Topic 3 - Empirical and policy aspects of demand for labour Professor Christine Greenhalgh

1. Topic 3 - Empirical and policy aspects of demand for labourProfessor Christine Greenhalgh P Cahuc and A Zylberberg (2004) Labor Economics, Chapter 4: Labor Demand, part 2. Griliches, Z., 1969. Capital–skill complementarity. Review of Economics and Statistics 51, pp. 465–468. T Boeri and J van Ours (2008) The Economics of Imperfect Labor Markets, Chapter 2: Minimum Wages. A Manning (2003) Monopsony in Motion, Chapter 12: The Minimum Wage and Trade Unions. H Robinson (2002) ‘Wrong side of the track? The impact of the minimum wage on gender pay gaps in Britain’, Oxford Bulletin of Economics and Statistics, Vol. 64 (5), December.

2. Demand for labour input – maximising profit by minimising costs of production π(Y) = P(Y).Y - C( W, R, Y) P = price of output (can vary with output if not perfectly competitive output market); Y = level of output chosen to maximise profit; W = wage per unit of employment; R = cost per unit of capital K Profit maximising output is where price equals a mark-up factor times marginal cost of production Size of mark-up depends on output price elasticity Mark-up = 1 if product market is perfect competition Mark-up is > 1 if imperfect competition Optimal combination of inputs is when each factor is used so that its marginal productivity equals the profit mark-up times its factor cost

3. Derivation of an empirical demand function for labour (1) • Decide on production function (summary of technological possibilities) against which firms have to maximise profits • Specify nature of product and factor markets to decide whether prices are seen as constant (competitive) or changing with quantities (not competitive) • Write down conditions for max. profits and derive the demand for labour • Examples of production functions are Cobb-Douglas (considered restrictive as σ = 1) CES (constant elasticity of factor substitution but with values of σother than 1) • This approach permits estimation of unconditional demand for labour (any output may be chosen)

4. Derivation of an empirical demand function for labour (2) • Alternative approach avoids choice of specific production function and specifies directly a cost function • Cost function has to have properties considered reasonable for case of cost minimisation in choice of inputs for a given output • Examples given in Cahuc and Zylberberg are Leontief & Translog functions • These cost functions permit the elasticity of substitution to vary with wages and with share of input in total costs • The cost function approach permits estimation of the conditional demand for labour, given a known level of desired output

5. Elasticity of demand for labour L = f (W, R) or L = f (W, R, Y) ηLW = unconditional elasticity: how much does demand vary if wage rate changes and choice of profit maximising output also changes? ηLW|Y= conditional elasticity: how much does demand vary if wage rate changes but output is kept constant? Conditional elasticity reflects the possibility of factor substitution between inputs of capital and labour ηLW = ηLW|Y + ηLY.ηYW Unconditional ηLW is sum of substitution and scale effects Scale effect is multiple of output elasticity of demand for labour and elasticity of output w.r.t. the wage rise

6. Empirical values for demand elasticities Cahuc & Zylberberg quote Hamermesh (1993) Unconditional ηLW = 1.0 Conditional ηLW|Y = 0.3 It can also be shown that: ηLW|Y = - (1- s) σ where s is share of labour in total cost and σ is the elasticity of substitution of labour and capital Given conditional elasticity of 0.3 and known share of labour of 0.7 in most advanced countries then elas. of substitution σ = 1.0

7. Implications of these estimates • Unit value of unconditional elasticity implies the wage bill is constant along the demand curve • This suggests a fairly large rate of trade-off between jobs and wage rises for union bargaining (in right to manage model) • Large trade-off for government with imposition of minimum wages in competitive markets • Large difference between conditional and unconditional elasticity means that the scale effect is a significantly big component of the adjustment to any wage cost increase • Unitary elasticity of substitution means that Cobb-Douglas production function is an acceptable approximation for analysing aggregate production

8. Adjustments in the short and long run with asymmetric costs Distinguish between no. of workers and hours per worker in labour demand • Changing employment incurs hiring or firing costs (which are not equal, thus asymmetric) • Changing hours of work incurs payment of overtime hours or compensation for short time Distinguish between workers on permanent contracts and those on temporary contracts • Temporary workers generally have lower claims to redundancy pay • Some temporary workers are hired at higher hourly rates e.g. agency staff

9. Empirical evidence on adjustment • Over the business cycle hours per worker adjust more than no. of workers => labour hoarding • This phenomenon reflects higher adjustment costs for workers than for hours • In the US: hiring costs > firing costs • In France: firing costs > hiring costs • Net impact on jobs/unemployment of rise in hiring and firing costs is difficult to estimate: • Rise in hiring costs is expected to reduce demand for workers • Rise in firing cost encourages labour hoarding • Expected profit per worker is reduced by increase in firing costs so this reduces hiring

10. Relative adjustment rates for temporary and permanent staff Evidence for Spain: Benito and Hernando in Oxford Bulletin Econ. Stat. 70(3) June 2008 Data 1985-2001 - rapid rise in share of temp. staff from 9% mid 80s to 20% by 2001 • Wage elasticity of demand all workers = - 0.4 • Wage elasticity for permanent workers = - 0.0 • Wage elasticity for temporary workers = - 2.1 • Output elasticity of demand all workers = 0.18 • Output elasticity for permanent workers = 0.11 • Output elasticity for temporary workers = 0.63

11. Capital-skill complementaritySource: Griliches 1969 Divide workers into two types – skilled S and unskilled N As before capital K has price of R Wage of skilled worker is Z, unskilled is W How do relative demands for skilled and unskilled change if W, Z or R change? Hypotheses: σNK > σSK as the unskilled are more easily substituted for capital than skilled and σKN> σSN as capital is more easily substitutable than is skilled labour with unskilled

12. Empirics of capital-skill complementarity Griliches shows that the relative demands for factors can be expressed by the following two functions: (1) S/N = f (W/Z, R/Z) with signs of coefficients +ve and –ve Rise in W/Z causes normal relative price effect (switch to cheaper substitute) Rise in R/Z shows bigger switch from K to N than from K to S, so S/N falls (2) S/K = f (W/Z, R/Z) with signs of coefficients –ve and +ve Rise in W/Z causes bigger switch between K and N than between S and N, so S/K falls Rise in R/Z gives normal relative price effect

13. Estimates and implications of capital-skill complementarity • Griliches’ estimates using two databases for the US in 1950s and 1960s confirm the signs of all four coefficients What are the implications? • Suppose capital becomes cheaper through time, for example due to innovation in producer durables, then R/Z falls • In (2) this will cause production to become more capital intensive even relative to skilled workers • But in (1) this will cause the demand for skilled workers to rise relative to the demand for unskilled workers • See next lecture for more on this topic

14. Theory - Minimum wages, labour demand and supply Competition v. Monopsony • Minimum wages (MW) in perfectly competitive labour markets - face immediate trade-off of jobs and wages along the demand curve • Under Monopsony (or Oligopsony) standard model shows can be some increase in employment instead (MW creates horizontal supply curve with constant MC) • To maximise employment under Monopsony MW is set at the competitive market wage • Any higher MW faces trade-off along demand curve Additional theory relating to labour market frictions • Reactions to rise in wage can be increased labour supply, more intensive job search and a fall in turnover • Also efficiency wage theory suggests rise in productivity of those in work leading to higher employment

15. Employment as minimum wage rises Employment On Supply Curve On Demand Curve Minimum Wage = Minimum Wage = Minimum Wage Monopsony Wage Competitive Wage

16. Empirical studies of effects of minimum wages (quoted in Boeri and van Ours) • UK – Stewart Economic Journal (2004) found no adverse effects on low wage employment • Problem that his study was too early? (UK MW was set at very low rates in 1999-2001) • US – Card and Krueger AER (1994) compared workers in fast food in New Jersey and Pennsylvania • Found NJ employment in these establishments rose when MW was increased in this state • Suggests there was monopsony despite rapid turnover in this sector (or efficiency wage effect reduced turnover) • EU – Dolado et al. Economic Policy (1996) • Mainly found negative effects on employment • Effects in Europe worse for young people

17. Minimum wages in G5 countries (2005)Note -Germany has no national minimum wage Approx. 70% of its workers are covered by wages set in collective bargaining agreements In all four countries in table MW coverage is 100%

18. UK National Minimum Wage- rates since 1999 Age group   22+yrs      18-21yrs    16-17yrsApr-99       £3.60          £3.00          noneJun-00       £3.70          £3.20          noneOct-01       £4.10          £3.50          noneOct-02       £4.20          £3.60          noneOct-03       £4.50          £3.80          noneOct-04       £4.85          £4.10          £3.00Oct-05       £5.05          £4.25          £3.00Oct-06       £5.35          £4.45          £3.30Oct-07       £5.52          £4.60          £3.40Oct-08      £5.73       £4.77        £3.53

19. Changes in Minimum Wage rates Age group   22+yrs      18-21yrs    16-17yrs ∆ 99-08 59% 59% ∆ 99-04 35% 37% ∆ 04-08 18% 16% 18%  Adjusting for inflation – Real rise since 1999 in Adult Min Wage is +31% Next increase is due 1st October 2009 Announcement expected in week of 11th May

20. Questions for policy now • Having raised MW by > 30% in a decade should its real rate remain constant now? • Index linking could avoid MW rising above the competitive wage for low-paid workers • In the present severe recession has the competitive real wage fallen? (Seems likely) • If so should the real value of MW be reduced to maximise employment? • Might be sensible to keep nominal rates constant or even reduce them given near zero inflation • Implies trade-off between equity for the employed and for the unemployed

21. Minimum wages and gender equalityRobinson article in Ox. Bull. Ec. & Stats. 2002 • Many women work in part-time jobs with low wages • Expect MW to affect women more than men • Can we observe Male-Female wage differential falling when UK MW began? Study by Robinson (2003) compares evidence for period 1995 to 2000 (MW intro. was April 1998) • Robinson uses data from UK Labour Force Survey which is very large database • Able to track changes at all points in wage distribution • Problem here (as with Stewart) that this was the period of very low level of MW

22. Gender pay gaps in hourly wages – raw and adjusted for characteristicsMen and women adults; characteristics include region, industry, marital, education,union, temporary Comparison hourly rates for adults in 3rd quarter

23. Findings MW and gender wage gap • Gender pay gap rose between 1997 and 1998 but fell again from 1998 to 1999 • No net change over two years in raw gap, but a rise in gap adjusted for characteristics 1997-99 • Gender pay gaps (raw and adjusted) then fell between 1999 and 2000 by 2.6 & 3.2 (log) points respectively • Simulation results show a rise in MW would raise F/ M gender pay ratio by 3 points from 73.7 at £3.60 to 76.5 at £5.00 • This rise in MW has now happened so = good news for low paid women? • But what trade off with jobs? Back to labour demand curve!