Is There a Trade-Off between Wages and Working Conditions?

1. Is There a Trade-Off between Wages and Working Conditions? Stan Siebert University of Birmingham Paper prepared for e-Frame Conference on Measuring Well-Being and Fostering the Progress of Societies, 26-28th June 2012, OECD Conference Centre, Paris 1

2. Wages and working conditions • Two important points: • First, wages should vary with working conditions, and, if they do, then wages alone are not a good guide to how well-off people are • Second, government policy constrains choice: policy attempts to improve working conditions, in particular, by preventing dismissals “employment protection legislation” (EPL) • Improvement in working conditions should be accompanied by a fall in wages – if not, employment falls, temporary employment rises etc

3. Compensating wage differentials -CWD Nice working conditions Nasty conditions • A competitive labour market is meant to establish compensating wage differentials (CWDs) with high wages for bad job conditions and low wages for good – opposite. • Note, skill is kept constant: Wlow shows opportunities for low skill, and Whigh for high skill. • Note how the cluster of observations for low skill will tend to have more “cash” (to pay the rent), and worse conditions – high skill can afford better conditions Whigh skill High skill cluster of obs Wlow skill +CWD Full wage low skill cluster Important point: the low skilled are less well off than you think! Their high pay is partly because of worse conditions 3

4. Evidence on CWDs Evidence is that workers will forego sums of the order of 20-30% of the wage to secure good conditions. But EU countries heterogeneous – need to allow for government policy? 4

5. Further evidence on CWDs Note small CWD for job security in Finland - because wages cannot vary due to centralised collective agreements. Note Knabe et al (2010) show that the unemployed are not so unhappy being unemployed.

6. Market determination of wages and conditions Wages Cost of extra EPL to firms SLOW EPL A C SHIGH EPL B CWD=Value to workers DLOW EPL DHIGH EPL L1 L0 Labour • Simple theory – market establishes A or B according to which maximises employment • As shown, A is the result, with low EPL (because costs to firms of higher EPL would outweigh value to workers • If B is then imposed, wages must fall by the CWD – L falls a little • If wages are sticky, L falls a lot

7. Problems with the simple theory • Are there missing markets for job security, so both sides better off if it is mandated? • The analysis is static – what about employment adjustment, innovation? • What about the fact that EPL assists insiders, makes outsiders worse off, eg increases temporary employment? • Still, it is a starting hypothesis – that EPL reduces employment, particularly when wages are sticky 7

8. Employment effects of EPL Fiori et al (2012) show that EPL reduces employment when FDI is restricted. Also Bassanini et al (2009) show TFP growth is reduced in industries which have a high layoff propensity and where TFP “bites”. Also Kahn (2007) shows that EPL causes temp employment – simple model broadly supported

9. Conclusions • CWDs: • There appear to be CWDs – good job conditions are not cheap • We need to investigate variations between countries – CWDs cannot easily be revealed where “floors” are set for wages and working conditions • We need to know more about the CWD for job security • Policy: • EPL mandates will have adverse effects on outsiders if wages cannot fall