EconTalk this week

Cat owner David Skarbek of King's College London and author of The Social Order of the Underworld: How Prison Gangs Govern the American Penal System talks with EconTalk host Russ Roberts about the written and unwritten rules in America's prisons for the most violent and dangerous criminals. Skarbek explains how and why prison gangs emerged in the last half of the 20th century, their influence both inside and outside of prisons, and how their governance structure is maintained.

A direct link to the audio is available here.

Russ Roberts open the conversation by saying,

So, I want to warn listeners this episode of EconTalk may be a lot more disturbing than our usual fare. If you are listening with young children, you may want to preview before you share it with them. This has--I forget what the language is in the movie--I think it's 'thematic,' PG-13 for thematic material, or something like that. So I just wanted to let people know up front that there may be some disturbing images or conversation here.

Effect of board quotas on female labour market outcomes in Norway

And the short answer is, not much.

After Norway passed a law, in late 2003, mandating that public limited-liability corporations create boards with no less than 40 percent of each gender represented, the number and quality of women board directors rose and the pay gap vis-a-vis male board members shrank. But 10 years into this experiment, which now is being copied in other countries, there's not much evidence of a trickle-down effect for other women in the workforce,

In their paper Breaking the Glass Ceiling? The Effect of Board Quotas on Female Labor Market Outcomes in Norway authors Marianne Bertrand, Sandra E. Black, Sissel Jensen, and Adriana Lleras-Muney write,

We find no evidence of significant differential improvements for women in the post-reform cohort, either in terms of average earnings or likelihood of filling in a top position in a Norwegian business.

At best, the reform may have increased women's representation in the C-suite - top executive positions in the firm - of targeted firms, a very small group of individuals.

The representation of women does not improve anywhere else in the [targeted] firms' income distribution (top 95th percentile, top 90th percentile, top 75th percentile). We also see no improvements on gender wage gaps among top earners and find no evidence of changing work environments in affected firms.

Additionally, there is no evidence that the rise in female board members inspired younger women to consider business careers or delay child-rearing in order to further careers. In the authors' survey of 763 students at the prestigious Norwegian School of Economics, from which many board members have graduated in the past, fewer than 10 percent of women said the reform encouraged them to get a business degree.

If anything, the share of women obtaining business degrees fell after 2004 (except for 2007).

The authors also note that

[...] we see no apparent reduction in the large gender gap in earnings that emerge in the first few years post graduation.

Now what of the law of unintended consequences?

When faced with the quota, firms could either choose to comply with the law or change their status from public to private. The paper shows that a large number of public limited liability companies changed their status to private after 2003. Of the 563 companies that were ASA - that is, public limited liability companies in Norway - in 2003, only 346 remained ASA by 2005 and only 179 by 2008. Focusing on companies listed on the stock exchange prior to the reform (a strict subset of all ASA firms), it has been shown that the likelihood of delisting anytime between 2003 and 2009 was larger among those with a smaller pre-quota share of women on their board, suggesting that many firms might have delisted to avoid complying with the mandate. Thus the final number of new positions reserved for women was ultimately smaller than expected when the law was passed.

Also, using publicly available data, Matsa and Miller (2013) examine the effect of the quota on accounting performance. Using firms in Sweden as a control group, they show that the change in the board quota law led to a decline in operating profits.

Isn't this the real issue? If having more women on company boards really does lend to reduced profits then you can see why firms may not be too keen on having them.

The paper's abstract reads:

In late 2003, Norway passed a law mandating 40 percent representation of each gender on the board of publicly limited liability companies. The primary objective of this reform was to increase the representation of women in top positions in the corporate sector and decrease gender disparity in earnings within that sector. We document that the newly (post-reform) appointed female board members were observably more qualified than their female predecessors, and that the gender gap in earnings within boards fell substantially. While the reform may have improved the representation of female employees at the very top of the earnings distribution (top 5 highest earners) within firms that were mandated to increase female participation on their board, there is no evidence that these gains at the very top trickled-down. Moreover the reform had no obvious impact on highly qualified women whose qualifications mirror those of board members but who were not appointed to boards. We observe no statistically significant change in the gender wage gaps or in female representation in top positions, although standard errors are large enough that we cannot rule economically meaningful gains. Finally, there is little evidence that the reform affected the decisions of women more generally; it was not accompanied by any change in female enrollment in business education programs, or a convergence in earnings trajectories between recent male and female graduates of such programs. While young women preparing for a career in business report being aware of the reform and expect their earnings and promotion chances to benefit from it, the reform did not affect their fertility and marital plans. Overall, in the short run the reform had very little discernible impact on women in business beyond its direct effect on the newly appointed female board members.

Ref.:

• Matsa, David A., and Amalia R. Miller, 2013. “A Female Style in Corporate Leadership? Evidence from Quotas.” American Economic Journal: Applied Economics, 5(3): 136-69.

EconTalk this week

Campbell Harvey of Duke University talks with EconTalk host Russ Roberts about his research evaluating various investment and trading strategies and the challenge of measuring their effectiveness. Topics discussed include skill vs. luck, self-deception, the measures of statistical significance, skewness in investment returns, and the potential of big data.

A direct link to the audio is available here.

Wage inequality and firm growth

At VoxEU.org Holger Mueller, Paige Ouimet and Elena Simintzi look at the relationship between Wage inequality and firm growth. Rising wage inequality has received much attention recently and this column describes new evidence on the determinants of the 'skill premium'.

There are two basic findings:

1) larger firms have grown substantially and
2) skill premia are larger at larger firms.

They therefore conclude that the growth of larger firms could help explain growing wage inequality.

To get to these results first it is necessary to identify the 'skill premium' and know how to measure it. The 'skill premium' is simply the wage difference between high and low skill workers. Defining the skill premium is one thing, measuring it is another.

Existing measures of skill premia, such as education, experience, or even occupations, are not adequate as they do not reflect a one-to-one mapping between job tasks and skill requirements. [...].

In our data, provided by Income Data Services (IDS), we observe how much a firm pays workers employed in different occupations and, crucially, how these occupations map into broader ‘job level’ categories which are comparable across firms. Since job levels are determined based on the skills required for the job, comparing wages for a worker classified at a high job level to a worker classified at a low job level allows us to more directly measure the skill premium. Moreover, since we have these data for a broad cross-section of firms measured at multiple points in time, we can observe within-firm and across-time patterns in the skill premium.

To provide further detail, consider a cleaner and a finance director. The cleaner corresponds to job level 1, work that “requires basic literacy and numeracy skills and the ability to perform a few straightforward and short-term tasks to instructions under immediate supervision”. The finance director corresponds to our highest skill category – job level 9 and involves “very senior executive roles with substantial experience in, and leadership of, a specialist function, including some input to the organisation’s overall strategy”. We measure skill premium using a ratio of a high-skill to low-skill job, at the same firm, in the same year.

Importantly,

When examining ‘top-bottom’ wage ratios in our sample (e.g., the wage associated with job level 8 divided by the wage associated with job level 1 within the same firm and year), we find they increase with firm size. A similar, albeit weaker, relationship arises when we look at ‘top-middle’ wage ratios (e.g. the wage associated with job level 8 divided by the wage associated with job level 4 within the same firm and year). In contrast, ‘middle-bottom’ wage ratios (e.g. the wage associated with job level 4 divided by the wage associated with job level 1 within the same firm and year) stay flat, or if anything slightly decrease with firm size.

• What is interesting is that when low job levels (1 to 5) are compared to one another, an increase in firm size has no effect on within-firm skill premia.
• In contrast, when high job levels (6 to 9) are compared to either one another or low job levels, an increase in firm size widens the wage gap between higher and lower skill categories.

The question this give rise to is Why do wages in high-skill job categories increase with firm size but not wages in low- and medium-skill job categories?

We provide two possible explanations.

• First, larger firms invest more in automation which allows them to replace labour with technology in certain routine jobs [...].

Consistent with this hypothesis, we find that wages associated with routine jobs decline relative to those associated with non-routine jobs as firms become larger, especially in medium-skill job categories.

• Second, larger firms may pay relatively lower entry-level managerial wages in return for providing better career opportunities [...].

Consistent with this hypothesis, we find that managerial wages in low- to medium-skill job categories are relatively lower in larger firms, while those in high-skill job categories are relatively higher in larger firms.

Is there a third factor here? We know that the division of labour is limited by the extent of the market and bigger firms have larger internal labour markets which gives raise to a greater levels of specialisation with some areas of specialisation being more valuable than others. These higher value jobs receive greater remuneration.

The last question is, What do the results say about overall wage inequality?

An increasing skill premium at larger firms will lead to greater wage inequality inside those firms. But how has the size of the median employer changed over the last two decades? US firms with 500 or more employees accounted for 51.5% of all employment in 2011. As such, we measure firm size by focusing on the largest firms and find evidence of strong firm growth among larger firms in practically all of the developed countries in our sample. These results suggest that part of what may be perceived as a global trend toward more wage inequality may be driven by an increase in employment by the largest firms in the economy.

So the upshot of this is that the growth of larger firms in the economy may partially explain the rise in wage inequality seen over the last few decades.

The eugenic effects of minimum wage laws

I came across a bit of the history of the minimum wage that I didn't know today. A 2005 article by Thomas C. Leonard in the Journal of Economic Perspectives (Vol. 19 No. 4 Fall 2005) discusses Eugenics and Economics in the Progressive Era. Leonard opens the article by noting,

American economics transformed itself during the Progressive Era. In the three to four decades after 1890, American economics became an expert policy science and academic economists played a leading role in bringing about a vastly more expansive state role in the American economy. By World War I, the U.S. government amended the Constitution to institute a personal income tax, created the Federal Reserve, applied antitrust laws, restricted immigration and began regulation of food and drug safety. State governments, where the reform impulse was stronger still, regulated working conditions, banned child labor, instituted “mothers’ pensions,” capped working hours and set minimum wages.

Less well known is that a crude eugenic sorting of groups into deserving and undeserving classes crucially informed the labor and immigration reform that is the hallmark of the Progressive Era (Leonard, 2003). Reform-minded economists of the Progressive Era defended exclusionary labor and immigration legislation on grounds that the labor force should be rid of unfit workers, whom they labeled “parasites,” “the unemployable,” “low-wage races” and the “industrial residuum.” Removing the unfit, went the argument, would uplift superior, deserving workers.

He goes on in the article to write about "The eugenic effects of minimum wage laws".

During the second half of the Progressive Era, beginning roughly in 1908, progressive economists and their reform allies achieved many statutory victories, including state laws that regulated working conditions, banned child labor, instituted “mothers’ pensions,” capped working hours and, the sine qua non, fixed minimum wages. In using eugenics to justify exclusionary immigration legislation, the race-suicide theorists offered a model to economists advocating labor reforms, notably those affiliated with the American Association for Labor Legislation, the organization of academic economists that Orloff and Skocpol (1984, p. 726) call the “leading association of U.S. social reform advocates in the Progressive Era.”

Progressive economists, like their neoclassical critics, believed that binding minimum wages would cause job losses. However, the progressive economists also believed that the job loss induced by minimum wages was a social benefit, as it performed the eugenic service ridding the labor force of the “unemployable.” Sidney and Beatrice Webb (1897 [1920], p. 785) put it plainly: “With regard to certain sections of the population [the “unemployable”], this unemployment is not a mark of social disease, but actually of social health.” “[O]f all ways of dealing with these unfortunate parasites,” Sidney Webb (1912, p. 992) opined in the Journal of Political Economy, “the most ruinous to the community is to allow them to unrestrainedly compete as wage earners.” A minimum wage was seen to operate eugenically through two channels: by deterring prospective immigrants (Henderson, 1900) and also by removing from employment the “unemployable,” who, thus identified, could be, for example, segregated in rural communities or sterilized.

While both progressive economists and their neoclassical critics believed that a minimum wage caused unemployment, it was the neoclassical economists of the time, like Alfred Marshall, Philip Wicksteed, A. C. Pigou in the U.K. and John Bates Clark in the U.S, who regarded the job losses as a social cost of minimum wages, not as a putative social benefit as the progressives saw them.

Leonard continues,

Columbia’s Henry Rogers Seager, a leading progressive economist who served as president of the AEA in 1922, provides an example. Worthy wage-earners, Seager (1913a, p. 12) argued, need protection from the “wearing competition of the casual worker and the drifter” and from the other “unemployable” who unfairly drag down the wages of more deserving workers (1913b, pp. 82–83). The minimum wage protects deserving workers from the competition of the unfit by making it illegal to work for less. Seager (1913a, p. 9) wrote: “The operation of the minimum wage requirement would merely extend the definition of defectives to embrace all individuals, who even after having received special training, remain incapable of adequate self-support.” Seager (p. 10) made clear what should happen to those who, even after remedial training, could not earn the legal minimum: “If we are to maintain a race that is to be made of up of capable, efficient and independent individuals and family groups we must courageously cut off lines of heredity that have been proved to be undesirable by isolation or sterilization ... .”

The unemployable were thus those workers who earned less than some measure of an adequate standard of living, a standard the British called a “decent maintenance” and Americans referred to as a “living wage.” For labor reformers, firms that paid workers less than the living wage to which they were entitled were deemed parasitic, as were the workers who accepted such wages—on grounds that someone (charity, state, other members of the household) would need to make up the difference.

For progressives, a legal minimum wage had the useful property of sorting the unfit, who would lose their jobs, from the deserving workers, who would retain their jobs. Royal Meeker, a Princeton economist who served as Woodrow Wilson’s U.S. Commissioner of Labor, opposed a proposal to subsidize the wages of poor workers for this reason. Meeker preferred a wage floor because it would disemploy unfit workers and thereby enable their culling from the work force. “It is much better to enact a minimum-wage law even if it deprives these unfortunates of work,” argued Meeker (1910, p. 554). “Better that the state should support the inefficient wholly and prevent the multiplication of the breed than subsidize incompetence and unthrift, enabling them to bring forth more of their kind.” A. B. Wolfe (1917, p. 278), an American progressive economist who would later become president of the AEA in 1943, also argued for the eugenic virtues of removing from employment those who “are a burden on society.”

Frank Taussig, one of the leading economists of the time, asked the question “how to deal with the unemployable?” in his book Principles of Economics (Taussig 1921, pp. 332–333)

Taussig identified two classes of unemployable worker, distinguishing the aged, infirm and disabled from the “feebleminded . . . those saturated with alcohol or tainted with hereditary disease . . . [and] the irretrievable criminals and tramps. . . .” The latter class, Taussig proposed, “should simply be stamped out.” “We have not reached the stage,” Taussig allowed, “where we can proceed to chloroform them once and for all; but at least they can be segregated, shut up in refuges and asylums, and prevented from propagating their kind.”

The idea held by progressive economists that the unemployable could not earn a living wage was bound up with the progressive view of wage determination.

Unlike the economists who pioneered the still-novel marginal productivity theory, most progressives agreed that wages should be determined by the amount that was necessary to provide a reasonable standard of living, not by productivity, and that the cost of this entitlement should fall on firms.

But how should a living wage be determined? Were workers with more dependents, and thus higher living expenses, thereby entitled to higher wages? Arguing that wages should be a matter of an appropriate standard of living opened the door, in this era of eugenics, to theories of wage determination that were grounded in biology, in particular to the idea that “low-wage races” were biologically predisposed to low wages, or “under-living.” 7 Edward A. Ross (1936, p. 70), the proponent of race-suicide theory, argued that “the Coolie cannot outdo the American, but he can underlive him.” “Native” workers have higher productivity, claimed Ross, but because Chinese immigrants are racially disposed to work for lower wages, they displace the native workers.

John R. Commons, one of the leading (old) institutional economists (the new institutional economics follows from the work of Ronald Coase) argued that wage competition not only lowers wages, it also selects for the unfit races.

“The competition has no respect for the superior races,” said Commons (1907, p. 151), “the race with lowest necessities displaces others.” Because race rather than productivity determined living standards, Commons could populate his low-wage-races category with the industrious and lazy alike. African Americans were, for Commons (p. 136), “indolent and fickle,” which explained why, Commons argued, slavery was required: “The negro could not possibly have found a place in American industry had he come as a free man . . . [I]f such races are to adopt that industrious life which is second nature to races of the temperate zones, it is only through some form of compulsion.” Similarly, Wharton School reformer Scott Nearing (1915, p. 22), volunteered that if “an employer has a Scotchman working for him at $3 a day [and] an equally efficient Lithuanian offers to the same work for $2 . . . the work is given to the low bidder.”

Leonard continues by looking at the reaction of the progressives to the situation in other countries,

When U.S. labor reformers reported on labor legislation in countries more precocious with respect to labor reform, they favorably commented on the eugenic efficacy of minimum wages in excluding the “low-wage races” from work. Harvard’s Arthur Holcombe (1912, p. 21), a member of the Massachusetts Minimum Wage Commission, referred approvingly to the intent of Australia’s minimum wage law to “protect the white Australian’s standard of living from the invidious competition of the colored races, particularly of the Chinese.” Florence Kelley (1911, p. 304), perhaps the most influential U.S. labor reformer of the day, also endorsed the Australian minimum-wage law as “redeeming the sweated trades” by preventing the “unbridled competition” of the unemployable, the “women, children, and Chinese [who] were reducing all the employees to starvation . . .”

For these progressives, race determined the standard of living, and the standard of living determined the wage. Thus were immigration restriction and labor legislation, especially minimum wages, justified for their eugenic effects. Invidious distinction, whether founded on the putatively greater fertility of the unfit, or upon their putatively greater predisposition to low wages, lay at the heart of the reforms we today see as the hallmark of the Progressive Era.

As an aside, Austria wasn't the only place down-under which tried to protect the white workers standard of living against competition from the Chinese. New Zealand however used a taxes rather than labour regulation. The 1881 Chinese Immigrants Act has imposed a 10 pound poll tax on Chinese immigrants. There were also steep custom duties on opium.

So the history of the minimum wage isn't, unfortunately, just about making the worst-off better-off.

EconTalk this week

Paul Romer of New York University talks with EconTalk host Russ Roberts about reforming cities to allow growth and human flourishing. Topics discussed include charter cities, the role of population density in city life, driverless cars, and various ways to help the poorest people in the world.

A  direct link to the audio is available here.

Short-term, long-term, and continuing contracts

The reference point approach to incomplete contracts as developed by Hart and Moore (2008) has in the last few years been applied to an increasing number of issues to do with contracts and related areas. According to this approach one role of a contract is to get parties "on the same page", so as to avoid future misunderstanding. Misunderstanding leads to "aggrievement" and "shading" (in the form of departures from consummate (or welfare-maximising) performance), and consequent deadweight losses. For examples of a couple of areas to which the reference point approach has been applied see Walker (2013) for a survey of the application of the reference point approach to the theory of the firm and Halonen-Akatwijuka and Hart (2013) which looks at why parties may intentionally write incomplete contracts.

Now Halonen-Akatwijuka and Hart have a new NBER working paper out on Short-term, Long-term, and Continuing Contracts, NBER Working Paper No. 21005, issued in March 2015. The basic idea being that there are 3 forms of contract that we can write: short-term (a one period contract) long-term  (a multi-period contract) and continuing (a contract that is normally rolled over each period). There is a growing literature on why parties write long-term contracts. A leading explanation is that such contracts are useful to support specific investments, and there is much empirical support for this. As to why parties write short-term contracts, that is, contracts that are shorter than the likely term of their relationship a commonly seen answer is that it is costly for the parties to anticipate the contingencies that will arise during the latter part of their relationship and to write down unambiguously how to deal with them. The disadvantage of the long-term contract is that costly renegotiation may be necessary if there are no gains from trade in some future period covered by the contract. A short-term contract is disadvantaged because a new contract needs to be negotiated for each future period in which there are gains from trade.

A continuing contract - that is, a contract which is neither long-term nor short-term but usually rolled over each period - can be better than both these other types of contract. Examples of such contracts would be rental contracts where the lease is typically renewed; month to month rental contracts with no lease; employment contracts where each party can (under some conditions) terminate the relationship, but where they usually do not – most of the time business continues "as usual". In a continuing contract there is no obligation to trade in a future period but if there are gains from trade the parties will bargain "in good faith" using the first period contract as a reference point. This has the advantage that it can reduce the cost of negotiating the next contract.

Unfortunately such contracts also have a down side in that good faith bargaining may preclude the use of outside options in the bargaining process and as a result parties will sometimes fail to trade when this is efficient. So no one contract type is superior in all situations.

Refs.:

• Halonen-Akatwijuka, Maiji and Oliver D. Hart (2013). `More is Less: Why Parties May Deliberately Writes Incomplete Contracts', National Bureau of Economic Research, NBER Working Papers No. 19001, April.
• Hart, Oliver D. and John Moore (2008). `Contracts as Reference Points', Quarterly Journal of Economics, 123(1) February: 1-48.
• Walker, Paul (2013). `The `Reference Point' Approach to the Theory of the Firm: An Introduction', Journal of Economic Surveys, 27(4) September: 670-95.

EconTalk for two weeks

David Zetland of Leiden University College in the Netherlands and author of Living with Water Scarcity talks with EconTalk host Russ Roberts about the challenges of water management. Issues covered include the sustainability of water supplies, the affordability of water for the poor, the incentives water companies face, and the management of water systems in the poorest countries. Also discussed are the diamond and water paradox, campaigns to reduce water usage, and the role of prices in managing a water system.

A direct link to the audio is available here.

Lawrence H. White of George Mason University talks with EconTalk host Russ Roberts about the possibility of a monetary constitution. Based on a new book, Renewing the Search for a Monetary Constitution, White explores different constitutional constraints that might be put on the government's role in money and monetary policy. Topics discussed include cryptocurrencies, the gold standard, the Taylor Rule, the performance of the Fed, free banking, and private currency.

A direct link to the audio is available here.

Contracts, entrepreneurs, market creation and judgement: the contemporary mainstream theory of the firm in perspective

A great new paper is out in the Journal of Economic Surveys, Vol. 29, No. 2, 2015, pp. 317–338 on Contracts, entrepreneurs, market creation and judgement: the contemporary mainstream theory of the firm in perspective.

The paper surveys the contemporary mainstream theory of the firm. Contemporary meaning post-1970 while the mainstream "[...] consists of the ideas that are held by those individuals who are dominant in the leading academic institutions, organisations and journals at any given time, especially the leading graduate research institutions. Mainstream economics consists of the ideas that the elite in the profession finds acceptable, where by elite we mean the leading economists in the top graduate schools. It is not a term describing a historically determined school, but is instead a term describing the beliefs that are seen by the top schools and institutions in the profession as intellectually sound and worth working on".

As far as the theory is concerned, two general groupings of theories are briefly discussed: principal–agent models and incomplete contract models. Each of these general groups can be subdivided to give an elementary organisational structure for the contemporary theory of the firm. The principal agent groups contains three sub-groups: 1) the nexus of contracts view, 2) the firm as a solution to moral hazard in teams approach and 3) the firms as an incentive system view, while the incomplete contracts group contains five subgroups: 1) the authority view, 2) the firm as a governance mechanism, 3) the firm as an ownership unit, 4) implicit contracts and 5) the firm as a communication-hierarchy. Then, three of the most recent contributions regarding firms are considered. The reference point approach is looked at first followed by a discussion of Spulber's book The Theory of the Firm. Last, the "entrepreneurial judgement" perspective of Foss and Klein is considered.

A wonderful little paper. Not that I'm biased or anything.