© 2007 Thomson South-Western, all rights reserved N. G R E G O R Y M A N K I W PowerPoint ® Slides by Ron Cronovich 19 P R I N C I P L E S O F F O U R T H E D I T I O N Earnings and Discrimination

1 CHAPTER 19 EARNINGS AND DISCRIMINATION In this chapter, look for the answers to these questions:  What explains how much workers earn in particular occupations/jobs?  What factors explain differences across individuals in earnings? What is meant by human capital?  What are the difficulties in determining whether discrimination exists and what are its impacts?

2 CHAPTER 19 EARNINGS AND DISCRIMINATION Introduction  In competitive markets, the wages workers earn equal the value of their marginal products.  We shall examine earnings in two ways: Wages in particular occupations/jobs. This is explained by demand and supply forces in each labor market. Earnings of particular individuals. Earnings reflect characteristics of each person – factors that contribute to their productivity (across different types of job) which we label “human capital.”

3 CHAPTER 19 EARNINGS AND DISCRIMINATION Earnings by Occupation/Job: What explains why some jobs pay so much?  Value of marginal product for some types of jobs is very high, with workers adding significantly to a firm’s profitability.  In some occupations, many workers may have specialized education, skills, talents, creativity, etc. The market pays highly for these ‘unique’ talents.  High wages are sustained by the limited supply of workers. Supply at any point in time is inelastic; entry to the market is limited since few possess skills or are able to acquire them.

4 CHAPTER 19 EARNINGS AND DISCRIMINATION The Labor Supply Curve in Labor Markets Defined by Occupation/Skill plays a key role.  The primary source of labor for most occupations is people switching from other occupations. New labor market entrants are typically a small fraction of labor supply.  “Entry costs” – the difficulty of acquiring needed skills – determines the elasticity of labor supply in the short run, and also the nature (and time lags) of labor supply adjustments in the long run.

5 CHAPTER 19 EARNINGS AND DISCRIMINATION Labor Market for Highly Skilled Workers  Technological progress and a knowledge-based economy is increasing the demand for educated, highly skilled workers.  Entry costs for highly skilled, specialized jobs are often high.  Rising labor demand and inelastic supply in the short run leads to rising wages.  Some skilled workers (especially in manufacturing) are losing their jobs to foreign competition; even highly skilled white-collar jobs are far less secure given global competition.

6 CHAPTER 19 EARNINGS AND DISCRIMINATION Labor Markets for Unskilled/Lesser Skilled Workers  Employers will only pay workers the value of their marginal product. VMP is low for many services, retailing, and laboring occupations where output per worker is low and not rising very much over time.  Labor supply for unskilled workers is very elastic, and increasing over time due to immigration  Elastic labor supply in the short and in the long run keeps wages at ‘depressed’ levels.

7 CHAPTER 19 EARNINGS AND DISCRIMINATION Earnings, Full-time Workers, D.C., 2005 Chief executives$160,200 Engineering managers$118,900 IT managers$ 94,600 Lawyers$124,000 Doctors, surgeons$152,000 Sales reps, Manu. Products$ 81,000 Financial securities sales$ 86,600 Chemists$ 75,200 Electricians$ 40,800 Machinists$ 41,900

8 CHAPTER 19 EARNINGS AND DISCRIMINATION Lower paying occupations, Full-Time, D.C. Food service managers$49,200 Social workers$48,200 Writers, authors$53,000 Physical therapists$62,500 Bio technicians$45,000 Nursing and home aides$32,000 Receptionists, infor. Clerks$30,700 Retail sales persons$48,200 File clerks$34,700 Laborers, stock movers$31,800

9 CHAPTER 19 EARNINGS AND DISCRIMINATION Compensating Differentials: do we pay more to persons will do ‘bad’ jobs?  Compensating differential: a difference in wages that arises to offset the non-monetary characteristics of different jobs – such as unpleasantness, difficulty, or safety.  Examples: Coal miners, oil rig workers, fire fighters, securities guards, and some construction workers are paid more than other workers with similar education and skills. Night shift workers paid more than day shift. But,the ample supply of people who have to work, even doing unpleasant or unsafe work, results in their being few if any differentials for many unpleasant jobs.

10 CHAPTER 19 EARNINGS AND DISCRIMINATION Explaining Earnings of Individuals: Human Capital Theory  Workers have many skills and attributes that raise their productivity and their contribution at the work site. This “human capital” is rewarded in the marketplace.  Earnings = f ( Human Capital)  Earnings = f (Education, skills, amount and types of experience, ability to learn, imagination, energy, work commitment, motivation, ability to work together, reliability, …)

11 CHAPTER 19 EARNINGS AND DISCRIMINATION Testing this theory with earnings data of individuals  Government data (eg. Census surveys) provide data on many characteristics of individuals (identity suppressed) that economists use to analyze statistical patterns: income, age, education and degrees, city, occupation, industry, gender, race, ethnic origin, family status, etc..  Key information is missing! … such as types of experience and jobs, years out of the work force, motivation and personal attributes.

Weekly Earnings of Full-Time Employed Persons Age 25+ by Education, 2005 Educational attainment Median weekly earnings Less than H.S.$ 409 H.S. diploma583 Some college or Associate degree 670 Bachelor’s degree937 Advanced degree1,173 12

13 CHAPTER 19 EARNINGS AND DISCRIMINATION The Increasing Value of Skills Women Men 71% 82% % 44% 1980 Percentage difference in annual earnings for college graduates vs. high school diploma The earnings gap between college-educated and non-college-educated workers has widened in recent decades.

14 CHAPTER 19 EARNINGS AND DISCRIMINATION The Increasing Value of Skills Two hypotheses: 1. International trade Rising exports of goods made with skilled labor, rising imports of goods made with unskilled labor. 2. Skill-biased technological change New technologies have increased demand for skilled workers, reduced demand for unskilled workers. Difficult to determine how much each hypothesis contributes to the widening earnings gap; both factors are important.

15 CHAPTER 19 EARNINGS AND DISCRIMINATION Case Study: The Benefits of Beauty Research by Hamermesh and Biddle: People deemed more attractive than average earn 5% more than people of average looks. Average-looking people earn 5-10% more than below-average looking people. Other studies reveal penalties for being very overweight or very underweight. ** How can this be consistent with marginal product as a basis for paying people?

16 CHAPTER 19 EARNINGS AND DISCRIMINATION Case Study: The Benefits of Beauty Hypotheses?  Good looks matter for productivity In jobs where appearance is important, attractive workers are more valuable to the firm, command higher pay.  Good looks indirectly related to ability People who make an effort to project attractive appearance may be smarter or more competent in other ways, have more self confidence, etc.  Discrimination: employers prefer to associate with attractive co-workers.

17 CHAPTER 19 EARNINGS AND DISCRIMINATION The Superstar Phenomenon  Superstars like Tom Cruise, U2 earn many times more than average in their fields.  The best plumbers or carpenters do not.  Superstars arise in markets that have two characteristics: Every customer in the market wants to enjoy the good supplied by the best producer. The good is produced with a technology that allows the best producer to supply every customer at a low cost.

18 CHAPTER 19 EARNINGS AND DISCRIMINATION The Signaling Theory of Education An alternative view of education:  Firms use education level to sort between high-ability and low-ability workers.  The difficulty of earning a college degree demonstrates to prospective employers that college graduates are highly capable.  Yet, the education itself has little impact on productivity or skills.  Policy implication: Increasing general educational attainment would not affect wages.

A C T I V E L E A R N I N G 1 : Discussion question Suppose you were offered this choice: A. You could spend 4 years studying at the world’s best university, but you would have to keep your attendance there a secret. B. You could be awarded an official degree from the world’s best university, but you couldn’t actually study there. Which do you think would enhance your future earnings more? 19

20 CHAPTER 19 EARNINGS AND DISCRIMINATION The Economics of Discrimination  Discrimination: offering different opportunities to similar individuals who differ only by race, ethnicity, gender, or other personal characteristics  Relevant employment practices: how are jobs advertised? who is interviewed and selected? who is trained and given opportunities? who is promoted and how far? how salaries are set?  Statistical discrimination as a motive – does the firm train and promote a woman who may be more likely to leave the work force than a man?

21 CHAPTER 19 EARNINGS AND DISCRIMINATION Federal Law Prohibits Employment Discrimination  Title VII of the 1964 Civil Rights Act prohibits discrimination in all aspects of employment on the basis of race, gender, national origin by private employers. Law extended to government agencies in  Enforced in federal court. Suits may be filed by individuals or groups of persons. Prevailing plaintiffs may be entitled to injunctive relief, back pay, and other damages.  Litigation is complex, takes time, and expensive.

22 CHAPTER 19 EARNINGS AND DISCRIMINATION U.S. Median Weekly Earnings, Selected Occupations, 2005 what do these data demonstrate? occupation both sexes menwomen gender gap Chief executives$1,834$1,903$1, % Aircraft pilots1,3661,368n.e.d. Educ. administrators1,1141, % Fire fighters944952n.e.d. Registered nurses9351, % Social workers % Secretaries % Telemarketers367n.e.d.360 Waiters/waitresses % Maids/housekeeping % n.e.d. = not enough data for BLS disclosure requirements 22

23 CHAPTER 19 EARNINGS AND DISCRIMINATION Race and Gender Earnings, Full-time Workers (Source: “women earn 79 cents on the dollar**). Black/white Salary Ratio Black/white Salary Ratio Women/men Salary Ratio ** Women Men All Races

24 CHAPTER 19 EARNINGS AND DISCRIMINATION Measuring Labor-Market Discrimination  Taken at face value, these differences look like evidence that employers discriminate.  But there are many possible explanations for wage differences besides discrimination; the data above do not control for differences in other factors that affect wages.

25 CHAPTER 19 EARNINGS AND DISCRIMINATION Dimensions of human capital that must be considered. white males 75% more likely to have college degree than black males white males 11% more likely to have graduate degree than white females women have less on-the-job experience than men. Census data report age but not the amount of actual job experience, or the history of the types of past jobs. public schools may not be equivalent by race. (e.g., funding, class sizes) Virtually every measure of human capital that is used is subject to the criticism that it is not “complete”.

26 CHAPTER 19 EARNINGS AND DISCRIMINATION Decomposing the Race and Gender Earnings Gap, Full-time workers, Black/White %age gap Female/Male %age gap Wage Difference -21.8% -28.6% Amount due to differences in education, age, region, occupation, industry, and sex -11.4% - 7.6% “UNEXPLAINED” - 9.8% %

27 CHAPTER 19 EARNINGS AND DISCRIMINATION Measuring Labor-Market Discrimination – an imaginative study Recent study by Bertrand and Mullainathan finds evidence of labor-market discrimination: 5000 fake résumés sent in response to help-wanted ads. Half had names more common among blacks, like Lakisha Washington or Jamal Jones. The other half had names common among whites, like Emily Walsh or Greg Baker. Otherwise, the résumés were the same. The white names received 50% more calls from interested employers than the black names.

28 CHAPTER 19 EARNINGS AND DISCRIMINATION Evidence in employment discrimination (Title VII U.S. Civil Rights Act) cases  Proving discrimination is complex, since the actions of employers and employees involve complex issues of assessing qualifications and job performance vs. actions that are illegal.  The role of statistics in class-action cases is often conclusive. Analysis of hundreds or thousands of individuals’ records can show a pattern of practice.  Legal outcomes vary: plaintiff or defendant prevails, or case settled (not necessarily implying guilt).

29 CHAPTER 19 EARNINGS AND DISCRIMINATION Discrimination by Consumers  Discrimination by consumers may result in discriminatory wage differentials. Suppose firms care only about maximizing profits, but customers prefer being served by whites. Then firms have an incentive to hire white workers, even if non-whites are willing to work for lower wages.

30 CHAPTER 19 EARNINGS AND DISCRIMINATION CHAPTER SUMMARY  Wage differences reflect the underlying demand and supply functions for particular jobs. High marginal product and limited supply of workers with necessary skills combine to produce the highest wages. Elastic labor supply explains persistently low wages.  Workers with more human capital are more productive and command higher wages than workers with less human capital.  Workers with college degrees may get better job offers because the degree signals high natural ability to employers.

31 CHAPTER 19 EARNINGS AND DISCRIMINATION CHAPTER SUMMARY  Wages also may differ with natural ability, effort, and chance.  Some differences in earnings are due to discrimination on the basis of race or other characteristics. Measuring the amount of discrimination is difficult.  Even without discrimination, the distribution of income may not be viewed as equitable or desirable – a topic we explore in the following chapter.