BEM 146: Pay & ILM (ch 14) Colin Camerer, Fall 03 Competitive model Competitive model –All workers & firms the same (e.g. migrant farm worker picking) –Marginal revenue product of a worker (MRP) is easily measured –Market wage=MRP If wages too low, workers quit & firms raise wage If wages too low, workers quit & firms raise wage If wages too high, firms lose money and go bankrupt If wages too high, firms lose money and go bankrupt This is stylized, only observed in “McJobs” unskilled labor. Useful as a benchmark. This is stylized, only observed in “McJobs” unskilled labor. Useful as a benchmark.

Complications to wage=MRP competitive model 1. Skill & compensating differentials 1. Skill & compensating differentials 2. Discrimination 2. Discrimination –2.5 is “beauty premium” skill or discrimination? 3. Upward-sloping wage profiles 3. Upward-sloping wage profiles 4. Wage compression (wage-MPR too flat) 4. Wage compression (wage-MPR too flat) 5. Internal labor markets 5. Internal labor markets –5+ gift-exchange & efficiency wages

1. Wage equations Pay depends on skills & compensating differentials Pay depends on skills & compensating differentials –W_it= a+b_e(Educ_it)+b_p(Prod_it)+... Residual is unobserved human capital (tautology?) Residual is unobserved human capital (tautology?) General human capital: General human capital: –Language, computer skills, friendliness, meanness… –Other examples? Firm-specific human capital: Firm-specific human capital: –Knowing people, specialized customers, “culture”… –Is this really large?? (Or is it invented to explain upward-sloping wage profiles?) Compensating differentials Compensating differentials –Negative: Safety (  value of a life, NYC taxi night premium), health (mines), “combat pay” (high malpractice medicine, teaching MBAs) –Positive: Fun (interning in TV/radio), volunteering ($=0),… –Other examples?

Estimate returns to education from wages (b_e) Appear to be large, country-specific… Appear to be large, country-specific… (Is there an upward bias in measurement?) (Is there an upward bias in measurement?)

2. Discrimination Large gender, race gaps in wages & hiring: Why? Large gender, race gaps in wages & hiring: Why? –Tastes of employers (or customers) E.g. “audit” studies of restaurants, “resume” study E.g. “audit” studies of restaurants, “resume” study  performance of discriminated-against employees should be *better* than average  performance of discriminated-against employees should be *better* than average Fact: Black NFL coaches Fact: Black NFL coaches – % black, 29% white made playoffs black coaches win 1.1 more games/season black coaches win 1.1 more games/season But…firms who are color-blind should earn more $... But…firms who are color-blind should earn more $... –Discrimination “traps” Workers must invest in unobservable skills Workers must invest in unobservable skills Discrim’d workers don’t invest, don’t get hired… Discrim’d workers don’t invest, don’t get hired… Does this explain gender & race gaps? Does this explain gender & race gaps? Easy to “break” with affirmative action (“role models”) Easy to “break” with affirmative action (“role models”) –Statistical discrimination Race, gender are proxies for unobservable skill Race, gender are proxies for unobservable skill –e.g., risk of women quitting to have children  lower wages –NYC cab drivers won’t pick up black customers (safety) –Fact: Amygdala (fear area) lights up with unfamiliar other-race faces. Is this a taste or a mistake?

Jamal vs Emily in resume study (Bertrand & Mullainathan, 03) (black/white names)

2.5 Beauty premia: Skill or discrimination?

3. Upward-sloping wages are the norm Seniority and pay Seniority and pay –Pay tends to rise even when productivity does not –Workers take pay cuts to quit Why? Why? –Ties workers to the firm to protect firm’s investment in general & firm-specific human capital (expensive for workers –Firms “save” on behalf of workers. –E.g. taking 9-month prof. salary in 12-month payments –  laying off older (“overpaid”) workers breaches social contract (e.g. 1980s downsizing & LBOs)?

4. Wage compression Wage compression: Wages flatter than MRP Wage compression: Wages flatter than MRP Why? Why? –Status: People like being paid more, dislike being paid less –E.g. interindustry wage differentials— Why does a janitor who mops floors earn more at a fancy law firm? Influence costs: Underpaid workers bug management Influence costs: Underpaid workers bug management Measurement error (MPR is *very* hard to measure) Measurement error (MPR is *very* hard to measure) Exception: In professions where MRP is easy to measure (sports, sales, market trading)  less wage compression Exception: In professions where MRP is easy to measure (sports, sales, market trading)  less wage compression

5. Internal labor markets (ILM) Many labor markets are “internal” Many labor markets are “internal” –Promotion/search from within –Clear plateaus with job requirements tied to $ –E.g., Caltech staff, army, professional firms Why? Why? –Capture private info about skills –Repeated-game provides incentives –Provides incentives (“tournaments”) tournaments predict convexity of salary, e.g. CEO jump tournaments predict convexity of salary, e.g. CEO jump

5+ Gift-exchange vs efficiency wages Two puzzles: Two puzzles: –Why do firms pay “too much” and lay workers off rather than cut wages in downturns? –Why is there involuntary unemployment? Why don’t workers underbid to get jobs? Why don’t workers underbid to get jobs? Resolution: Resolution: –Gift-exchange: Pay “too much” to buy worker morale. Wage cutting is betrayal. –Efficiency wages: Firms pay too much, fire bad workers. Workers work hard to avoid being unemployed. But why not cut wages in a downturn? But why not cut wages in a downturn? Why don’t’ firms “sell (scarce) jobs” to capture supramarginal wage they are overpaying? Why don’t’ firms “sell (scarce) jobs” to capture supramarginal wage they are overpaying?