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Labour Market Economics

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Revision notes on the labour market for A2 economics

Revision notes on the labour market for A2 economics

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  • 1. 1. The Labour Market The labour market is a factor market – it provides a means by which employers find the labourthey need, whilst millions of individuals offer their labour services in different jobs. The supply of and demand for labour is affected by what is happening in local, national andinternational markets and economies.Labour Demand – Marginal Revenue Product How many people should a business look to employ? Theories of the demand for labour try to analyse links between the demand for labour and avariety of economic factors. We start with the marginal revenue productivity theory of thedemand for labour.Marginal Revenue Product (MRPL) measures the change in total revenue for a firm from selling theoutput produced by additional workers.MRPL = Marginal Physical Product x Price of Output per unito Marginal physical product is the change in output resulting from adding an extra worker.o The price of output is determined in the product market – in other words, the price that abusiness can get in the market for the goods and services that they have produced.A numerical example of marginal revenue product is shown in the next table:LabourpeopleemployedCapital (K)Units ofcapitalTotalOutput (Q)unitsMarginalProductUnitsPrice perunit ofoutput whensold (£)Marginal revenueproduct = MPP x P(£)0 5 0 / 5 /1 5 30 30 5 1502 5 70 40 5 2003 5 120 50 5 2504 5 180 60 5 3005 5 270 90 5 4506 5 330 60 5 3007 5 370 40 5 2008 5 400 30 5 1509 5 420 20 5 10010 5 430 10 5 50 We are assuming in this example that the firm is operating in a perfectly competitive marketsuch that the demand curve for finished output is perfectly elastic at £5 per unit. Marginal revenue product follows directly the behaviour of marginal physical product. Initiallyas more workers are added to a fixed amount of capital, the marginal product is assumed torise. However beyond the 5thworker employed, extra units of labour lead to diminishing returns.As marginal physical product falls, so too does marginal revenue product. For example the 5thworker taken on adds $450 to total revenue whereas the 9thworker employed generates just£100 of extra income.
  • 2. The story is different if the firm is operating in an imperfectly competitive market where the demandcurve is downward sloping. In the next numerical example we see that as output increases, the firmmay have to accept a lower price per unit for the product it is selling. This has an impact on themarginal revenue product of employing extra units of labour. One again though, a combination ofdiminishing returns to extra labour and a falling price per unit causes marginal revenue product(eventually) to decline. In our example below, it starts to fall once the 7thworker is employed.Labour Capital (K) Output (Q) MPP Price (£) MRP = MPP x P (£)0 5 0 10.01 5 25 25 9.60 2402 5 60 35 9.00 3153 5 100 40 8.70 3484 5 150 50 8.20 4105 5 210 60 7.90 4746 5 280 70 7.70 5397 5 360 80 7.00 5608 5 430 70 6.80 4769 5 450 20 6.50 13010 5 460 10 6.00 60MRP theory suggests that wage differentials result in part from variations in the level of labourproductivity and also the value of the output that the labour input produces.The main assumptions of the marginal revenue productivity theory of the demand for labour are:o Workers are homogeneous in terms of their ability and productivity (clearly unrealistic!)o Firms have no buying power when demanding workers (they have no monopsony power.)o Trade unions have no impact on the labour supply (the possible impact on unions on wagedetermination is considered in later chapters.)o The physical productivity of each worker can be accurately and objectively measured andthe market value of the output produced by the labour force can also be calculated.o The industry supply of labour is assumed to be perfectly elastic. Workers areoccupationally and geographically mobile and can be hired at a constant wage rate. Thismeans that the marginal cost of taking on extra workers is assumed to be constant.The profit maximising level of employmentNow we consider how many people a business might decide to employ. The profit maximising level ofemployment occurs when a firm hires workers up to the point where the marginal cost of employingan extra worker equals the marginal revenue product of labour. I.e. MCL = MRPL.This is shown in the labour demand diagram shown below.
  • 3. oLimitations of MRPL theory of labourdemand1. Measuring productivity: Often it ishard to measure productivity becauseno physical output is produced or theoutput may not be sold at a marketprice. This makes it tough to place atrue valuation on the output of eachextra worker. How does one go aboutvaluing the final output of peopleemployed in teaching, social care orthe armed forces? It is easier tomeasure output in industries where atangible product is produced each day.2. Pay Award Bodies: In some jobswages and salaries are setindependently of the state of labourdemand and supply. Over five millionpublic sector workers for example fire-fighters, pharmacists, council workers, nurses andteachers have their pay set according to decisions of independent pay review bodies with“market forces” having only an indirect role in setting pay-rates.3. Self employment and Directors’ Pay: There are over three million people classified as self-employed in Britain. How many of these people set their wages according to the marginalrevenue product of what they produce? And what of those people who have the ability to settheir own pay rates as directors or owners of companies? Recently we have had fiercedebates about the huge level of bonus payments paid to city workers many of whom werebehind the risk-taking that contributed towards the credit crunch. Was their pay justified on thegrounds of marginal revenue product? How does one go about measuring the marginalrevenue product of people working in complex financial markets?WageRateEmployment of Labour (E)Marginal Revenue Product (MRPL)Marginal Cost ofEmploying LabourW1E1E2W2E3W3A rise in the wage rate causes a contractionof labour demand as the marginal cost ofemploying extra workers risesThe profit-maximisinglevel of employment iswhere the marginalrevenue product of labour= the marginal cost ofemploying labour
  • 4. Shifts in the Demand for LabourThe number of people employed at each wage level can change and in the diagram below we see anoutward shift of the labour demand curve. The curve shifts when there is a change in the conditions ofdemand in the jobs market. For example: A change in demand for a product which means that a business needs to take on fewerworkers A change in the productivity of labour A change in the level of national insurance contributions made by employers or other costsof employing people such as health and safety legislation and training levies A change in cost and productivity of machinery and technology which might be able toproduce or provide a good or service in place of the labour input.Labour as a Derived Demand The demand for labour is a derived demand i.e. thedemand depends on the demand for the products theyproduce. When the economy is expanding, we expect to see a rise inthe aggregate demand for labour providing that the risein output is greater than the increase in labour productivity. In contrast, during a recession or a slowdown, theaggregate demand for labour will decline as businesseslook to cut their operations costs and scale back onproduction.In a recession, business failures, plant shut downs and short-termredundancies lead to a reduction in the derived demand for labour. The construction industry is anexample of the derived demand for labour. The decade long property boom in the UK has led toWageRateEmployment of Labour (E)Labour Demand (1)W1E1Labour Demand (2)E2
  • 5. rising prices, output and employment but since 2008 the property market has been in recessionleading to many thousands of job losses.Case Study: Pay Cuts in a RecessionThe recession is having a huge effect on the UK labour market. Unemployment is rising at a very fastrate; the number of unfilled vacancies has dropped. And the total number of people in a job either fulltime or part time is now on the slide. How best should business respond to the recession in terms ofthe pay and conditions they offer to their employees.Pay cuts and pay freezes are being flagged up as an increasingly common option by businessesstruggling to survive. Staffs working for the publisher Penguin who earn over £30,000 have had theirsalaries frozen. Premiership rugby clubs in Britain have agreed to freeze their salary cap at £4m. Anda new survey from the British Chambers of Commerce covering 300 member firms found that 43%plan to freeze wages and salaries in the coming year. Nearly one business in ten will go a step furtherand attempt to cut basic pay and salaries – a measure almost unprecedented in the experience oftoday’s workers.”There are many broader economic effects of a situation in which wage packets and salaries are eitherheld constant or cut. Pension incomes:o A series of pay cuts this year and next may affect the value of pensions of people whoare on final salary schemes. This will be fiercely resisted by trade unions - especiallythose representing workers in the state sector Productivity and efficiency:o Will reductions in pay lead to lower productivity? Pay cuts of 10 per cent or a freeze onwages (which amounts to a cut in real pay) could have a negative effect on workermorale. Equityo Will pay cuts be across the board from executive level through to shop floor workers? Impact on consumer demand:o Will a squeeze on real take-home incomes lead to an even deeper cut in consumerspending - aggravating the extent of the recession in the domestic economy? Manybusinesses will be using a mixture of layoffs, reduced hours, less overtime and wagefreezes - all of which have a negative effect on average earningsAn inward shift of labour demand ought to bring about a reduction in the real value of wages andsalaries in a competitive labour market. But wage freezes or cuts are not yet common across mostindustries. Some employers are trying more imaginative ways to reduce their payroll expenses. Somehave offered their workers longer holidays or sabbaticals on a fraction on their annual pay. Othershave slashed the amount of overtime available. Many employers recognise that - having strained hardto recruit their best workers - it would be foolish and counter-productive to get rid of them in arecession, whose duration few are confident in predicting.
  • 6. Elasticity of Demand for LabourElasticity of labour demand measures the responsiveness of demand for labour when there is achange in the wage rate. The elasticity of demand for labour depends on:1. Labour costs as a % of total costs: When labour expenses are a high proportion of totalcosts, then labour demand tends to be elastic. In many service jobs such as call-centres,labour costs are a high proportion of the total costs of a business.2. The ease and cost of factor substitution: Labour demand will be more elastic when a firmcan substitute quickly and easily between labour and capital inputs. When specialised labouror capital is needed, then the demand for labour will be more inelastic. For example it mightbe fairly easy and cheap to replace security guards with cameras but a hotel would find italmost impossible to replace hotel cleaning staff with machinery!3. The price elasticity of demand for the final output produced by a business: If a firm isoperating in a competitive market where final demand for the product is price elastic, theymay have little market power to pass on higher wage costs to consumers.Labour Supply The labour supply refers to the total number of hours that labour is willing and able tosupply at a given wage rate. It is the number of workers willing and able to work in a particular job or industry for a givenwage. The labour supply curve for an industry or occupation will be upward sloping. This is because, as wages rise, other workers enter this industry attracted by the incentive ofhigher rewards. They may have moved from other occupations or they may not havepreviously held a job, such as housewives or the unemployed. The extent to which a rise in the prevailing wage or salary in an occupation leads to anexpansion in the supply of labour depends on the elasticity of labour supply.WageRateEmployment of Labour (E)Labour Demand (1)W1W2E2E1Labour Demand (2)E3Labour demand (2) is more elastic – perhaps because the employercan easily switch to capital inputs as a means of producing an output ifwage rates were to increaseLabour demand (1) is relatively inelastic – e.g. -0.4 i.e. a 10% fall in thewage rate might only lead to a 4% expansion of labour demand
  • 7. Key factors affecting labour supplyThe supply of labour to a particular occupation is influenced by:1. The real wage rate on offer in the industry itself – higher wages should boost the numberof people willing and able to work.2. Overtime: Opportunities to boost earnings come through overtime, productivity-related payschemes, and share option schemes.3. Substitute occupations: The real wage rate on offer in competing jobs is another factorbecause this affects the wage and earnings differential that exists between two or moreoccupations. So for example an increase in the relative earnings available to trained plumbersand electricians may cause some people to switch their jobs.4. Barriers to entry: Artificial limits through the introduction of minimum entry requirements orother legal barriers to entry can restrict labour supply and force average pay levels higher e.g.legal services and medicine where there are strict “entry criteria” to the professions.5. Improvements in the occupational mobility of labour: For example if more people aretrained with the necessary skills required to work in a particular occupation.6. Non-monetary characteristics of specific jobs – include factors such as the level of risk,the requirement to work anti-social hours, job security, opportunities for promotion and thechance to live and work overseas, employer-provided in-work training, subsidised health andleisure facilities and occupational pension schemes.7. Net migration of labour – the UK is a member of the EU single market that enshrines freemovement of labour as a guiding principle. A rising flow of people seeking work in the UK ismaking labour migration an important factor in determining the supply of labour available tomany industries – be it to relieve shortages of skilled labour in the NHS or education, or tomeet the seasonal demand for workers in agriculture and the construction industry. Therecession has caused inward migration to slow down and in some cases to reverse.WageRateEmploymentLabour SupplyW1D1E1W2D2E3W3WageRateEmploymentE1 E2LS1E2W1LS2
  • 8. Elasticity of labour supply The elasticity of labour supply to an occupation measures the extent to which labour supplyresponds to a change in the wage rate in a given time period. In lower-skilled occupations, labour supply is elastic because a pool of labour is employableat a fairly constant market wage rate. Where jobs require specific skills and training, thelabour supply will be more inelastic because it is hardto expand the workforce in a short period of time whendemand for workers has increased.Equilibrium wages and wage differentials There is a wide gulf in pay and earnings rates betweendifferent occupations in the UK labour market. Even inlocal labour markets there will be variations in paylevels – for example, in London bus drivers working for different companies can seedifferences in pay of up to £6,000 a year? In 2010, chief executives of FTSE-100 companies were paid on average 145 times theaverage salary. Back in 1999 the multiple was 69. On current trends it will be 214 by 2020, oraround £8m a year.WageRateEmploymentLabour Supply(short run)W1D1E1W2D2LabourSupply(long run)E3abW3cWageRateEmploymentD1D2E1 E2Inelastic and elastic labour supply curves A perfectly elastic labour supply curveLabourSupplyPublic sector employees in the UKaccount for less than 1% of the top1% of the income distribution scaleReport of the High Pay Commission
  • 9.  In the 30 years to 1979, the share of income going to the top 0.1 per cent of earners droppedfrom 3.5 per cent to 1.3 per cent. Today, the top 0.1 per cent takes home as big a share as itdid in the 1940s.Wage DifferentialsNo one factor explains the gulf in pay that persists betweenoccupations:1. Compensating wage differentials - higher pay canoften be reward for risk-taking in certain jobs,working in poor conditions and having to workunsocial hours.2. Equalising difference and human capital - in acompetitive labour market, wage differentialscompensate workers for the opportunity costs anddirect costs of human capital acquisition.3. Different skill levels - the gap between poorlyskilled and highly skilled workers gets wider eachyear. Market demand for skilled labour grows morequickly than for semi-skilled workers. This pushes uppay levels. Highly skilled workers are often ininelastic supply and rising demand forces up the"going wage rate" in an industry.RealWageRateEmploymentW1RealWageRateEmploymentD2D1E2 E1The equilibrium price of labour (market wage rate) in a given market is determined by the interactionof the supply and demand for labour. Employees are hired up to the point where the extra cost ofhiring an employee (their wage) is equal to the addition to sales revenue from hiring them, their MRP.LabourSupplyD1E1LabourSupplyW1W2D3W3E3Graduates and NEETSOne person in four in the workforcehas a degree, a share that hasdoubled in the past 18 years.Despite the increased supply ofgraduates, they still earn hourlywages that are 61% higher thanthose paid to individuals holdingonly A-levels.In another snapshot of thepopulation, data shows that theproportion of 19-to-24-year-oldswho are neither in education,employment or training (NEETS)has risen to 19.1% in the summerof 2011 up from 16.5% in 2010.
  • 10. 4. Differences in labour productivity and revenue creation - workers whose efficiency ishighest and ability to generate revenue for a firm should be rewarded with higher pay. E.g.sports stars can command top wages because of their potential to generate extra revenuefrom ticket sales and merchandising.5. Trade unions and their collective bargaining power - unions might exercise theirbargaining power to offset the power of an employer in a particular occupation and in doing soachieve a mark-up on wages compared to those on offer to non-union members6. Employer discrimination is a factor that cannot be ignored despite equal pay legislationSticky wages in the labour market Economists often refer to the existence of “sticky wages.” In a fully flexible labour market, adecrease in the demand for labour should cause a fall in wages and a contraction inemployment - just like any demand curve shifting down. However, sticky wages refers to a situation in which the real wage level doesnt fallimmediately, partly because many employees have wages specified in employmentcontracts that cannot be re-negotiated immediately, and because workers (perhapsprotected by their trade unions) are resistant to cuts in nominal wages. If the wage level cannot fall when demand falls, it leads to a much bigger drop in employmentand, more importantly, involuntary unemployment because of a failure of the labour marketto clear. The evidence for sticky wages is a good counter-argument to neo-classical models of thelabour market that suggest that real wage levels respond flexibly to any changes in labourdemand and supply conditions. Will wages become less sticky during the recession? There are signs that workers, fearful fortheir jobs at such a difficult time, have become more willing to consider and perhaps acceptpay freezes or wage cuts traded off against improved job security.RealWageRateEmploymentW1RealWageRateEmploymentLdE1LsW2E2LsLd
  • 11. Government policies and the labour supplyThe main policies designed to increase the supply of labour available to the economy are as follows:1. Reforms to the system of direct taxation: In the 1980s, Thatcherite economics focused oncutting income tax rates particularly at the top end and switching from direct towards indirecttaxation. More recently, governments have tended to focus more on reductions in the lowerrates of income tax and tax allowances for lower-paid workers. The theoretical idea remainsbroadly the same, that lower direct taxes increase the post-tax reward to working and act asan incentive for more people to join the labour supply. In 2007 the government announcedthat the 10% starting rate of income tax would be withdrawn in 2008 and that the basic rate oftax would be cut from 22% to 20%. From 2010 the government plans to have a top rate ofincome tax of 50% for the highest income earners.2. Reforms to the benefits system: The emphasis here has changed away from the rathercrude idea of cutting the real and relative value of welfare benefits towards encourage peopleinto searching for work, towards a reliance on tax credits (for example the Working FamiliesTax Credit) to give parents with children a greater financial incentives to work. The aim is toreduce the disincentive problems created by the unemployment and poverty trap.3. Increased investment in education and training: This is designed to boost the humancapital of the labour force and improve the occupational mobility of the labour force to meetthe changing demands of employers across different industries.4. A more relaxed approach to labour immigration: Particularly where there are shortages ofworkers with skills such as consultants and fully trained nurses in the NHS, or shortages ofteachers in certain subjects. The effect of net inward migration on the labour supply is shownin the diagram below.RealWageRateEmploymentLabour SupplyW2E1W1LabourDemanddLabourSupplywithmigrationE2Strong inflows of labour into the economy canhave the effect of increasing the labour supplyThis puts downward pressure on real wages(for a given level of labour demand) e.g.through helping to relieve labour shortages inparticular industries and occupationsIf migration provides a boost to the laboursupply and to labour productivity, there is theprospect of an outward shift in a country’s longrun aggregate supply
  • 12. The Work-Leisure Trade Off Will people work longer hours if they are offered higher pay? Standard economic theory would suggest that the real wage is a key determinant of thenumber of hours. The real wage is the money wage rate adjusted for changes in the pricelevel and it measures the quantity of goods and services that can be bought from each hourworked. An increase in the real wage on offer in a job should lead to someone supplying more hoursover a given period of time There is the possibility that further increases in the wage rate might have little effect on anindividual’s labour supply. Indeed, there is the possibility of a backward-bending individuallabour supply curve. This is illustrated in the next diagram.Two distinct individual labour supply curves are shown.1. In the first curve, higher real wages lead to an increase in the number of extra hours supplied,although the rate at which the individual gives up their leisure time and work longer hoursdiminishes as the real wage rises.2. In the second curve, for most of the range of real wages, the same prediction holds true, butwhen as real wages step upwards, eventually an individual may choose to actually work fewerhours (ceteris paribus) giving us what is sometimes termed a “backward bending” laboursupply curve.Income and substitution effectsTo understand why this might happen we consider the income and substitution effects that arise froma change in the real wage being paid to an individual worker. We start with the income effect.o The income effect: Higher real wages increase the income that someone can earn from ajob, but they also mean that the hours of work needed to earn enough to pay for a productdeclines. Higher pay levels mean that a target real wage can be achieved with fewer hours oflabour supply. So this income effect might persuade people to work less hours and enjoyextended leisure time.RealWageRateHours of WorkSupplied (LS)Individual LabourSupply (1)Individual LabourSupply (2)L1 L3 L2
  • 13. o The substitution effect: The substitution effect of a higher wage rate should unambiguouslygive people an incentive to work extra hours because the financial rewards of working areraised, and the opportunity cost of not working (measured by the wages given up whenpeople opt for leisure instead) has increased.o With the income and substitution effects working in opposite directions, there is no hard andfast prediction about whether people will choose to increase their labour supply as real wagesincrease.o Are the income and substitution effects different for male compared to female workers?o What about younger workers entering the labour market for the first time who are looking tosave to finance a deposit on a house or to fund other major items of spending?o How might people closer to retirement age respond to changes in real wages?o What of workers in households where at least someone else is in paid employment comparedto a household where there is only one main “breadwinner”?The importance of incentives Most of us rely on income from our work to pay for the things we need and higher pay andbetter conditions should be an incentive perhaps to work some extra hours or search for workin the first place. But for many workers there are disincentives to supply their labour – and these problemsoften affect people in lowly paid jobs. This is known as the problem of the poverty trap and there is an example in the case studybelow.Case Study: The Poverty Trap worsens in ScotlandThe soaring cost of childcare is worsening the poverty trap according to a new report commissionedfor the save the Children Fund in Scotland. More than one quarter of Scots parents on low incomescannot work full time because of the cost of registered childcare that has risen by more than 10 percent this year across most of the country.Joanne Brady, a single mother of two children from Glasgow, is unable to work because she losesmore in means-tested child tax credits than she gains in income. “They take 20 per cent off for eachchild when you go to work. You still have to pay your housing, travel and lunches and its just notadequate.” Ms Brady, 27, is among the 28 per cent of parents with children under 18 and an incomeof less than £15,000.Source: News reports, July 2008
  • 14. 2. Monopsony in the Labour Marketo With increasing frequency these days we read in the media of stories of people – often in lowpaid jobs – who claim that they are being underpaid for the job that they do. To There are many possible reasons for this and one of them is the effect of an employer usingtheir monopsony power. This is the focus of this chapter.Monopsonyo A monopsony producer has buying power in the labour market when seeking to employextra workers and may use that buying-power to drive down wage rates.o The monopsonist knows that they face an upward sloping labour supply curve, in other words,to attract more workers in their industry, they must pay a higher wage rate – so the averagecost of employing labour rises with the number of people taken on.o Because the average cost of labour is increasing, the marginal cost of extra workers willbe even higher, since we assume that an increase in the wage rate paid to attract one extraworker must also be paid to existing workers.o The profit maximising level of employment is where the marginal cost of labour equateswith the marginal revenue product of employing extra workers.o In the diagram, Eq workers are taken on, but the monopsonist can employ these workers atan average wage rate of Wq – a pay level below the marginal revenue product of the lastworker.o In this sense, the monopsonist is exploiting labour by not paying them the full value of theirmarginal revenue product.WageRate(W)Employment of Labour (E)Demand = MRPLLabourSupply(ACL)WqEqMarginal Cost ofLabour (MCL)MRPLA monopsony is a market dominated by a single buyer. A monopsonist has the market powerto set the price of whatever it is buying (from raw materials to labour inputs)
  • 15. o Trade unions may seek to counter-balance the monopsony power of an employer bycontrolling aspects of the labour supply and by usingwhatever collective bargaining power they possess tonegotiate wages higher without being at the expenseof employment levels.Examples of monopsony employerso Major employers in a small town (e.g. a car plant, amajor supermarket or the head office of a bank)o Nursing homes as employers of care assistants.o The government can also have monopsony power asthe major employer in the teaching profession or theNational Health Serviceo Local authorities are also big employers for examplein refuse collection, street-cleaning and in runningcouncil nursing homes and local librarieso Agencies who employ thousands of people in thehotel, catering and cleaning industrieso The farming sector which employs huge numbers ofpeople on temporary terms during the peak harvestingseasonGovernment intervention in labour markets to combat the effects of worker exploitationAn employer having monopsony power in the labour marketdoes not necessarily mean that workers will find their wagesand other terms and conditions worse than if the market forlabour was more competitive.That said there often are an economic and a clear socialjustification for legal interventions in the jobs market to providesupport and backing for thousands of vulnerable and oftenpoorly-paid people.Two examples of such intervention are1. Legal protections such as the Gangmasters Authority2. The national minimum wage (NMW) and also acampaign for a living wage. The London living wagewas introduced in 2005 and more than 100 London-based employers have signed up to it.Gangmasters Licensing Authority (GLA)The Gangmasters Licensing Authority was set up in 2006 tocombat exploitation of workers in agriculture, horticulture andfood processing plants, by overseeing the people who supplymuch of the labour.In 2008 it set up operation Ajaz – an investigation into pay andworking conditions in a cluster of industries where workers arethought to be most vulnerable to exploitation – it targetedemployers in the agriculture, horticulture, forestry, shell fishingand food processing industries.Young workers look for better payand conditionsThe prospect of better pay hasovertaken job satisfaction as the keyreason for moving to another job, asurvey suggests. But employmentprospects in the UK labour marketremain poor with the recovery at afragile stage.Its well known that under-25s arestruggling to find work. The latestofficial figures show that 935,000 areunemployed in the UK. Research bythe Institute for Employment Studiessuggests those under 30 have seentheir real pay fall £890 a year sincethe credit crunch first hit in 2008Adapted from news reportsSouth Africa wine grown byabused workersWorkers helping to make SouthAfricas wines are subject to unsafeworking conditions and inadequatehousing, a report has said. HumanRight Watch says workers on wineand fruit farms face exposure topesticides and are blocked fromforming trade unions.Theseworkers are some of the worst paidin the country - despite strict labourlaws.Fashion chain Zara acts onBrazil sweatshop conditionsSpanish fashion chain Zara saythey are strengthening theoversight of their production systemafter workers were found toiling in aBrazilian sweatshop. A raid in SaoPaulo found mostly Bolivianimmigrants working for a pittance inunsafe conditions. A raid in SaoPaulo found people working incramped, unsanitary conditions, forlong hours.
  • 16. The National Minimum Wage (NMW)The National Minimum Wage (NMW) is a minimum amount per hour that most workers in the UK areentitled to be paid. The NMW rates are reviewed each year by the Low Pay Commission and from 1October 2011 the main hourly rate for workers aged 21 is £6.08 (£4.98 for workers aged 18-20, withlower rates for workers aged 16-17 (£3.68) and for apprentices under 19 years old £2.60).How might a minimum wage impact on employment and the wage decisions of a monopsonybusiness?o Because the minimum wage is a pay floor, the monopsonist cannot pay a wage below ito So the NMW effectively becomes the marginal and average cost curve for hiring workers upto employment level Emin.o Thereafter to hire additional staff, the wage rate must be bid up, again creating a divergencebetween the average and marginal cost of labour.o The effect on the diagram is that with an appropriately set rate, the profit maximising level ofemployment after a minimum wage is higher (E2) and the wage rate paid to labour has alsoincreased (W2).o In this example, making certain assumptions, a minimum wage might actually boost totalemployment and secure better pay for workers in occupations and industries where there issome monopsonistic power among the buyers of labour.WageRate(W)Demand =MRPLLabourSupply(ACL)WqEqMRPLNationalMinimum WageMarginalCost withNMWNMWE2 Employment of Labour (E)
  • 17. 3. Discrimination in the Labour MarketWhat is discrimination?o Nobel-prize winning economist Kenneth Arrow has defined discrimination as “the valuationin the market place of personal characteristics of the worker that are unrelated to workerproductivity”.o These personal characteristics may be sex, race, height, appearance, age, national origin orsexual preference – or indeed any other identifiable characteristic.o Discrimination is a cause of labour market failure and a source of inequity in thedistribution of income and wealth and it is usually subject to intervention e.g. throughregulation and legislation.o Discriminatory treatment of minority groups leads to lower wages and poor employmentopportunities, including less training, job insecurity and fewer promotions. The result is thatgroups exposed to discrimination earn less than they would and suffer a fall in relative livingstandards.Why does discrimination occur in the labour market?1. The Taste Model (Gary Becker) - Discrimination arises here because employers andworkers have a ‘distaste’ for working with people from different ethnic backgrounds or finalcustomers dislike buying goods from sales people from different races i.e. people prefer toassociate with others from their own group. They are willing to pay a price to avoid contactwith other groups. With reference to race, this is equivalent to racial prejudice.2. Employer ignorance – Discrimination arises because employers are unable to observedirectly the productive ability of individuals and therefore characteristics such as gender orrace may be used as ‘proxies’ – the employer through ignorance or prejudice assumes thatcertain groups of workers are less productive than others and is less willing to employ them,or pay them a wage or salary that fairly reflects their productivity, experience and applicabilityfor a particular job.3. Occupational crowding effects – Females and minorities may be crowded into a cluster oflower paying occupations.
  • 18. Younger workers are often among the most vulnerable in the labour market. Since the 2008-09 recessionemployment among workers aged 18-24 has contracted by nearly 400,000 and the unemployment rate amongthis group has jumped from 12% to over 18%. Little wonder that politicians are under great pressure to investextra funds in improving job prospects for this segment of the labour forceDiscrimination against female workers - the “gender pay gap” in the UKThere is little doubt that a permanent gap exists between average pay rates for females and males inthe UK labour market. Evidence of the gender pay gap comes from the New Earnings Survey.The gender gap, measured by full-time median hourly pay rates excluding overtime, shrank from 12.2per cent to a record low of 10.2 per cent in the year to April 2010, according to an annual survey ofhours and earnings by the Office for National Statistics. Men’s median hourly earnings were £13.01,while for women the rate was £11.68. The median is the level at which half of workers fall above andhalf below.In 1997 the gender pay gap in median earnings for full-timers was around 17 per cent and now it’sdropped to around 10 per cent. The median gender gap for all employees, including part-timers, in2010 fell from 22 per cent to 19.8 per cent. The gender gap was widest in south-east England andnarrowest in Northern Ireland.What factors explain the gender pay gap in the UK?1. Human capital: i.e. there are differences in educational levels and work experience betweenmales and females. Breaks from paid work, including time to raise a family, can impact onwomens level of work experience.2. Part-time working: a significant proportion of women work part-time and part-time worktypically pays less well than full-time jobs. Fewer hours worked inevitably has an effect on theweekly gross earnings of female workers compared to men.3. Travel patterns: on average, women spend less time commuting than men with the resultthat they will have a smaller pool of jobs to choose from. It may also result in lots of womenwanting work in the same location near to where they live which will result in lower equilibriumwages for those jobs.
  • 19. 4. Occupational segregation: 60 per cent of women work in just 10 occupations. Occupationswhich are female-dominated are often relatively poorly paid jobs (e.g. Caring, Cashiering,Catering, Cleaning and Clerical jobs) and there is continued under-representation in higherpaid jobs within occupations – the so-called "glass ceiling" effect.5. Employer discrimination: Work by the LSE calculates that up to 42% of the gender pay gapis attributable to direct discrimination against women. Since 1995 the number of equal paycases registered with employment tribunals has more than doubled.6. The effects of monopsony power: Females may be relatively geographically immobile(because they are tied to their husbands place of employment) and may be paid less than acompetitive wage by a monopsonist employer.Government Intervention to reduce the gender gapo The Equal Pay Act introduced in 1970 sought to provide legal protection for female workersand encouraged employers to bring the pay for males and females into line.o The Sex Discrimination Act of 1975 outlawed unequal opportunities for employment andpromotion in the workplace because of gender and it set up the Equal OpportunitiesCommission.o Attention has switched in recent years away from legislation towards encouraging morewomen to stay on in further and higher education providing and targeted assistance for singleparents to find work and thereby increase the labour market participation ratio among femaleworkers.
  • 20. Theory of labour market discriminationWe can model the effects of discrimination using a simple labour demand and supply frameworkIt is difficult to be precise about the effects of discrimination in the labour market. Employers rarelyhave full information about the productivity of all of their workers, let alone prejudiced or ignorantviews about the relative merits and de-merits of different groups. Increasingly employers’organisations along with trade unions are working hard to break down barriers to the employment ofdifferent minority groups and in highlighting instances of discriminatory behaviour.The issue of labour market discrimination will remain with us for many years. It is closely linked to theissue of labour migration and in particular, the risks of discrimination of the many thousands ofworkers from Eastern Europe who have come into the UK either on a temporary or permanent basisnow that twelve countries have joined the European Union.Ee EmWmWeEeEdWdWeEmployment of White malesEmployment of Non-White FemalesWageSupplyMRPLMRPL DisSupplyMRPLMRPL WmIf employers are prejudiced about the relative productivity of different groups of workers, this will bereflected in their estimates of the marginal revenue productivity of each group. The MRPL ofdiscriminated groups is lower than for other groups.This is reflected in lower relative wages and a lower level of employmentWage
  • 21. 4. Trade Unions in the Labour MarketTrade unions are organisations of workers that seek through collective bargaining with employersto protect and improve the real incomes of their members, provide job security, protect workersagainst unfair dismissal and offer a range of other work-related services including support for peopleclaiming compensation for injuries sustained in a job.o Association of Flight Attendants (AFA)o Association of Teachers and Lecturers (ATL)o Bakers, Food and Allied Workers Union (BFAWU)o Communication Workers Union (CWU)o Fire Brigades Union (FBU)o National Union of Journalists (NUJ)o Prison Officers Association (POA)o Professional Footballers Association (PFA)o Transport and General Workers Union (T&G)Main roles of unionso Improve the real incomes of their memberso Lobby for better working conditions and pensionso Provide job securityo Protect their workers against unfair dismissalo Provide a counter-balance to the monopsony power of some employerso Support people claiming compensation for injuries sustained in a jobo Protect workers against possible employment-related discriminationUnion Membership Trends1. There has been a long term decline in union membership. In 2008, only 28 per cent of peoplein a job in the UK were members of a trade uniona. Only one in six private sector employees in the UK were union members in 2006b. Almost three in five public sector employees in the UK were union membersc. Around one third of workers say that their pay and conditions are influenced by tradeunion collective bargainingd. The hourly earnings of union members averaged £13.07 in 2008, 12.5 per cent morethan the earnings of non-memberse. Nearly 60 per cent of people working in education are members of a trade union butonly 6 per cent of people in hotels and restaurants and only 11 per cent of peopleworking in wholesale, retail and motor tradesf. Only one worker in five in manufacturing industry is a member of a uniong. Only one worker in ten aged between 16-24 years is a trade union member2. Union density is highest in the Scandinavian countries of Sweden (70.8 per cent), Finland(70.3 per cent), and Denmark (69.1 per cent) and lowest in Hungary (16.9 per cent), theUnited States (11.6 per cent) and France (7.8 per cent).3. Unions now have significantly less power and influence to determine pay and conditions thantwenty years ago although in some industries (including postal workers, railway worker, firefighters and prison officers) unions are still prepared to exert their “industrial muscle”.
  • 22. 4. Under new legislation, employers must recognise a union in pay and employment discussionswhen a majority of the workforce want to be represented and has voted for it. But there is littleevidence that union members secure any significant wage “mark-up” or greater job protectionthan people in non-union jobs5. In current times, employers have less incentive to fear unions (many work in partnership withbusinesses) but individuals have less incentive to belong since inflation is low and theeconomy is strong6. The number of active trades unions has declined byover 40% between 1990 and 2005 – there have been anumber of mergers.Why has union membership declined?1. Many people no longer believe that union membershipis worth their whilea. Low inflation means less pressure for higherpay to protect real incomesb. Tougher employment laws make it harder forunions to strikec. Perception that trade unions have lost some oftheir relevance2. Changes to the nature of the UK labour marketa. Increased number of people working part-time or flexi timeb. Shift towards shorter employment contractsc. Decline in the number of jobs in heavy industry (de-industrialisation)3. Some employers have resisted having trade unions in their workplace – or prefer to deal onlywith one or two unions on pay and other issuesTrade union powerTrade union membership in Britainpeaked at over 13 million 30 yearsago but now stands at just over 7million, despite the number ofworkers rising over the period. Onlyabout 15% of private sectorworkers are in a union compared toover half of those in the publicsector
  • 23. The number of monthly industrial disputes / stoppages in the UK has been at historically low levels for more thana decade. The 1970s and 1980s were years when strike-action was common in many industries.Unions have less power and influence in the labour market than they did two decades ago although inseveral big industries they can still exert their “industrial muscle”. Power has gradually ebbed away fora variety of reasons:1. Employment legislation which has outlawed illegal strikes, given employers the right to seekcompensation for the effects of certain forms of industrial action and requires all unions tohold secret ballots of their members before any strike action is permitted2. The effects of increased competition in product markets – in nearly every domesticmarket for goods and services, there is greater competition than there was a few years ago.Be it the intensity of global competition from lower-cost producers or the deregulation ofmarkets that has increased market contestability, trade unions have had to adjust to a worldwhere the pricing power of manufacturers and service industries has been severely curtailed.Hence the increasing demands from businesses to link pay and conditions to workerproductivity. There are still some fairly militant trade unions around – notably in the publicsector services including transport. The train drivers’ union, ASLEF, has been one of the moremilitant unions in recent years, conducting strikes on the rail network and LondonUnderground.3. Patterns of employment: There has been a long term change in the structure ofemployment in the British economy away from traditionally strong union sectors such asheavy engineering, coal-mining, steel and textiles, towards service sector jobs in the privatesector where union density is much lowerAverage weekly earnings are higher in the public sector than in the private sector. That said the chart showsaverage wages and there will be huge differences within this figure – for example in the private sector, contrastthe earnings of top premier league footballers with people working as kitchen workers in a London hotel
  • 24. Unions and wage negotiations – labour market theoryo Unions might seek to exercise their collective bargaining power with employers to achievea mark-up on wages compared to those on offer to non-union members.o For this to happen, a union must have some control over the labour supply available to anindustry.o In the past this was possible if a union operated a closed shop agreement with an employer– i.e. where the employer and union agreed that all workers would be a member of aparticular union.o However in most sectors, the closed shop is now history – outlawed by legislation.More frequently, a union may simply bid for better pay through bi-lateral face-to-face negotiationswith employers to achieve an increase in wages ahead of the rate of inflation so that real wages rise,and other improvements to working hours and conditions.The balance of power between employers and a trade union in their periodic wage negotiationsdepends on a range of factors including:1. Unemployment: when labour is scarce and there are shortages of skilled workers, then thebalance of power tilts towards unions. Unions are always less powerful when the demand forlabour is falling and labour is less scarce.2. Competitive pressures in product markets – when a firm is enjoying a dominant monopolyposition and high levels of abnormal profit, the unions will know that the employer has thefinancial resources to meet a more generous wage settlementWageRateEmploymentLabour Supply (unioncontrolled)E1E2LabourDemandW1W2EmploymentLabour Supply (unioncontrolled)E1E2LabourDemandLabourSupply totheEconomyW1W3Elastic labour demand – union control oflabour supply forces wages higher – butemployment contractsInelastic labour demand – unions may bemore effective in negotiating higher paylevels and increasing total factor earnings
  • 25. The conventional case against trade unions1. Unions act as a distortion in the workings of the labour market2. They drive wages higher and profits & employment lower than if the labour market was fullycompetitive3. They may prevent the introduction of new, flexible work practices4. They may delay the introduction of new technology which thus affects productivity5. Their collective bargaining power can lead to higher wages and cost-push inflationarypressures which leads to a worsening of macroeconomic performance6. Unions can cause labour market failure such as real-wage unemploymentCounter-arguments1. The new ‘partnership model’ between employers and unionsa. Unions and their members stand to gain fromi. Higher productivityii. The workforce having more flexible skillsiii. Improved working conditions and employment rights2. Higher pay does not automatically lead to fewer jobsi. Monopsony argument (see previous page)ii. Higher pay can create incentives for higher productivity and working morehours3. Keynesian effects of increased incomes on consumer demand for goods and services – risingaggregate demand – leading to a boost to short run economic growth4. Trade unions have modernised to reflect changes in the domestic and global economy5. Their role is becoming ever more importanta. Threats to the stability and future of occupational pensionsb. Persistent discrimination in the labour market (gender glass ceilings, age, ethnicity)6. They can work with management and employers to improve efficiency and competitiveness –and therefore achieve a positive sum game7. There has been a step change in industrial relations in the UK – which has made the UKeconomy a favoured venue for inflows of foreign direct investment – there are far fewerindustrial stoppages and days lost from strike action (see the chart below)