targeted level of consumption in their local situation. Now it may be that there simply were no avenues through which peasants could turn extra production into investment. But while this was true for some it was not true for all, and of course some did take on extra land or wage work when available. But on the whole accumulation was not a societal norm or expectation.
I found all of this very illuminating as I applied it back to the medieval economy of western Europe. Because when you dig right down to it all the theories common among the liberal economic tradition both in its Marxist versions and in neo-liberal ones you find out that medieval landlords did not in most cases seek to maximize labor output, and that the old common idea that western serfs toiled from dawn to dark in their landlords fields and barely had time to try to wrest a crop from their own tiny wretched plots was by and large hooey. Instead most landlords expected to get ‘customary’ rents. Which required workers to exert efforts up and as often down to meet those expectations.
This is probably as muddled as the last, but you get much different economic models if you assume that the focus of workers or pre-industrial landlords either was not on accumulation as much as consumption. And that work inputs could and did ease as soon as consumption targets were met and that what was important beyond that was equity rather than efficiency.
“An honest day’s work for an honest day’s pay.” and “Good enough for today”.
The discretionary spending trough. I have long, deep association with a huge monopsony, known as the military industry congress complex, I like to call it the trough.
The trough is crony capitalism, corporate welfare or militarist Keynesianism. The trough is locally important in tea party, NRA card toting counties in red states usually sunbelt where “training” for fiction can go on year round.
Other smaller troughs exist fed by federal outlays in the “rest of the discretionary budget”.
The crony capital part of the US budget tilting with SS, Medi’s, welfare, snap and Obamacare.
We DoD troughers recognized this tilting years ago.
Chicago public schools have possibly uniquely cracked what I call the ghetto code: that ghetto schools fail because students (and teachers!) don’t seen anything remunerative enough waiting for them in the job market after graduation to make it worth putting in the necessary effort. This seemingly inescapable vicious circle was revealed by Berkeley political scientist Martín Sánchez-Jankowski in his book Cracks in the Pavement. The professor spent nine years on the ground studying five NYC and LA impoverished neighborhoods. He had spent the previous ten years with street gangs.
“U.S. News and World Report just released its annual rankings of the nation’s best high schools: Six of the top 10 in Illinois are in CPS and another three in the top 20.”
“from 2003 to 2013 and found Chicago students grew 11 points on the 8th grade math test and 7 points on the 4th grade reading test. The state grew just 7 points and 3 points, respectively.”
“[B]etween 2006 and 2014, the percentage of CPS students earning a bachelor’s degree within 6 years of high school graduation jumped from 8 percent to 14 percent. The national rate is 18 percent. … They found that Latino students enrolled in CPS are more likely to graduate high school than their counterparts in many suburban districts, including Maine Township High Schools and Evanston Township High School.”
“Salary figures provided by the Chicago Public Schools show teachers here have the highest average salary of any city in the nation. But, according to the Chicago Teachers Union’s calculations, Chicago teachers would rank second behind New York City.”
not as muddled as you suppose, and certainly not as muddled as theory.
people work sometimes for the joy of the work. bad management or simple lack of opportunity can kill that joy. i know too many people who have taken jobs as janitor and risen to own the company to think it might be good enough to just work to the standard. on the other hand, prepare to be disappointed. it’s not a question of pushing the rate for the “lesser” workers, but of finding a better job that fits your talents because you are “there” when the boss needs someone who can actually do the better job.
on the other hand “theory” seems to me to be trying to squeeze a nickel out of the children’s milk money. the relationship has too many variables to admit of any “solution.” it’s not even a question of separating the signal from the noise, but of identifying better causes among an unlimited number of less useful “causes.”
the best answer is just to be the good boss that Bruce is looking for: pay the better workers better and find them better jobs. of course that means knowing your workers, and being a better boss yourself.
meanwhile, unless there is truly a limit to what the market will bear (those peasants had no way to make “more” in any meaningful sense… at some point their leisure was worth more to them than the extra nickel they could squeeze out of what market there was) “society” still needs to make sure the “lesser” workers can still make a reasonable life for themselves… that may not mean “more money.”
and the minimum wage is the best way i can think of to solve the problem for management: “i can’t pay my workers more and still beat my competitors’ price.”
maybe instead of beating theory to death, we ought to try to do the right thing. and see how it works out.
“but of identifying better causes among an unlimited number of less useful “causes.”
i should have said “identifying the cause that fits the present situation instead of the “cause” that fits the “average’ (or theoretical) situation.”
The first chart implies a degree of commodification of labor that managers believe in but first line supervisors know from experience is not true. Even in very simple jobs the ability to show up consistently on time and sober is important. Higher than “minimum” pay allows employers to choose better employees. Even though they have only a minimal ability to figure out which ones they are during the interview process they can fire the poor employees with the knowledge that they can retain the better ones and stand a reasonable chance of hiring a better one.