G401 November 4, 1998 Professor Rasmusen NOTES ON LABOR REGULATION These notes contain materials on labor regulation. We started discussing this yesterday, and will continue tomorrow. As we discussed in class, there are a lot of kinds of labor regulation. What we did in class was to list a variety of them but to discuss them only briefly. Then we discussed minimum and maximum wages in depth. If there's one thing you get out of G401 that will make it all worthwhile, it is a deep understanding of the effect of price ceilings and floors. So we'll keep coming back to it. Consider the the following proposed regulation: MINIMUM WAGE. No employer may pay less than 50,000 dollars per year to any graduate of IU's Kelley School of Business. Some questions to ask of any regulation are: 1. Is there some form of market failure that justifies it? (E.g., externalities, monopoly, information asymmetries) 2. Who does it benefit and who does it hurt?(Cui bono?) (Follow the money) 3. Are the conditions in place for government failure? (E.g., concentrated benefits and diffused costs of the regulation, complexity so its true effects are not apparent to voters). Let's ask these here. 1. Market Failure? There does not seem to be any market failure reason to put a minimum wage in place. When an IU grad takes a job, there are no real externalities on anyone else. There is no monopoly on either side--there are lots of students and lots of jobs. It is true that there is information asymmetry-- employers do not know each graduate's ability, and must estimate it-- but a minimum wage wouldn't help with that. 2. Cui bono? Currently, employers think some IU grads are worth more than 50,000, and already pay them more. At a first approximation, these grads would be unaffected by the minimum wage. Employers think other grads are worth less than 50,000. So they would not hire them if they had to pay 50,000. A few employers, though, are getting a good deal currently. They are paying the current market wage for average-quality IU graduates--say, 35,000-- but value them at a higher level --say, 60,000. This can't be all employers, since then they'd bid the wage up to 60,000, but it could be true of a few of them. These employers will pay the 50,000 wage, and the students they hire will benefit from the regulation. These employers are the ones high up on the demand curve for labor. At a second approximation, the best IU grads would see their salaries go up. This is because employers can't hire the lower quality IU grads anymore at, say 35,000, so they may switch to asking for a higher-quality IU grad at 55, 000. But if many companies do this, it will drive up the wage from 55,000 to something higher. Thus, low and average quality IU grads will mostly be hurt by the minimum wage, and high quality IU grads will be helped. Employers will be hurt, because they will have to hire fewer low and average IU grads, will have to pay more for the ones they do hire, and will have to pay more for the high-quality grads. The real-life minimum wage is much lower, of course, but the form of analysis is the same. The minimum wage reduces employment of the unskilled, but drives up the wage of those unskilled workers who are still employed. It also drives up the wages of more skilled workers, because employers substitute the more skilled labor the unskilled labor. Thus, unionized labor, though not employed at the minimum wage, has a strong reason to support the minimum wage. 3. Government failure? If there is no market failure, and there is a regulation in place, there must be government failure, since the regulation will reduce total surplus. The 50,000 dollar minimum wage is not in place, so there must not be government failure with it. There is not, because the costs would be concentrated on the average IU grad, and this cost-- unemployment-- would be immediately noticeable. Top-ability IU students and Purdue graduates would be willing to support the regulation, but their benefits are so much less than the costs to the IU students that they would not lobby hard enough to get the law through. The inefficiency of the minimum wage can also be explained another way. The regulation prohibits a mutually advantageous trade. If an IU grad is willing to work for 40,000, and an employer is willing to hire him at 40,000, it must be that both would benefit from that trade of labor for cash. But the trade is illegal. So what results is Pareto inefficient-- both worker and employer could be made better off by eliminating the regulation. Some of what I've just gone through in words is what the consumer and producer surplus analysis does in graphs. Really, the verbal explanation is more important, because it can applied to many things that are hard to graph. We'll do that in class tomorrow or next week. Think about: 1. The 40-hour week, with time-and-a-half required for overtime. 2. Mandatory vacation benefits, which are common in Europe. 3. The old Jim Crow laws that restricted hiring of black workers.