Saturday, January 27, 2007

The sensitivity of industries to labour regulations

Don Boudreaux over at Café Hayek pointed to an article by Gary Becker and Richard Posner ($) published in yesterday’s Wall Street Journal. Here’s an excerpt:

An increase in the minimum wage raises the costs of fast foods and other goods produced with large inputs of unskilled labor. Producers adjust both by substituting capital inputs and/or high-skilled labor for minimum-wage workers and, because the substitutes are more costly (otherwise the substitutions would have been made already), by raising prices. The higher prices reduce the producers' output and thus their demand for labor. The adjustments to the hike in the minimum wage are inefficient because they are motivated not by a higher real cost of low-skilled labor but by a government-mandated increase in the price of that labor. That increase has the same misallocative effect as monopoly pricing.
Surely, just like the minimum wage, other regulations on labour also have a greater impact on certain industries relative to others. I started thinking about this when another commentator asked why the U.S. doesn’t adopt a 35-hour work week. Here’s most of what I posted in response on Café Hayek:

….regulations on hours worked can be just as painful to certain sectors as minimum wage requirements. First, it does seem odd that 40 hours is considered to be a "natural" and permanent level (although, I think the French have already proven what a failure the 35-hour week can be). Second, I can’t understand how an obligatory set of hours can be optimal for ALL industry sectors. Perhaps regulations on hours of work distorts the ability of each sector to find its own "natural" level through heuristic means, or whatever, thus hampering productivity and efficiency in certain sectors. I’ll explain.

Any strict regulation on hours worked, be it 40 hours or whatever, may not work for all sectors for at least two reasons: i) some sectors are productive in spurts (I’m reminded of a post on freexchange where a reader notes that "anyone building a house or undertaking a project that requires a number of diversified tasks comes up against the brick wall of inefficiency" when faced with regulations on hours worked); and ii) not all sectors have the same firm-size make-up. An IMF report shows that moving from a 40-hour to a 35-hour work week encouraged French workers in "large firms to take second jobs or to move to small firms where the 35-hour work week is not obligatory." In other words, while a 35-hour work week might be optimal for sectors comprised of small firms, it is likely not optimal for larger corporations, the backbone of our economy.

Another reader points out something that I didn’t add, but I should have:

I agree that it should be up to the company how many hours one should work - up to some maximum allowed under law under at-will labor. I mean, as long as you know the terms before you agree to the work, companies should have a lot of flexibility.

I just wanted to take note of the subject of work hour regulations here because I thought it might be interesting to sometime explore its impact on various industry sectors. Perhaps some industries have more to gain from a barrier-free labour market than others. Further, perhaps the existence of certain regulations on labour distorts the "natural" sectoral make-up of a nation's economy.


Nick said...


dingus said...

The "mischief" avoided by regulation may differ as well. While mostly the aim is probably to ensure workers don't enslave themselves and can lead normal lives without their employers demanding an unreasonable amount of their time, in many industries or occupations, there are potentially safety concerns raised by working too much and workers becoming hazards to themselves and others due to fatigue. Take, for example, the work being done now on hours of work for truckers. Any limit doesn't do anything much for the trucker's qualtiy of life; it is meant to prevent accidents.

dingus said...

And I echo nick's astute comments.

true dough said...

I believe that there is a role for government to ensure that nobody is doing another person harm (eg. I'd advocate for a very general law on maximum hours worked, but nothing that's too intrusive on the firm), but regulation by the government in most situations isn’t necessary. Actually, it’s often even ineffective, I believe.

As to your example of truck drivers, I’m still thinking this over…but, if highways were privately owned, the owners would impose safety regulations on them to keep them operating smoothly. Truckers, and the companies they work for, would be made to comply to safety rules set by the firm in order to use the roads. Further, the owners of the roads would have an incentive to keep them well-maintained.

Some people might argue that paying to use a road isn’t an attractive idea. But we pay now; we pay in taxes. And much of what we pay is not as wisely spent as it would be if the money were spent by a firm.

true dough said...

I think Nick is building on something.

dingus said...

"As to your example of truck drivers, I’m still thinking this over…but, if highways were privately owned, the owners would impose safety regulations on them to keep them operating smoothly. Truckers, and the companies they work for, would be made to comply to safety rules set by the firm in order to use the roads. Further, the owners of the roads would have an incentive to keep them well-maintained."

Not necessarily. If their interest was to increase the number of trips -- that is, if they also owned the truck or the freight and had an interest in delivery as rapidly as possible, and the cost of accidents was less than the cost of maintenance then why maintain? Or, if they earned tolls for access, without there being a decent competitor with an alternate route, then there's no incentive to maintain.

Also add to that public safety -- what is the incentive if there is private ownership?

dingus said...

"And much of what we pay is not as wisely spent as it would be if the money were spent by a firm. "

Really? I hear stuff like that and it sounds so libertarianishly dogmatic.

Imagine if the government played no role in the construction of roads. Firms would compete to buy or lease land on which to build roads. They'd have to have colossal capital to get rights to the land, then colossal capital to build the road. It's hard to see how a toll that pays for the investment could come in at a price point where the users could actually pay it. Monopolies or oligopolies would dominate. Rent seeking would occur. Competition would be unlikely, markets would be more or less captive. And without a real substitution of the product or service, the efficiencies of competition -- ie competitive tolls, better quality roads just aren't there. There would be malinvestment as competing roads were constructed and abandoned, with externalities imposed on the public in terms of destroyed agricultural, residential or commercial land.

But the private sector minds its pennies better because... why? Shareholders are more diligent than taxpayers? So all is good?

true dough said...

Well, I have to admit, the private ownership of highways was a thought I was entertaining, BUT, I stand by the argument that a system that is owned and operated by the government is not as strong as one that introduces competitive industry.

What if all governments in Canada switched to a private contract scheme instead of maintaining highways themselves (as some already have)?

I’m looking at it like this: When a firm vertically integrates (say it begins producing its own raw materials, thus eliminating the supplier), what incentive does it have to maintain the quality of its raw materials? Little, to a degree. When it purchased its raw materials from a seller, the seller has an incentive to maintain quality, else the purchaser would get its raw materials elsewhere.

Perhaps there’s a parallel here to road infrastructure. If highways are owned and operated by the government, do they have as much incentive to keep them in good condition as a firm would if it were contracted to do the work? If the highways are privately contracted, quality would increase. As far as costs increasing, as I understand it, they did not increase in Sweden after switching to a private contract scheme. They decreased. Whether we can compare this to Canada, I don't know.

happyjuggler0 said...

Becker and Posner covered the privatisation of Indiana's toll road here and here. They also give a couple of responses to comments here and here.

The links start at the comments section, you have to scroll up to see the original posts. I can't figure out how to link to the top of the pages, sorry.

Things that are sometimes called natural monopolies can be hard politically to privatise, and it may well be that without regulation to prevent abuse it would be a bad idea. But a good start is to privatise them anyway, with regulation, perhaps like Indiana did.

Then perhaps, or perhaps not, over time when "everyone" is used to the idea of private ownership of these assets, it may be foreseeable to actually rationally end the regulation of at least some such assets. Or not. But I don't think "we can get there from here". We at the very least need a partial step first.

dingus said...

"If the highways are privately contracted, quality would increase."

But what's the mechanism, to whom are the private firms accountable? If competition is impaired, cost cutting and quality impairment is an easy way to enhance shareholder value.

That's it! I'm no longer going to drive on your road, sir! The shoulders are in poor repair!

true dough said...

I try to avoid the subject of natural monopolies because it’s such an easy target for groundless arguments based on one’s favourite ideology, or so it seems. Empirical evidence is lacking (and so is my knowledge on highway, telephone, etc. economics).

I’ll admit that Becker and Posner provide a nice framework for discussion, but they run into the same quagmire. Eg, Becker: “To an extent, the toll-road operator may be able to discourage substitution by price discrimination, but this is unlikely to be fully effective and indeed can actually increase the allocative inefficiency of the monopoly.” And then he just runs with it (much like I attempted to do in my argument, but Dingus wouldn’t allow it). I don’t dismiss Posner’s argument (nor do I agree), but I’d love to know where the hell he gets it from. (Yes, perhaps if I didn’t avoid this subject I’d know.)

The only thing individuals can (usually) agree on with some certainty is that there often seems to be a trade-off between efficiency and revenues.

Anyway, again, Becker and Posner provide a nice framework for discussion. Thanks for the links, happyjuggler0.

true dough said...

Okay, and now I’ll return to “running with it”…


Why does quality have to be impaired? Firms will compete for the renewal of their contract. (Of course, it would be most efficient if the government remained with the same firm.)

To pull a quote from Becker: “…other companies are more likely to find ways to compete against private monopolies than against government ones….The main challenge arises when it is more difficult to stimulate competition for the privatized company because of so-called "natural monopoly" conditions in the industry….but controls could be imposed on the prices and other conditions that can be levied imposed on consumers by the privately owned road.”

(That’s from juggler’s second link.)

If we accept this, as I do, quality is more likely to suffer under a government monopoly. Who holds the government accountable?

Anecdotal evidence: Looking at the bad state of northern Ontario’s highways (eg. 1/4 of a lane on a major trucking route outside of Timmins, having completely collapsed down a cliff, was merely pyloned off for more than 7 months), it’s hard to see how governments really are held accountable.

Oh, FWIW, I should correct myself on a previous comment. Sweden did not entirely switch to private contracts for highway maintenance. Some work is still done in-house by the government.

true dough said...

I hesitate to post three times in a row, but it is my blog….

I mentioned before about costs decreasing if maintenance was privatized. Posner has something to add to this that didn’t occur to me earlier:
“…their pricing and purchasing decisions, including decisions regarding wages and labor relations, are not distorted by political pressures and corruption.”
Think of all those flaggers standing, bored as heck, getting paid a fairly nice wage...considering.

happyjuggler0 said...

I'm not the biggest Posner fan, but Gary Becker seems to like him, so I let his bias overcome mine. ;)

The main reason I included his posts though was Becker's main post doesn't really make sense without Posner's post which outlined some details.

I too usually try to stay away from debates about natural monopolies. I prefer to spend my energies on things more obviously wrong, or obvious right as the case may be.

true dough said...

Oh, I’m clumsy. I meant to say "eg Posner: To an extent..." Perhaps you figured that out.

Anyway, I’m glad you linked to both pieces. It made more sense that way, as you say.

I haven’t read enough of Posner to form an opinion of him. Although, from the little that I have read, I find that Becker substantiates his claims better. Or, perhaps Becker is just a better "teacher." I don’t know.

dingus said...

"their pricing and purchasing decisions, including decisions regarding wages and labor relations, are not distorted by political pressures and corruption"

Well, the public sector does have an open tendering process, where the private sector tends towards concentration, and rewarding preferred suppliers. Labour relations in the private and public sectors are both governed by legislation. And private sector corruption? Heard of Enron?

true dough said...

I'm sure that the point you're trying to make is that corruption can exist in both public and private sectors. I won't argue with that.

But, in Becker's defence, he's talking specifically about corruption in pricing and purchasing decisions, which are more likely to occur in the private sector. In Enron's case, corruption was caused by accounting fraud. The difference is that governments can enforce rules on corporations to limit accounting fraud and such. Meanwhile, when the government is pressured into offering a certain wage, or making purchases from a certain region, etc, the situation is quite different.

Who sets limits on the government? Those who lobby the government are more likely to lobby in favour of higher subsidies, higher wages, etc. Not to bring wages down from an inflated level, for example.

dingus said...

"Who sets limits on the government?"

Umm...the opposition? Voters? Institutions designed to enhance accountability, like the auditor general? Does that sound hopelessly naive?

true dough said...

Yes, it sounds naïve to think that pressure from the opposition, voters, et al is sufficient enough to cause the government to make the same kind of purchasing and pricing decisions as a firm would.

I'm not implying that governments don't have good intentions; however, I believe that there are things that firms, “by nature,” can do better than the government. They have different priorities and objectives, and well they should.

The chances that the government will overspend are much greater than the chances of a firm not wanting to keep its costs down by its own initiative. Again, do you really believe that voters, lobbyists, etc are going to pressure the government in power to, say, pay/hire road construction crews less if they’re being overpaid/overhired? Or to lay off workers in periods of poor growth?

dingus said...

Well, I've worked in both, and I enjoy being in the private sector more, simply because budgetary pressures are a lot lower. In the public sector I had many, many (many!) things I was expected to do with a minimal budget. New budget funds were not forthcoming because it was perceived as politically unpalatable. Wages and salaries stalled for a decade, and even then only moved in concert with inflation. Financial accountability checks and processes bordered on the obsessive and counterproductive. We lived in fear of an audit by the a-g, or worse some unsatisfied contractual deliverable ending up in the news, or National Citizens Coalition report and the Minister then breathing fire at us. I gave it up.

I now find it much easier to get funds for projects in the private sector and easily justify high wages and contractor fees. I just think its way easier to sell shareholders on the value of activity than it is taxpayers.

That's just my experience, but I always get a little puzzled about characterizations of govt that go on about there being few checks, bureaucrats as profligate spenders etc., while the private sector is simply by definition super efficent and effective at reducing costs. It really doesn't reflect my experience at all. Models and theories say different. Shrug.

Thanks for the discussion. I enjoy the blog.

true dough said...

Thank you. And thanks for your comments!