The economics of castles

When I'm in Britain or Ireland, one of my favourite sightseeing trips is to visit medieval castles. Even the ruined ones are fun to visit. Actually, maybe the ruined ones are more fun to visit, because you get to imagine what they would have looked like in their heyday. Britain and Ireland are full of castles, many of which were built by and housed local nobles. In fact, in relative terms there were very few royal castles, which the literature in history and economic history has interpreted as a sign that centralised states were weak.

However, this recent article by Desiree Desierto and Mark Koyama (both George Mason University), published in the journal European Economic Review (ungated earlier version here) challenges that view. They instead show that there was an economic logic to the proliferation of private castles.

Desierto and Koyama develop a game theoretic model of medieval states, which first recognises that the monarch cannot rule alone but must rely on a coalition of local lords or barons. Each lord agrees to join the coalition, and pledges resources to the monarch in exchange for a (however small) share of control of the kingdom. The monarch can renege on the agreement, taking the resources without offering a share to the lord. However, the lord would then rebel, leaving the coalition. What allows the lord to leave the coalition, and gives them bargaining power, is the presence of their own castles, since they can retreat to their castle when they rebel against the monarch. Without a private castle, the lord would have little bargaining power, and would anticipate the monarch reneging on any agreement, and so they would not join the coalition in the first place. In economic terms, the castle gives the lord an outside option. 

So, the monarch tolerates private castles held by the lords, because the presence of those castles gives the lords the feeling of security they need to join the kingdom. And, in turn, the presence of those castles disciplines the monarch. Rebellions are more costly to suppress when the lords can retreat to a well-defended private castle. The lords' outside option increases the feasibility of rebellion and ensures that the monarch mostly keeps to their agreement with the lords.

In short, the private castles induce an equilibrium where the kingdom is larger and more stable than it would be without them. Notice that this is the opposite of the conventional view that private castles represent a sign that a state was weak.

Desierto and Koyama support their argument with descriptive evidence, noting that:

In Norman England after the Conquest, castles were built across the country: by 1154 there were 225 baronial castles (compared to 49 royal castles) in England... Baronial castles allowed the Dukes of Normandy to extend their authority over the far larger territory of Anglo-Saxon England. Similarly, in the twelfth century Angevin rule expanded over much of France as semi-independent lords in Gascony accepted the lordship of Henry II.

Desierto and Koyama also note that powerful medieval monarchs did not act to systematically eliminate private castles, and in fact the monarchs often gave away their own castles to local lords. And the power of the lords did keep the monarchs in check - a lord's probability of rebelling against the monarch was positively correlated with the number of private castles in the lord's family network. That last point might sound contradictory, but since castles make rebellion by lords a more credible threat, this can deter monarchs from reneging and reduce the number of rebellions overall. However, when rebellion does occur, lords connected to more castles were more likely to participate in the rebellion.

So, if private castles were so important for the stability of medieval states, why did private castles eventually disappear? Desierto and Koyama note that:

The answer is military technology, not the rising power of the state. Technological changes and the associated ‘‘military revolution’’ that took place beginning in the late Middle Ages reduced the value of medieval fortifications. The main technological innovation was the introduction and improvement of gunpowder weapons, which began in the fourteenth century but only really began to have a serious impact in the fifteenth century with the introduction of iron cannonballs.

This is not a new insight, but it does align well with their model. However, it somewhat reverses the logic of the conventional view, which is that greater state power, along with military technology, reduced the prevalence of private castles. Instead, in Desierto and Koyama's model, the rise of gunpowder reduces the ability of lords to retreat to a well-defended castle in the event of a rebellion (because the castle could not be as well-defended against cannons). This reduced the lords' bargaining power, giving the monarch and the centralised state greater power. As a result, the state should become less stable. In support of this, Desierto and Koyama use the Wars of the Roses in England as an example:

England experienced a large number of rebellions and civil wars between 1450 and 1500. These conflicts are conventionally grouped under the label of the Wars of the Roses (1455–1485), but the period of weak state capacity and frequent rebellion extended from Jack Cade’s uprising in 1450 through Perkin Warbeck’s invasion and the Second Cornish Uprising in 1497. The causes of these rebellions were complex, multifaceted, and varied across cases. Nonetheless, the frequency of civil war during this period is consistent with our model’s prediction that a decline in the military value of castles would destabilize feudal realms.

And so, as gunpowder reduced the military value of castles, private castles became much less useful as a source of bargaining power for lords. That helps explain why the medieval pattern of widespread private castles gave way to state-controlled castles from the mid-15th Century onwards. Now, I'll be thinking more carefully about the vintage of the castles I visit on my next trip to Europe next month!

Kansas City rent strike rebalances relative bargaining power towards tenants

Today in my ECONS101 class, I covered search models of the labour market. In these models, a matching between a worker and an employer creates a surplus, which is then shared between the worker and employer depending on their relative bargaining power. The greater the worker's relative bargaining power, the greater the share of the surplus the worker will claim, meaning that wages will be higher. The lesser the worker's relative bargaining power, the lesser the share of the surplus the worker will receive, meaning that wages will be lower.

Search models are not just useful for thinking about labour markets though. They can be used in any situation where two (or more) parties are matched together in a way that creates a surplus, which is then shared between them. A joint venture between firms is an example. So is a marriage. In both cases the parties match together, create a surplus, and then share that surplus based on their relative bargaining power. A further example exists in the market for rental housing. Landlords and tenants are matched together. That matching creates a surplus, which is shared between them. And relative bargaining power matters, as this Yahoo!News article from the end of last year (originally published in the Washington Post) demonstrates:

In the two years she has lived at Bowen Tower, Cynthia Barlow’s apartment has flooded, been plagued by mold and been infested with cockroaches. The building’s heat stopped working. When the elevators broke over the summer, emergency workers carried a sick neighbor down 10 flights of stairs.

Meanwhile, Barlow’s rent for the two-bedroom unit increased from $993 per month to $1,213.

Growing frustrated, she hung fliers in the elevators and hosted potlucks, persuading a majority of tenants in the 90-unit building to join the Bowen Tower Tenant Union and stop paying rent until conditions improved. So far, they’ve won a meeting with the landlord, and a judge has knocked thousands of dollars off the rent debt of one resident facing eviction.

“I got tired of being treated the way I was treated,” Barlow said.

The rent strike is part of a strategy that housing activists have started to replicate in midsize cities across the country.

When tenants organise themselves into a tenant union, then ceteris paribus (holding all else equal) that increases the tenants' relative bargaining power with the landlords. If the tenants were to all leave their apartments, then the landlord has to search for new tenants, which is costly. Now, an individual tenant could threaten to move out, but filling one apartment with a new tenant is relatively easy. When an entire block of tenants makes the same threat, the landlord is facing serious disruption. More importantly, a rent strike means that, instead of losing or negotiating with one tenant at a time, the landlord faces coordinated action including withholding rent, legal disputes, repair demands, and public pressure from many tenants at once.

The tenants' increased bargaining power (due to unionising) should result in lower rents and improved maintenance of the apartments. The way this worked in practice was that tenants, feeling more powerful with the backing of other tenants, stopped paying rent. However:

Barlow is scheduled for eviction court in January, and Bowen Tower management hasn’t renewed her lease.

There is only so far that tenants can push their greater relative bargaining power, particularly where alternative affordable housing is scarce and legal protections are weak. However, the Bowen Tower case also shows why collective action may matter. Ultimately, the tenants appear to have prevailed and won substantial concessions. This later article notes that the rent strike ended after four months, when the landlord promised repairs and lower rents, and after tenants had withheld nearly US$110,000 in rent. 

Tenant unionisation does not guarantee success, and the risks to tenants can be substantial. But it does mean that tenant unions can shift the bargaining outcome, and the share of the surplus, especially when they are able to sustain coordination long enough to make the landlord’s alternative more costly than negotiation.

[HT: New Zealand Herald]

Minimum wages and student summer employment

The research literature is starting to coalesce around minimum wages have small disemployment effects, consistent with the standard demand-and-supply model (see the meta-analysis in this post, or the links at the end of this post, for more details). To add to that evidence, this recent article by Adam Wright, Darius Martin, and John Krieg (all Western Washington University), published in the journal Contemporary Economic Policy (), looks at the impact on student summer employment. Specifically, Wright et al. use data from Washington state, and focus on students enrolled in Western Washington University in Bellingham, which has about 15,000 undergraduate students.

Wright et al. match student data from 2013 to 2019 to employment records from the Washington State Employment Security Division (ESD) from 2009 to 2019. The ESD data includes both earnings and hours worked, but only for employers that pay into the state's unemployment insurance programme. This excludes workers for the federal government and the self-employed, who are unlikely to be students. However, it also excludes students "students working under financial assistance programs provided by the school", so Wright et al. supplement the ESD data with data on student employees at WWU. Because the employment data starts before the student data, Wright et al. can control for past work experience. And because the data are quarterly, they are able to look separately at employment effects over summer, and during term time.

There are over 31,000 students in the analysis sample, and nearly 260,000 student-by-quarter observations. Wright et al. apply a fairly straightforward panel regression model, controlling for work experience and for the unemployment rate of Whatcom County (where the WWU campus is located). They look at three outcome variables: (1) hours worked; (2) wage income; and (3) a binary variable indicating whether a student worked any hours at all. The overall effects of the minimum wage are not statistically significant. However, when looking at the results by season, Wright et al. find that:

In summer, when students are most likely to work, higher minimum wages significantly predict reduced work hours and the probability of employment, whereas the relationship with income is negative but imprecisely measured. In particular, the coefficient estimates imply that a 100% increase in the minimum wage is associated with 90.08 fewer hours worked in the summer and a reduction in the probability of work by 34.2% points. This suggests that the 16% minimum wage increase experienced in 2016–2017 was linked to a 14.4 h decrease in summer hours worked (an 8.5% decrease relative to the average) and a 5.5% point decrease in summer employment (an 8% decrease)... Minimum wage policy does not appear to predict disemployment in non-summer quarters, leading wage income to rise with increasing minimum wages in winter and spring...

So, minimum wages reduce student summer employment. It is unclear why Wright et al. decided to illustrate the size of the effect with a 100% change in the minimum wage (although that is what the coefficient in the table represents), since that size of change is never observed in the data. It is better to say that a 10% increase in the minimum wage would reduce hours worked in summer by about nine hours (compared with a mean of 170 hours of work in the summer quarter). It's a small effect, but not zero. And since student summer employment tends to be concentrated in low-wage industries like retail or hospitality, that makes sense. Turning to the effect of previous work experience, Wright et al. find that:

...higher wage income in winter and spring quarters when minimum wages increase only holds for students with prior work experience. However, there is statistically significant drop in employment in summer for both students with and without work experience. We estimate that a 100% minimum wage increase for workers with no pre‐matriculation work experience is associated with 115 fewer hours of work and a 38.8% point decrease in the probability of employment during the summer quarter. These estimates imply that the 16% minimum wage increase in 2017 corresponded with inexperienced students working 18.1 fewer hours and being 12.8% points less likely to be employed in the summer. These results are attenuated for those who entered WWU with work experience: a 100% minimum wage increase corresponds to 21.4% point reduction in summer employment for this group whereas the relationship between minimum wages and hours worked is negative but statistically insignificant.

The key finding is that students with no prior work experience and more negatively affected by the minimum wage increase than students with prior work experience. This is to be expected, since employers facing a higher minimum wage would be likely to concentrate employment in more experienced (and more productive) workers, even within summer student workers.

Next, comparing the effects between students who are local to Whatcom County and those who are not, Wright et al. find that:

...the negative relationship between minimum wages and summer employment only occurs for non‐locals, with estimates comparable to those experienced by students with no prior pre‐matriculation work history... Taken together, the full sample and quarterly results indicate that those with higher search costs may be more negatively impacted by minimum wage changes.

The mention of search costs here is important. In a search model of the labour market, workers face a search cost, made up of the time and effort spent looking for a job. Locals face lower search costs, because they likely have networks of local acquaintances and friends who can more easily help them find work, compared with non-locals. These results show that, in the context of higher minimum wages, those differences in search costs really matter.

Wright et al. are careful to point out that their results are correlations rather than causal. Specifically, their analysis lacks a control group. Nevertheless, it provides some descriptive evidence that is consistent with the emerging consensus of small but significant disemployment effects of the minimum wage. However, it would be interesting to see whether these results stood up to a more careful analysis using methods designed to elicit causal impacts. Nevertheless, Wright et al. conclude that:

Our results suggest that minimum wages particularly hurt inexperienced workers in summer, the quarter in which students tend to work most.

As someone who teaches students who rely on summer employment to build up reserves that they can draw on during term time, these results, even if they are not definitively causal, are a worry.

Read more:

• A bunch of research findings on minimum wages in New Zealand
• The disemployment effects of Canadian minimum wages
• Jeffrey Clemens on the disemployment effects of the minimum wage
• The impact of an online minimum wage
• Seattle's minimum wage, revisited
• The latest evidence supports negative employment effects of the minimum wage
• Latest research suggests the minimum wage DOES reduce employment
• More empirical support for the disemployment effects of the minimum wage
• The minimum wage and job vacancies
• The minimum wage and hiring standards
• The employment effects of the minimum wage, from American Community Survey data
• The minimum wage and homelessness
• New York restaurants find a new way to respond to the minimum wage
• The minimum wage and workplace safety
• How employers respond to minimum wage increases
• Minimum wage increases and employer noncompliance
• Higher minimum wages and poverty revisited
• Minimum wages and health
• Effects of the minimum wage on the nonprofit sector
• 15 years of US research on the minimum wage elasticity of employment
• Local minimum wages and low-quality housing rents in Japan

Unemployment and trans-Tasman migration

The New Zealand Herald reported earlier this month:

Record numbers of people leaving New Zealand to work in Australia could have a negative affect on the workforce over the medium-term.

A report by economic think tank Infometrics shows Australia’s rate of unemployment was lower than New Zealand’s in the first quarter of this year, which was a break from the average rate between 2014 and 2018 when Australia’s rate was 0.7 percentage points higher than New Zealand’s.

“There is a definite correlation between transtasman migration and the relative labour market performances in New Zealand and Australia,” Infometrics director Gareth Kiernan said in the report.

Correlation doesn't necessarily mean causation. The New Zealand Herald article's title is therefore misleading: "‘Drain’ leaves NZ’s unemployment higher than Australia". Now, there are two problems with the New Zealand Herald article here, especially in terms of the title. First, there could be reverse causation - higher unemployment in New Zealand, and lower unemployment in Australia, causing more migration, not migration causing changes in unemployment. To see why, consider the incentives for workers in New Zealand. If unemployment in Australia is lower than New Zealand, then if wages were similar, Australia would more a more attractive option. Workers would start moving to Australia. Wages are not similar though - they are higher in Australia. That increases the incentives to move from New Zealand to Australia even further. The takeaway is, though, that unemployment differences may be causing migration, not the other way around.

The second issue is that, based on a simple supply and demand model of the labour market, migration could affect unemployment in both countries, but the effect would be in the opposite direction to what the New Zealand Herald suggests. To see why, consider the diagrams below, which show the labour markets of Australia on the left, and New Zealand on the right. In both labour markets, the market wage (W1 in Australia, and WB in New Zealand) is above the equilibrium wage (W0 in Australia, and WA in New Zealand). This means that there is excess supply of labour in both countries. There are more people wanting to work than there are jobs available. That is, there is unemployment in both countries. This excess supply of labour is the difference between QS1 and QD1 in Australia, and the difference between QSB and QDB in New Zealand.

Now consider what happens as workers more from the New Zealand labour market to the Australian labour market, as shown in the diagrams below. Supply of labour decreases in New Zealand from SLA to SLC, and at the market wage, the quantity of labour supplied decreases to QSC. This decreases the excess supply of labour in New Zealand (to the difference between QSC and QDB), so unemployment decreases. In the Australian labour market, the supply of labour increases from SL0 to SL2, and at the market wage, the quantity of labour supplied increases to QS2. This increases the excess supply of labour in Australia (to the difference between QS2 and QD1), so unemployment in Australia increases. So, the migration of workers from New Zealand to Australia should have the effect of decreasing unemployment in New Zealand, and increasing unemployment in Australia, not the reverse.

Now, there are many alternative models of the labour market, aside from the model based on supply and demand for labour. However, I don't think those alternatives would suggest decreases in labour supply would increase unemployment. For example, in a search model of the labour market, fewer available workers in New Zealand might mean that job vacancies remain unfilled for longer, since it would take employers longer to find a suitable worker, but unemployment would be unaffected (on the other hand, wages would increase, because with fewer workers available, each worker has slightly higher relative bargaining power).

So, there may be a correlation between unemployment differences between Australia and New Zealand, and trans-Tasman migration. But that doesn't mean that the migration will make unemployment differences worse.

It's not just Gib delivery workers benefiting from greater relative bargaining power, but it may not last

As I noted back in September, a low unemployment rate benefits workers (in that case it was Gib delivery workers). Not just because they are more likely to be employed, but also because it raises their relative bargaining power in negotiations with employers, increasing the likelihood of higher wages and better working conditions. It's not just Gib delivery workers though, as the New Zealand Herald reported last week:

After an unsettling two and a half years, people’s working habits are changing fast. Experts are calling it an “employees’ market”, with job seekers not afraid to lay out their expectations from employers.

Seek NZ country manager Rob Clark said the script had been flipped on its head.

“It’s really competitive out there. Companies and organisations are having to think quite differently about how to attract talent.

“Pre-pandemic it was probably a case of ‘it’s a privilege for you as a job seeker to come and work for me as an organisation’, and that’s now flipped on its head. Organisations are really having to work a lot harder to attract that talent because it’s just more competitive.”

Clark said it comes down to simple supply and demand.

“The employment landscape is still very much a candidate-short one, and by that we mean the number of jobs has increased significantly and at a much faster rate than we’ve seen the number of candidates available.

“The outcome of that is we’re seeing fewer applications per job. It’s a market where there’s a very high demand for candidates and there’s just a relatively short supply of them compared to what we’ve been used to.”

It doesn't really come down to supply and demand. It's better explained by a search model of the labour market. As I explained in my post in September:

 In a search model of the labour market, each match between a worker and an employer creates a surplus, which is then shared between the worker and the employer. The share of the surplus (and hence, the wage for the job) will depend on the relative bargaining power of the worker and the employer. If the worker has relatively more bargaining power, then they will receive a higher share of the surplus, in the form of a higher wage...

What has changed is two things. First, the unemployment rate is low. Low unemployment increases the relative bargaining power of workers, because if a worker leaves their job (or refuses an employment offer), the employer then has to start the process of searching for a new worker all over again. The employer would face the search costs of the time, money, and effort spent searching for a worker and evaluating potential matches.

Workers can use their relatively high bargaining power in a number of ways. They can bargain for higher wages, or better working conditions. The Herald article talks about workers demanding greater flexibility, a continuation of the conditions that many (but not all) of us experienced through the Covid lockdowns.

However, workers had better bank those higher wages and better working conditions fast. The Reserve Bank is raising interest rates, and as I explained in The Conversation earlier this week, that will lead to higher unemployment. And as the unemployment rate increases, workers' relative bargaining power falls, and employers' relative bargaining power rises. Once that happens, it will be interesting to see how many employers are willing to entertain their workers' demands for greater flexibility.

Read more:

• Gib delivery workers may be due for a payday

Gib delivery workers may be due for a payday

The New Zealand Herald reported last week:

Workers who deliver hundreds of tonnes of Gib to building sites across Auckland each day are striking for better pay.

About 40 truck drivers and labourers are picketing outside the Penrose base of the delivery company CV Compton.

They want an 11 per cent pay rise, but the company has offered much less...

It took time to train workers to deliver the plasterboard but they often lasted less than a week on the job because it was heavy labour, [Driver assistant James] Ramea said...

Gib was in demand and those delivering the plasterboard were working hard, [First Union organiser Emreck Brown] said.

"Prices of Gib has increased in the last couple of years and this year it has increased significantly. We need some support from the company just to help the members who're helping the company."

In a search model of the labour market, each match between a worker and an employer creates a surplus, which is then shared between the worker and the employer. The share of the surplus (and hence, the wage for the job) will depend on the relative bargaining power of the worker and the employer. If the worker has relatively more bargaining power, then they will receive a higher share of the surplus, in the form of a higher wage.

In this case, there is reason to believe that the workers' bargaining power has increased. That isn't because "those delivering the plasterboard were working hard", or even because it takes "time to train workers to deliver the plasterboard but they often lasted less than a week on the job because it was heavy labour". Those factors likely haven't changed recently.

What has changed is two things. First, the unemployment rate is low. Low unemployment increases the relative bargaining power of workers, because if a worker leaves their job (or refuses an employment offer), the employer then has to start the process of searching for a new worker all over again. The employer would face the search costs of the time, money, and effort spent searching for a worker and evaluating potential matches.

Second, because the "Prices of Gib has increased in the last couple of years", the value that the workers create for the employer have increased. That in itself doesn't affect wages in a search model of the labour market (although it does in a supply and demand model, where the demand for labour is based on the value of the marginal product of labour). However, because the workers are threatening to strike, the costs of the strike to the employer are likely higher because of the high value of gib deliveries foregone. That also increases the relative bargaining power of the workers.

None of this is to say that the gib delivery workers are going to see a huge increase in their wages. Employers tend to retain most of the bargaining power. However, the gib delivery workers have a bit more bargaining power than they would have had until relatively recently, and should be able to leverage that additional bargaining power for better wages and conditions.

Remote work, wages, and compensating differentials

The labour market has undergone a massive upheaval since the pandemic, with the sudden shift to remote work, which has persisted even as the pandemic's effects wane. Or rather, some but not all sectors of the labour market have seen a sudden shift to remote work - I am yet to see a remote barista, for instance. Why has remote work persisted (in some sectors)? Clearly, this only happens if both workers and employers benefit. That is part of the premise of this new NBER Working Paper (ungated version here) by Jose Maria Barrero (Instituto Tecnologico Autonomo de Mexico) and co-authors.

Barrero et al. are focused on the effect of remote work on wage pressures. However, I think there is a more interesting story that sits alongside it, in relation to compensating wage differentials. Barrero et al. note that:

In equilibrium, workers and employers share the amenity-value gains arising from the shift to remote work. Since workers reap the direct benefits of the shift at any given wage, employer benefits take the form of wage-growth restraint during the transition to a new equilibrium with compensation packages that reflect the greater amenity value of higher remote work levels...The Nash bargaining benchmark, for example, says employers get half the surplus created by the rise of remote work.

This relates closely to search models of the labour market, where the surplus generated from a successful match between an employer and a worker is shared between both parties. The shares of the surplus that employer and worker receive depend on their relative bargaining power. In this case, remote work generates an additional surplus, which is shared between employer and worker. That additional surplus may arise from higher productivity of the worker at home, or from the worker spending more hours working (because they spend fewer hours commuting), or because the employer has to spend less on the work environment (because fewer employees are there on any given day, which this earlier post notes has also had an effect on the market for office real estate). How is this additional surplus shared? The additional value of production (or cost savings) are only partially passed onto the worker by the employer. The employer keeps a share for themselves.

This means that, although wages go up, they don't go up by as much as the additional value that is generated. This relates to the idea of a compensating differential, because workers are happy to accept a lower wage (or a lower increase in wages) when their job has positive non-monetary characteristics. To the extent that working from home is a positive non-monetary characteristic, workers would therefore accept a lower wage if their job includes more working from home.

And that is essentially what Barrero et al. find, using data from the Survey of Business Uncertainty (SBU) in April and May 2022. Specifically, they asked:

...each business executive in the SBU the following question: “Over the past 12 months, has your firm expanded the opportunities to work from home (or other remote locations) as a way to keep employees happy and to moderate wage-growth pressures?” According to the responses, 38 percent of firms did so in the previous 12 months... larger firms and firms in... Education, Healthcare & Social Assistance or in FIRE, Professional & Business Services, and Information are more likely to moderate wage-growth pressures by expanding remote work opportunities...

...we also ask: “Over the next 12 months, will your firm let employees work from home (or other remote locations) at least one day per week to restrain wage-growth pressures?” Forty-one percent of business executives respond “yes” to this question... the pattern of responses by firm size and across industry sectors to this forward-looking question is very similar to the response pattern for the backward-looking question. 

Notice that the sectors that report high degrees of remote work are those that you mostly would expect (although healthcare may be a bit of a surprise, but there are a lot of administrative staff in that sector, and some primary healthcare can be delivered remotely). Barrero then ask about how much the firms can (or have) restrained wage growth, and find that:

On a size-weighted basis, we estimate that expanded remote-work opportunities moderated overall wage-growth pressures by 0.9 (0.1) percentage points over the 12-month period ending in April/May 2022. Looking forward, we estimate that expanded remote-work opportunities will moderate wage-growth pressures by another 1.1 (0.1) percentage points in the 12 months following April/May 2022. These estimates have good precision, as indicated by the standard errors reported in parentheses.

Notice that remove work has reduced the extent to which firms are increasing wages (at least, as reported by the firms themselves). And by sector:

Over the two years centered on April/May 2022, the unweighted mean wage-growth moderation effect is 1.3 percentage points among Goods Producers and 1.4 points among firms in Trade, Transportation & Warehousing, and Leisure & Hospitality. These sectors offer relatively few jobs that can be readily performed in remote mode. In contrast, the mean wage-growth moderation effect over two years is 2.7 points in Education, Healthcare, Social Services and Other Services and 3.0 percentage points in FIRE, Professional & Business Services and Information. Except for Healthcare, these sectors have a relatively high share of jobs that can be performed in remote mode...

This provides some evidence that it is remote work driving the lower wage increases, since the effects are greatest in sectors where remote work has become more common. Finally:

We also draw out two other interesting implications of our evidence. First, we estimate that the amenity-value shock associated with the recent rise of remote work lowers labor’s share of national income by 1.1 percentage points. Second, we provide evidence that the “unexpected compression” in the wage distribution since early 2020 is partly explained by the same amenity-value shock, which operates differentially across the earnings distribution.

In other words, the shift to remote work and the compensating differential will have some interesting effects on the measurement of inequality. The labour share of income, which many people equate with a measure of inequality between workers and owners of capital, will decrease. However, because most remote work jobs are relatively high-earning jobs, their smaller wage increases relative to lower-earning non-remote-work jobs will tend to decrease measured income inequality.

No doubt some governments will pat themselves on the back if inequality appears to decrease. However, it's not really much of an improvement if income inequality is reducing, but only because the non-monetary job characteristics of those at the top of the income distribution are improving. This highlights one of the limitations of income inequality as a measure of differences in personal wellbeing.

However, that isn't the story that Barrera et al. are trying to tell in their paper. They conclude that:

...the recent rise of remote work materially lessens wage-growth pressures. In doing so, the rise of remote work eases the challenge confronting monetary policy makers in their efforts to bring the inflation rate down to acceptable levels without stalling economic growth.

I guess that may be some good news. To the extent that remote work persists, and to the extent that central bankers are paying attention, we might expect that interest rates may not have to increase as much in order to bring inflation back under control.

[HT: Marginal Revolution] 

Full employment, bargaining power, and wages for low-income workers

I had an article published in The Conversation this morning, with the headline "NZ has reached ‘full employment’ – but not all workers will benefit from a tighter labour market". The article lacks some of the theoretical background behind some of the points that I make, and that theory relates to things that I will discuss with my ECONS101 class later this trimester, so I thought it would be worthwhile to outline them in a bit more detail here. In particular, this bit:

When there is full employment, it starts to become more difficult for employers to find workers to fill their vacancies. We are seeing this already, with job listings hitting record levels.

A tight labour market, where there are relatively more jobs than available workers, increases the bargaining power of workers.

But that doesn’t mean workers have all of the power and can demand substantially higher wages, only that workers can push for somewhat better pay and conditions, and employers are more likely to agree.

This shift in bargaining power is why some employers are now willing to offer significant signing bonuses or better work conditions and benefits, including flexible hours or free insurance.

This is based on the underlying theory of a search model of the labour market. A search model recognises that each matching of a worker to a job creates a surplus that is shared between the worker and the employer. This surplus is the difference between the additional value that the worker will create for the employer, and the search cost (essentially, the cost of finding and hiring the worker). Because job matching creates a surplus, and the employer wants that surplus, the worker has a small amount of bargaining power, with the employer. This is because, if the worker rejects the job offer, the employer has to start over in looking for someone else to fill the vacancy and will face additional search costs.

How is the surplus split between the worker and the employer? It depends on their relative bargaining power. The worker will have relatively more bargaining power (and will capture more of the surplus) if search costs are relatively higher for the employer than for the worker - for example, if the employer would find it harder to find an alternative worker, and/or the worker could more easily find an alternative job. This happens when unemployment is low, or when the skill requirements of the job are high (so that few other workers could do the job). The worker will also have more bargaining power if the costs of remaining unemployed are low (so the worker doesn’t so much mind saying no to a job offer). This happens when unemployment benefits are generous, or when the stigma or negative psychological costs of being unemployed are low.

Now, coming back to the situation of full employment, the unemployment rate is low (in fact, as I note in the article, the unemployment rate is currently the lowest it has been since 1986). Employers are finding it difficult to fill vacancies, so search costs are high. Both of these are factors that give workers more bargaining power, as I noted above. Workers can leverage that bargaining power to get higher wages and/or better work conditions.

Does that mean that all workers will be better off? No, and this is the key point I make in The Conversation:

Many low-income workers are in jobs that are part-time, fixed-term or precarious. Low-wage workers are not benefiting from the tight labour market to the same extent as more highly qualified workers.

Nevertheless, a period of full employment may allow some low-wage workers to move into higher paying jobs, or jobs that are less precarious and/or offer better work conditions. That relies on the workers having the appropriate skills and experience for higher-paying jobs, or for increasingly desperate employers to adjust their employment standards to meet those of the available job applicants.

Low-income workers tend to also be working in jobs that do not have high skill requirements. That means that there are more other potential workers who could fill those roles. In other words, it is a bit easier for an employer to find a worker to fill a low-skilled vacancy than to fill a high-skilled vacancy. That means that, even in times of low unemployment, low-income workers do not necessarily benefit from greater bargaining power (as noted above, workers have more bargaining power when the skill requirements of the job are higher). Or, at the least, low-income workers do not benefit to the same extent that higher-income workers do.

And it gets worse. In the article, I didn't make the point that when the cost of living is high (as it is now), low-income workers may feel like they have little choice but to accept low wage offers, because the alternative (no job and a low job-seeking benefit) is so much worse. That isn't a consequence of full employment, but rather that even though benefit rates are indexed so that they increase as the cost of living increases, that adjustment is always playing catchup.

 So, as I conclude in my article:

Although a full employment economy seems like a net positive, not everyone benefits equally, and we shouldn’t ignore that some low-wage workers remain vulnerable.

The economics of the government's plan for 'social unemployment insurance'

One of the big (and surprising) announcements in the Budget earlier this year was that the government was developing a 'social unemployment insurance' scheme. This would presumably sit alongside the current unemployment benefit system, but would work in a similar way to accident compensation, paying each person who is made unemployed (and meeting certain conditions) 80 percent of their prior wage up to a certain cap.

This would represent a significant shift in the style of social security system that New Zealand operates. In my ECONS102 class, we distinguish three types (or models) of social security system:

1. A social assistance model - where there is an emphasis on self-reliance and responsibility, and the government provides support (often means tested) where a person would otherwise face hardship;
2. A social insurance model - where social assistance is available and based on previous contributions to a fund (which might be an individual account, or a general account for all insured people); and
3. A social citizenship model - where all citizens have a right to assistance for any contingencies they face (and the assistance is often not means tested).

In reality, most social security systems have features in common with all three types, but New Zealand's system up until now has mostly been a social assistance model, with the exception of accident compensation, which is clearly a social insurance scheme. This proposed introduction of social unemployment insurance would move unemployment assistance into the social insurance model (it would be interesting to see what the government would do with sickness and invalids benefits, or whether they would remain under the old system, along with sole parents and student allowances).

Anyway, there was a great article in The Conversation today by Simon Chapple and Michael Fletcher (both Victoria University of Waikato) that outlines some of the economic issues with a social insurance scheme:

However, there are two problems with the private insurance market, meaning they under-provide relative to people’s real need.

The first problem is called “adverse selection”, meaning people choosing to buy insurance have better information about the risks facing them than insurance businesses do, and no good reason to disclose that information.

To protect themselves from this, insurance companies set premiums higher. In turn, due to the costs, this leads to people being under-insured. Ultimately, society’s best interests aren’t met.

There’s also the problem of “moral hazard” – if a person has insurance they may take on more risk, without the insurer knowing exactly which customers are adopting riskier behaviour.

Again, insurance companies set higher premiums and people are generally under-insured. And again, this isn’t in society’s best interests...

These market failures mean there is potential for well-designed government interventions to meet the social interest. In particular, making everyone join a social insurance scheme would fix the adverse selection problem.

But a compulsory social insurance system also expands the scope for moral hazard. People might change their behaviour to increase their eligibility for an insurance payout. They might take on jobs with higher redundancy risks, or be less motivated to look for work, because the consequences are now less severe.

The problems of information asymmetry (including adverse selection and moral hazard) is among my favourite topics to teach in my ECONS102 class. Chapple and Fletcher are right that the unemployment social insurance scheme would not have an adverse selection problem (provided it is compulsory, in the same way that accident compensation currently is), and the key problems would be moral hazard.

To expand on the moral hazard problems a little bit, workers would be less fearful of losing their jobs, because they would receive a higher unemployment payment than previously. So, at the margin, workers would not work as hard, and productivity might decrease. Similarly, absenteeism might increase, which also reduces productivity. 

On the other hand, wages might increase. To see why, consider a search model of the labour market. This model recognises that each matching of a worker and a job creates a surplus that is shared between the worker and the employer, based on their relative bargaining power. A higher unemployment payment increases the worker's bargaining power, since they can afford to hold out for a better deal. Employers will have to offer slightly higher wages than before, in order to attract workers to leave the unemployment payment and accept the job offer. So, wages will increase, and employers will find that vacancies take a little longer to fill.

Workers may also benefit from better job matches. Since they can afford to stay on the higher unemployment insurance payment for longer, they can afford to wait and find a job they really want, rather than accept the first half-decent offer they receive. The number of unemployed will likely increase, and the average length of unemployment spells will also increase.

Clearly, there is a lot for the government to balance here. Chapple and Fletcher also note that:

If it turns out there are gaps in the current system, advocates of social insurance must also consider:

• such a scheme may simply be substituting for one or several of the existing solutions, which would then reduce if the scheme were introduced

• reforming and improving what already exists may be preferable in terms of cost, effectiveness and equity than introducing an entirely new system

• there may be implications for both equity and erosion of the core welfare system of creating a separate, higher tier of assistance for some.

At this stage, all we have had from the government is an announcement, and a promise of "public consultation later in 2021". Presumably that consultation has been delayed until next year, due to the pandemic. It will be interesting to see what comes out of this.

Sex ratios, bargaining power, and mate preferences

Last year, I wrote a post critiquing some research on 'sexual economics', because they used the supply and demand model as an underlying theory. A better underlying theory is based on a search model (see this post on the economics of sex robots, for example). Usually, we apply the search model to the labour market, but as I note in my ECONS101 class, it can also be used to describe matching in marriage markets, or in the markets for 'shorter-term relationships'.

The simple explanation in the relationship market works like this. Each matching of a couple [*] to each other creates a surplus that is shared between both of them. Because relationship matching creates a surplus, this provides each partner with a small amount of market power (or bargaining power). That is because if one of them rejects the opportunity for the relationship, the other has to start looking for someone else. Each partner is somewhat reluctant to start their search over, so each partner can use that to their advantage. The division of the surplus created by the match will depend on the relative bargaining power each partner. Whichever partner has more bargaining power will get a better deal.

That brings me to this recent article by Kathryn Walter (University of California, Santa Barbara) and 107 (!) other co-authors (spread across 76 institutions!), published in the journal Proceedings of the Royal Society B (open access). Walter et al. reported on a large cross-country sample of over 14,000 survey respondents from 45 countries, and investigated the relationship between sex ratios (the number of males per 100 females) and mate preferences. Specifically:

Participants completed a 5-item questionnaire on ideal mate preferences for a long-term romantic partner. Participants rated their ideal romantic partner on five traits: kindness, intelligence, health, physical attractiveness and good financial prospects. All items were rated on bipolar adjective scales ranging from 1 (very unintelligent; very unkind; very unhealthy; very physically unattractive; very poor financial prospects) to 7 (very intelligent; very kind; very healthy, very physically attractive; very good financial prospects). Using the same scales as for preferences, participants additionally rated themselves on the same five traits: kindness, intelligence, health, physical attractiveness and good financial prospects.

They used these data to construct two measures of preferences for each of the five items: (1) an absolute mate preference (which is the research participant's preference rated from one to seven); and (2) a relative mate preference (which is the research participant's preference, relative to the average of all people in the sample from their city/country, measured as a z-score). The rationale for the relative measure is:

...to account for the fact that the same absolute preferred trait value may be more or less demanding depending on the availability of that trait in the local population.

They also used various alternative measures of the sex ratio, based on the inclusion of different age groups. Using a multi-level model and controlling for various socio-economic differences between countries, Walter et al. find that for relative preferences:

The interaction between sex and sex ratio predicted relative preference for good financial prospects and relative preference for physical attractiveness for every measure of sex ratio...

In general, as men became more numerous, men, compared to women, decreased their relative preferences for good financial prospects, whereas women, compared to men, tended to increase their relative preferences for good financial prospects...

In general... as men became more numerous, men decreased their relative preference for physical attractiveness, whereas women tended to increase their relative preference for physical attractiveness...

The interpretation of these results isn't quite correct, because men weren't becoming more (or less) numerous, because the data were cross-sectional. Instead, we should read it as saying "Ceteris paribus, in cities or countries where men are more numerous..." However, the takeaway message is clear, and consistent with a search model of the relationship market, where bargaining power matters. In places where the sex ratio is skewed more towards men, men have less bargaining power in the relationship market, and women can afford to be choosier, preferring men with better financial prospects and men who are better-looking. The opposite happens for men's preferences - they must be less choosy and can't afford to limit themselves to women with better financial prospects or better-looking women. In contrast, in places where the sex ratio is skewed more towards women, men have more bargaining power in the relationship market, and men can afford to be choosier, preferring women with better financial prospects and women who are better-looking. The opposite happens for women's preferences - they must be less choosy and can't afford to limit themselves to men with better financial prospects or better-looking men.

It is interesting that bargaining power doesn't appear to affect preferences for intelligence, kindness, or health. Walter et al. suggest that this may be because "they are so highly desired, and therefore more invariant". The mean preferences for those attributes were so high, that people are not willing to trade them off at the observed levels of the sex ratio. Perhaps they would if the sex ratio was extremely skewed, but that isn't what Walter et al. observe.

Overall, these results demonstrate that bargaining power matters, not just in the labour market, but also in other situations where matching is a feature.

[HT: The Dangerous Economist]

*****

[*] This same explanation could easily be extended to polyamorous relationships.

Lower unemployment rates, worker bargaining power and wages

There was good news on the unemployment front this week. As the New Zealand Herald reported:

The number of people unemployed in New Zealand has been dropping by more than 1000 a week in recent months, with an extremely tight labour market pushing employers to up pay to keep staff.

Statistics New Zealand revealed today that in the three months to June 30, the unemployment rate fell to 4 per cent, from 4.6 per cent at the end of March...

The total number of people unemployed fell by 17,000 over the three month period, to 117,000, a drop of 12.4 per cent, the largest percentage drop since the Department of Statistics began the household labour force survey in 1986.

Unemployment is now below where it was in the middle of 2019.

Wage inflation and the unemployment rate are linked. A search model of the labour market can be used to explain why. [*] A search model recognises that the labour market requires a matching of workers to available jobs. Each match between a worker and a job creates a surplus (which is the difference between the additional value that the worker will create for the employer, and the search costs - the costs of searching for a worker and evaluating potential matches). The employer and the worker share the surplus. How the surplus is shared depends on the relative bargaining power of the worker and the employer. If the employer has less bargaining power and the worker has more, then the worker can demand a bigger share of the surplus, and wages will be higher. On the other hand, if the employer has more bargaining power and the worker has less, then the employer can offer a lower wage, and wages will be lower.

Now, think about what happens when the unemployment rate falls. Most workers already have a job, and so the number of people looking for jobs decreases (this doesn't mean that workers with jobs don't look for a better opportunity, only that they are less motivated to do so than unemployed people are). Employers have fewer workers to choose from to fill their vacancies. This gives workers more bargaining power, because the employer will find it more difficult to find an alternative match for their job. Workers will get a slightly higher share of the surplus, and wages will increase.

This is more or less what economists expected to happen. Based on a New Zealand Herald article from earlier in the week:

"We expect wage inflation will have jumped as record labour market tightness, exacerbated by the closed border and the Q2 increase in minimum wage, sees firms willing to pay top dollar," [Finn Robinson and Sharon Zollner of ANZ] said...

"Across the country, finding staff across all skill levels is becoming increasingly difficult –and that means that the labour market is a seller's market at the moment (ie workers have the bargaining power right now)," they said.

"If firms aren't willing to shell out top dollar for staff, then people can relatively easily jump ship and find jobs with businesses who will.

In the actual data released on Wednesday, the labour cost index rose by 2.1 percent, and the New Zealand Herald reported:

Construction wages were the biggest riser in the index, up 3 per cent, although Statistics New Zealand said the biggest reason for the increase in the index was caused by retail and accommodation wages which were impacted by the increase in the minimum wage to $20 per hour on April 1.

The effect of a minimum wage on wages of employed workers can also be explained with the same search model of the labour market. A higher minimum wages improves the 'outside option' for workers (it makes the alternative to accepting a job a bit less unattractive). This means that workers are less likely to feel pressured into accepting any job offer, and that increases their bargaining power. As above, workers will get a slightly higher share of the surplus, and wages will increase.

The combination of a lower unemployment rate and a higher minimum wage both lead to higher wages in a search model of the labour market.

*****

[*] A search model is not the only model that we can use to link changes in wages and changes in unemployment rates. I'll post next about using The supply and demand model can also be used in a stylistic way to show similar effects. However, the difference is that in the search model, changes in unemployment rates can cause changes in wages, whereas that is not the outcome in the supply and demand model, where an exogenous change causes both changes in wages and changes in unemployment.

The story of sexual economics should not be written by psychologists

On Thursday, I posted about the economics of sex robots. In particular, I drew attention to search models as a way of thinking through the economics related to sex. The key driver in a search model is the relative bargaining power of the parties to the agreement. If some change gives a party more relative bargaining power, they will get a better deal.

However, search models are not the only way to think about the economics of sex. This 2017 article by Roy Baumeister (Florida State University) and co-authors, published in the Journal of Economic Psychology (open access), instead uses the workhorse model of microeconomics - supply and demand. They note that:

Sexual economics theory rests on standard basic assumptions about economic marketplaces, such as the law of supply and demand. When demand exceeds supply, prices are high (favoring sellers, that is, women). In contrast, when supply exceeds demand, the price is low, favoring buyers (men)...

Importantly, they aren't describing the market for sexual services (i.e. prostitution). Instead:

 ...often what is sold is not just sex but exclusive access to sex with a particular person.

How do Baumeister et al. justify their theory? As follows:

The core idea is that women are the sellers and men are the buyers. This starts with the abundant evidence that ‘‘everywhere sex is understood to be something females have that males want”...

Because the man typically wants sex more than the woman, she has a power advantage. According to the ‘‘principle of least interest,” the person who desires something less has greater control and can demand that the other (more desirous) person sweeten the deal by offering additional incentives or concessions... Hence sexual economics theory begins with the assumption that female sexuality has exchange value, whereas male sexuality does not...

In return for sex, women can obtain love, commitment, respect, attention, protection, material favors, opportunities, course grades or workplace promotions, as well as money. Throughout the history of civilization, one standard exchange has been that a man makes a long-term commitment to supply the woman with resources (often the fruits of his labor) in exchange for sex — or, often more precisely, for exclusive sexual access to that woman’s sexuality. Whether one approves of such exchanges or condemns them is beside the point. Rather, the key fact is that these opportunities exist almost exclusively for women. Men usually cannot trade sex for other benefits.

The onset of a sexual relationship thus involves the man and woman choosing each other. In perhaps overly simple terms, he chooses her presumably on the basis of her sex appeal, that is, how much he expects to enjoy having sex with her. Meanwhile, she chooses him on the basis of the resources he can provide, that is, on the basis of nonsexual benefits he can furnish to her. This exchange defines the nature of the same-sex competition. Women compete to seem more sexually attractive than their rivals. Men compete to seem a better provider than their rivals.

The rest of the article describes differences in competition between women, and between men. It is interesting to read, but I'm more concerned about the framing of the model. It's not clear to me that the authors, all of whom are psychologists of various types, have really thought through the plausibility of the economic model they are attempting to use.

The basic model of supply and demand relates to a perfectly competitive market, which has a number of characteristics: (1) many buyers and sellers; (2) homogeneous 'products'; (3) complete information; and (4) no barriers to entry into or exit from the market. Under those conditions, neither buyers nor sellers have any control over the price - they are 'price takers', and the market 'price' is determined by the interaction of supply and demand.

Now, thinking about sexual economics, it's not clear to me that either (2) or (3) is satisfied. Every person is different, with different preferences. So, the assumption of homogeneous products cannot be fulfilled. Also, we don't know everything about other people we might like to match with (at least, not at first, so complete information is also not available. So, the market is not perfectly competitive, and therefore cannot be described by supply and demand curves. [*]

Another important problem is that, in the supply and demand model, sellers can sell more than one unit of the product (in fact, they will continue to sell until the point where their marginal cost of production is equal to the price), and can sell to more than one buyer. And buyers will buy more than one unit of the product. None of this seems to be a fair characterisation of sex (unless psychologists inhabit quite a different world from the rest of us).

Now, if you read through the quote from the Baumeister et al. article above, and then go back and read my description of search models from Thursday's post, it should be immediately clear that the search model is a better characterisation of sexual economics. Moreover, it doesn't rely on the assumptions of homogeneous products or complete information, and definitely copes with faithful matches between single individuals.

The sad thing is that the rest of the Baumeister article is, as I said above, really interesting. And, the narrative probably stands up well if you take out the supply and demand framing, and replace it with a framing based on a search model. Someone needs to re-write an improvement on that article.

*****

[*] I'm being a little bit harsh here. As I note in my ECONS101 class, even though the demand and supply model relates to perfectly competitive markets, it still does a good job of describing qualitatively the changes in the price and quantity that will result from a change in market conditions, even when the market is not perfectly competitive.

The economics of sex robots

In my ECONS101 class, we cover search models of the labour market. Unlike the supply and demand model, search models do not rely on a concept of market equilibrium. Instead, it is the relative bargaining power of the parties (employers and workers) that determine the wage.

The simple explanation works like this. Each matching of a worker to a job creates a surplus that is shared between the worker and the employer. Because job matching creates a surplus, this provides the worker with a small amount of market power (or bargaining power). That is because if the worker rejects the job offer, the employer has to start looking for someone else to fill the vacancy. The employer is somewhat reluctant to start their search over, so the worker can use that to their advantage. The division of the surplus created by the match, and therefore the wage, will depend on the relative bargaining power of the worker and employer. If the worker has relatively more bargaining power, the wage will be higher. And if the employer has relatively more bargaining power, the wage will be lower.

This search model doesn't just apply to the labour market. You can also apply it to many situations that involve matching two or more parties. Which brings me to this post on sex robots by Diana Fleischman. Sex involves matching (unless you go it alone). The agreement on the what-where-how of sex will depend on the relative bargaining power of the sexual partners. The increasing availability of increasingly realistic sex robots looks likely to shake things up, because sex robots and women are substitutes (see also this earlier post on pornography and marriage as substitutes). As Fleischman explains:

What does this mean for women? When the sex ratio changes, so too do sexual norms; sex robots are going to emulate an increase in the ratio of women to men. Contrary to a prediction based on the idea that men would wield greater patriachal [sic] control if they were in higher numbers, a larger percentage of women relative to men on University campuses is associated with women who are more likely to have casual sex and less likely to be virgins. When there are more men than women, women are much less likely to have casual sex. The majority sex (in this case men) competes for the minority sex (in this case women) and the minority sex calls the shots. When there is a female majority in the population, women compete for access to mates with casual sex. Whereas a male majority competing for access to scarce women compete with long-term commitment.

Sex robots will emulate a majority women ratio, shifting women to compete for men’s attention by requiring less courtship and commitment in exchange for sex.

Taking a heteronormative perspective, the availability of sex robots reduces the relative bargaining power of women, and therefore increases the relative bargaining power of men. That means that men may be able to extract more of the surplus from potential sexual liaisons. That is, men may be able to get more of what they want. Fleischman notes that:

The long-term ramifications are unclear, especially the way long-term technologies and cultural norms will interact. Perhaps women will discover they have to make the costs of courtship both low and transparent to compete with sex robots.

Women, having to compete with sex robots, may have to offer men more. But not so fast:

Or, perhaps, new technology could enable women to recombine their genes with one another, making men enamored with sex robots (or men generally) totally redundant.

New technology for recombining genes and completely excluding men won't rebalance bargaining power back towards women. The technology necessary to reproduce without involving sex has existed for some time. Fleischman is conflating the reproductive goal of sex, with the pleasure goal of sex. To rebalance bargaining power back towards women, women need their own sex robots. Sex robots for all!

[HT: Marginal Revolution]

A cynical take on The Body Shop's 'open hiring' policy

In the world before coronavirus lockdowns, this article on Fast Company caught my attention, and I've been meaning to blog about it for a while:

Almost all retailers run background checks on prospective employees—one of the many obstacles for people who were formerly incarcerated and are now trying to find a job. For other job seekers, a drug screening for marijuana might cost them a position even in states where recreational use is legal. This summer, the Body Shop will become the first large retailer to embrace a different approach, called “open hiring.” When there’s an opening, nearly anyone who applies and meets the most basic requirements will be able to get a job, on a first-come, first-served basis.

The company piloted the practice, which was pioneered by the New York social enterprise Greyston Bakery, in its North Carolina distribution center at the end of 2019...

The results were striking: Monthly turnover in the distribution center dropped by 60%. In 2018, the Body Shop’s distribution center saw turnover rates of 38% in November and 43% in December. In 2019, after they began using open hiring, that decreased to 14% in November and 16% in December. The company only had to work with one temp agency instead of three.

I can immediately see two reasons why this might be a good approach for The Body Shop, and neither reason has anything to do with the 'halo effect' of appearing to be a good employer. Both reasons have to do with wages (which, if you read the story, you will notice are not mentioned anywhere).

First, consider a search model of the labour market. Each time a job is filled, this creates a match between the employer and a worker, and that match creates a surplus (the employer receives some additional profits from employing the worker). The employer and the worker share the surplus. How it is shared depends on their relative bargaining power. If the employer has less bargaining power and the worker has more, then the worker can demand a bigger share of the surplus, and wages will be higher. On the other hand, if the employer has more bargaining power and the worker has less, then the employer can offer a lower wage, and wages will be lower.

Now, think about The Body Shop's open hiring. Suddenly, they are willing to accept applications from almost anyone. Applications flood in. The Body Shop has lots of potential workers to choose from. If Worker A isn't willing to accept the wage that The Body Shop offers, then they can simply move on to Worker B, or Worker C, or any of the countless other applicants. Can you see that this 'open hiring' shifts the bargaining power in favour of The Body Shop? They can offer lower wages because the applicant pool is much larger than before.

Second, consider asymmetric information and adverse selection. Workers know how productive they are (more or less), but the employer doesn't know - this is private information. The employer usually wants to hire the most productive workers. So, they try to reveal the private information through screening. The background checks, and job interviews, and psychometric tests and whatever else that human resources people dream up are all ways of screening job applicants in order to determine which of them are most likely to be highly productive workers for the employer.

Now, consider what happens if you remove the screening tools like background checks. Now the employer can't tell the more productive and less productive applicants apart. Basically, they would have to assume that all applicants are the same, and the safer assumption to make is that they are all of the less productive type - we refer to this as a pooling equilibrium. Normally, we'd consider a pooling equilibrium to be bad - employers want to tell the more productive and less productive workers apart. However, if an employer had to assume that all workers were of the less productive type, then their best option is to offer a lower wage (why pay a high wage to workers who are likely to have low productivity?).

So, now you can see that there are two good (albeit cynical) reasons to see why The Body Shop's 'open hiring' philosophy makes good business sense. That's not the end of the story though. Background checks are a fairly imperfect screening tool, and even job interviews and psychometric tests can get things wrong. A better screening tool is to let the worker do some work, and observe their productivity. If the employer can then easily fire any less-productive workers, then this may be a more accurate way to identify the most productive job applicants.

In the U.S., many states have 'at-will employment laws', which basically mean that the employer can fire a worker at any time for any reason (there are exemptions, and the actual laws vary by state). It is interesting to note that North Carolina is a state with at-will laws, and North Carolina is where The Body Shop's distribution centre that trialled 'open hiring' is located.

The Body Shop may well have gotten a lot of positive press with this move, but it's likely that is not the only benefit they have enjoyed from 'open hiring'.

[HT: Marginal Revolution]

It's January, so that means rising house rents are in the news

There are few certainties in life: death, taxes, and January news items about rent increases (as I've highlighted last year, and in 2017, 2016, and 2015. I'm not sure I have anything new to say on the topic, but then again, neither do the media. So, here's this year's article from the New Zealand Herald, about Auckland and Wellington (see also this article as well):

An Auckland agent says more prospective tenants are flocking to house viewings than ever before as a photo posted to social media showed up to 50 people snaking their way through a Remuera rental this week.

One city tenant, aged in his 60s, said he and his wife were shocked when the first home they viewed - a three-bedroom Greenlane house with a rent of $830 per week - also had 50 people present.

The man - who only wanted to be known as Chris - had been keen to move out of his current rental because the landlord tried to bump the rent up by $20 per week.

But after seeing so many people in Greenlane, Chris and his wife - who own a property in Australia - decided to stay in their current rental and negotiate a lesser rent increase of $10 per week.

I have just two words to say: excess demand. Ok, I lied. I have more than two words. Excess demand happens when the market price is below the market-clearing equilibrium price. So, if you have lots of people looking for houses to rent, and not enough houses to go around, it's because the rents are too low. Normally, we would expect markets to adjust, but for some reason the rental market seems to be perpetually in a state of excess demand. In a 2016 post, I pondered whether efficiency rents might be an explanation for the persistently low rents:

If the landlord instead offered an efficiency rent (a rent below the equilibrium market rent), then they would have many potential tenants applying for the property, allowing the landlord to pick the best (the least likely to damage the property). It also gives the tenants an incentive to look after the property after signing the tenancy agreement, because if they don't they get evicted and have to find another place to live at a much higher cost.

Maybe landlords offer efficiency rents already and we just don't realise it?

This year, I had a student working on this topic for their ECON499 research project, based on a survey of landlords. I'll post in more detail on the results later, since I am re-analysing the data, but the student's simple analysis showed that landlords are more likely to offer below market rents to existing tenants, but offer market rents to new tenants. At least, that's what the landlords say they do. Which suggests that efficiency rents are not a strong explanation for the excess demand in the rental market. Maybe landlords are not good at setting rents? Seems unlikely - most landlords have a lot of experience and many properties.

Maybe what we're observing isn't really excess demand at all? If we think about the traditional excess demand in the goods market, the number of goods available is not enough to satisfy all buyers. So, some buyers go away from the market empty-handed, even though they were willing to pay the market price. However, in the rental market, most 'buyers' are already tenants somewhere else, so they aren't going away empty-handed - they are just going back to their previous property (as the example of Chris from the quote above shows).

A better way to think about this might be a search model of the rental market, in the same way that search models have been applied to understanding labour markets (where workers might be searching for a new job even though they already have one). Something to think about in future. In the meantime though, expect a flood of media coverage about rents every January.

Read more:

• That January tradition... rent increases, Wellington edition
• This is what happens when you have shortages of rental property
• Students, rental shortages, and renting over the summer
• January tradition continued... Rent increases again
• A January tradition - complaints about rising rents
• Out-of-control rent increases in Auckland - why?