LABOUR DEMAND AND PRODUCTIVITY
- Text: Benjamin, Gunderson, Lemieux and Riddell, Ch. 5, some of Ch. 6
(Quasi-fixed costs), parts of Ch. 13 (incentive pay)
Marginal Productivity Theory of Short-run Labour Demand:
- In short-run the following are givens:
- technology
- quantity of non-labour inputs
- firm organization
- Competitive labour market: many small employers, many workers.
- Simple idea:
- Employers seek to maximize profits.
- So, hire more labour if:
benefit > costs
Employer’s Benefit from hiring an extra unit of labour?
- The value of what that labour produces:
(Extra output from an extra unit of L)x (Extra money per unit of extra output)
= (marginal physical product of labour) x (marginal revenue)
= MPP x MR
= Marginal revenue product (MRP)
- The marginal revenue product curve plots the MRP against the quantity of
labour.
Shape of the MRP curve:
- Key question: How does MPP vary with L other things equal?
- other things?
quantity of other inputs
technology
firm organization and incentives .
- MPP curve: - may be upward sloping at low levels of L
- downward sloping at high L.
- Why?
- Low L: specialization, division of labour possibilities at low L.
MPP may rise initially as L rises.
(More L: less changeover time between tasks, better task
assignment, specialist becomes better at task, etc.)
- Higher L:
Diminishing returns: MPP eventually declines holding
other inputs constant.
Why?
- As L increases, each unit of L has less of the other inputs to
work with.
- Diminishing returns can give a downward sloping MRP curve.
- An additional consideration: How does MR vary with L?
- Key: the competitiveness of the output market.
- Competitive output market:
- Firms are too small to affect the price of their product.
- So: Marginal Revenue (MR) = Price of output (P).
- More L, more output, same price so MR is the same.
- Then shape of MRP driven by shape of MPP only.
- Non-competitive product market:
- The amount the firm produces affects the price it is paid.
- More output, must cut the price to sell it.
- Result: MR declines with output and L.
- MRP steeper downward slope than MPP.
Cost of an Extra Unit of Labour:
- Competitive labour market: employer must pay the “going rate” (W).
- small employer: wage independent of quantity hired (wage taker).
(labour supply to an individual employer flat)
- Later: will consider a wage-setting employer ("monopsony").
- Other labour costs?
- if they vary directly with time-worked can be treated as part of W;
- if don’t vary directly with time-worked: fixed cost (see below).
Employer Hiring Decision:
- MRP curve: shows employer gain from hiring extra L.
- W is the cost of extra L.
- Hire more labour as long as:
W<MRP
- Do not hire if:
W>MRP
Result?
- Firm hires up to the point where
MRP=W
- At this point each unit of L is paid W.
- The wage the worker earns is tied to productivity.
i.e., labour is paid its marginal product.
- Role of competition and worked mobility?
- say a worker is underpaid (W<MRP)
- competing employer: profitable to pay a wage closer to MRP
- worker is bid away unless they are paid W=MRP.
Short-run Labour demand curve for the firm:
- Hire where W=MRP.
- Labour demand curve:
- downward sloping part of the MRP curve.
(text: more precisely downward sloping part where Average Revenue
Product is above MRP -- see Fig. 5.1)
- If at point where W=MRP on upward sloping part of MRP:
profits minimized! economically irrelevant.
- Short-run labour demand curve: holds technology, plant, machines,
etc. fixed.
- Income distribution and this outcome? area under MRP is total value of output; WL is total wages paid; rest goes to other inputs or is profit.
Labour demand curve shifts:
- Can shift due to changes in MPP:
- Change in amount or quality of other factors of production
- Change in technology (process innovation)
- can raise productivity of existing jobs
- could lead to new ones too (MP=0 rises to >0)
- Change in organization or incentives.
- Can shift due to changes in MR
- Change in output price, position of the firm's product demand curve.
[ technology (product innovations) can work through MR ]
(see website: Varian's article on productivity, computers and organization in the U.S.)
Market Level Labour Demand Curve:
- Market demand curve: shows the quantity of labour demanded by all firms that
hire that type of labour.
- horizontal sum of labour demand curves over all employers.
- Possible complication? (pecuniary externality)
- As all employers change L, the price of their output could change.
( ↑L → ↑Supply of output → ↓Price)
- This shifts firm labour demand curves and gives a steeper market
labour demand curve.
- In market equilibrium: W=MRP across all employers.
- Shifts in market demand occur for the same reasons as shifts in firm
labour demand.
- note: feedback through output price possible if the shift affects
many employers.
- Baldwin, Durand and Hosein (2001): on industry restructuring in
Canada.
- at the industry level feedbacks through the output price are
often important.
- rising physical productivity may often translates into low
prices, not higher labour demand and higher wages.
i.e. MP rises, MR falls so MRP is almost unchanged.
Applications and Implications of MP Theory
Productivity and Wages
- Marginal productivity theory links wages and productivity (MRP).
- Historical wages trend and productivity.
- They tend to move together over the long-term (consistent with MP
theory)
- An important prediction:
- contrast this to many Marxist-radical economist predictions.
i.e., exploitation, employer reaps gains.
- MP theory provides a partial explanation of differences in wages between
jobs, workers, countries, etc.
- look to determinants of productivity to explain wages
e.g.,
- Skill level:
- determines what kinds of tasks the worker can do. Can they produce high MRP goods and services?
(education and training affect skills and a person's MRP)
- Quantity and quality of non-labour inputs.
- Business investment, government investments in
infrastructure can affect MRP.
(Krueger article: computers, pay and productivity)
- Technology
- affects productivity and via competition pay.
- Industrial Revolution: low-skill winners (higher MRP).
- Organization
- Henry Ford’s assembly line
- Schmitz paper (website): “What determines productivity?”
- role of work-rules in contracts of Minnesota / N. Ont. iron
industries in 1980s.
- Health and nutrition: can affect MRP in a given job type (this and low
wages in less developed countries)
- Think about average wage in India vs. Canada in terms of the above factors.
- MP theory a partial explanation? - supply matters too.
Sky-high wages: Can the model explain them?
- See text: Chapter 13 “Economics of superstars” pp. 401-402, “Tournaments”
pp.402-403, “Executive Compensation” pp. 411-412.
- Generic sports star "Joe Hero" paid $8 million per year.
- Star actress "Jill Fame" paid $10 million for a movie.
- CEOs, finance whizzes, corporate lawyers paid millions.
- Can such high wages be explained by marginal productivity theory?
- MP theory: Joe’s high wage reflects his value to the team owners:
- in terms of extra attendance revenues, sale of team
products, TV rights, etc.
- does competition between teams ensure that Joe is paid his worth?
- similar stories for the others: combination of high value and
competition.
- Economics of Superstars:
- Concern:
- cases where the best are paid massively more than the next best.
- this can occur even though the “best” is only slightly better than the
next best.
i.e. small differences in skill are magnified into large
differences in value and pay.
- Rooted in the nature of the service being provided.
- actor, author, athlete: large audience and taste for the best.
- manager of a large organization: can improve the productivity of a
large number of people.
- Incentive models of compensation: an alternative story?
- MP theory: given productivity, competition ensures wages equal MRP.
- Incentive schemes: causality runs the other way (from pay to productivity).
- Examples: piece rates (pay per unit of output produced), bonuses,
performance based raises, stock options or profit-sharing plans.
- Efficiency wage models: high pay policies (above “going rate”) may boost
productivity in some circumstances.
- why?
- psychology and gift exchange (Akerlof).
- anti-shirking device: work hard to keep the high wage job.
- high wage policy allows employer to pick and choose
(selection).
- Incentive stories and “very high pay”:
- Bonuses and stock options can be a large part of very high pay.
- idea is to provide incentives for good performance.
- Tournament model: an incentive model of high pay
- High salaries attached to top positions are like a prize.
- High-performance lower level managers can eventually be promoted
to a top position.
- High salary justified by top manager’s productivity plus increased
productivity of lower level managers who hope to win the prize.
- Trends in income inequality since the early 1980s:
- huge growth in incomes of the very highest earners.
See: E. Saez (2009) trends for the US; Mike Veall (2012) "Top
Income Shares in Canada" (Canadian data)
- Why? What has changed? Maybe:
- Winner-take-all markets and superstars: are more goods like this
than before?
- Incentive pay: more important than in the past?
- Anything else?
- Some views on growth in very high pay:
H. Varian (Chief Economist at Google):
"THE rise in individual inequality that we have seen is due in part to the rise in globalisation. When most businesses were local, the creation of wealth by a business was limited by the geographic range in which the business could operate. But nowadays even a relatively small business can go from local to national and then global operation in a short amount of time. Fortunes can be made by providing goods and services at a low price to a global market of 6 billion people.
Communication costs and computation costs will continue to drop for the foreseeable future, and we will continue to see new billionaires being created as an inevitable side effect of this technological trend. Ocean voyages, railroads and the telegraph, along with the businesses they enabled, created vast amounts of wealth, so we should expect the same from modern communications technologies."
(this fits with a MP theory story)
S. Sumner (Bentley U. writes the blog "Money Illusion"):
"Today the most productive members of society are notthose who produce things, they are those who discover the things that need to be produced. Once you have the blueprint, it is easy to produce many types of software and pharmaceuticals. The big money goes to those who figure out the blueprint, but also to those who allocatecapital to the guy whohas the idea for a Google, or Facebook, or Twitter.In contrast, the technicians who actuallyimplement the vision often earn modest salaries. Thus companiesare “discovered” in much the same way as aniron deposit is discovered by a skilled geologist.
And then there’s globalization, which means decisions about allocating capital can vastly improve productivity even in the old-line industries that were dominant inthe 1960s, when the rest of the world hardly mattered. Finance is not that important in an agricultural economy or even in an economy where the mass production of goods can be done with almost military precision. It becomes extremely important in an economy where it is not at all clear what should be produced, or on what continent that production should take place."
- Alternative stories?
D. Acemoglu MIT: many at the very top are in finance. Was deregulation key?
"politics may have been the key factor in setting in motion the forces that have led to the massive rise in top inequality and also shaped the path of development of the financial industry..."
J. Stiglitz: politics and economics together?
Great wealth→ political influence→ favorable policies → Wealthier!
- Could it partly be incentive problems in top-earner pay setting?
(Board member incentives and CEOs)
- Changes in attitudes toward high pay (A. Atkinson LSE)?
- Is very high pay socially more acceptable than 30-40 years ago?
- Is it mainly an English-speaking thing? (US, UK, Canada, Australia)
If so why haven't the MP stories had the same effect elsewhere?
- G. Mankiw: is speaking English increasingly valuable?
(entertainment, language of business)
Changes in employment composition over time
- Major shifts have occurred in the composition of employment by industry and
occupation (see handouts):
- move from agriculture to industry
- shift from manufacturing to services
- MRP theory suggests explanations in terms of changes in:
technology, changes in the pattern of product demand.
- MRP rising in growing sectors:
- they can offer higher wages
- workers shift to these booming sectors
- spillover to declining sectors: competition ensures wages rise in declining
sectors (or that declining sectors disappear).
- Can declining employment in Ontario’s forestry and auto sectors be explained via
changes in MRP?
e.g. falling output prices? relative quality of cars, price competition?
Natural resources, aging capital?
- Housing and financial bubbles (US): effects on employment by industry.
- These are demand explanations but supply side considerations may matter too.
e.g. growth in “pink collar” occupations and women’s participation.
An extension: MP theory and Long-term Employment Contracts
- See discussion of deferred compensation (Ch. 13, pp. 412-418)
- Simple model: w=MRP each period.
- What if employer-worker expect job to be long-term?
- contract need not tie w=MRP in each period.