1. PPA786: Urban Policy Class 18: Urban Labor Markets

2. PPA786, Class 18: Urban Labor Markets Class Outline ▫Labor Markets ▫Low-wage labor markets and the distribution of income ▫Discrimination in labor markets

3. PPA786, Class 18: Urban Labor Markets The Labor Market  Supply: The labor-leisure trade-off.  Demand: Firms select the profit-maximizing number of workers to hire at each wage.  Called derived demand because it is derived from the firm’s interest in producing and selling a product.

4. PPA786, Class 18: Urban Labor Markets The Demand for Labor  To maximize profits, the firm keeps hiring more workers until the marginal benefit from another worker equals the marginal cost.  Marginal benefit = amount of the product another worker can produce (MP L ) multiplied by the price of the product, P.  Marginal cost = wage rate = w.  So (MP L ) (P) = MRP L ( = VMP L ) = w.

5. PPA786, Class 18: Urban Labor Markets Labor Market Equilibrium Wage Employment D1D1 S W1W1 D2D2 W2W2

6. PPA786, Class 18: Urban Labor Markets Issues in Analyzing Labor Markets ▫Unemployment and participation ▫The distribution of wage rates and earnings by skill level ▫Discrimination

7. PPA786, Class 18: Urban Labor Markets Unemployment Wage Employment D S Unemployment W*

8. PPA786, Class 18: Urban Labor Markets Unemployment and Poverty ▫Unemployment is determined by macroeconomic forces. ▫We are coming out of a deep recession, so unemployment is now high by historical standards. ▫High unemployment (and the poor macroeconomic conditions that cause it) is closely linked to poverty.

9. PPA786, Class 18: Urban Labor Markets

10. Unemployment and Participation ▫The unemployment rate is the share of people who are actively looking for work but unable to find it. ▫The unemployment rate does not reflect discouraged workers. ▫Labor force participation has declined from its historical level of about 67% to 63.2% in 2013.

11. PPA786, Class 18: Urban Labor Markets Labor Markets & the Distribution of Income  Labor earnings are the main source of income.  So the nature of the labor market has an enormous impact on the distribution of income.  No theorem says that competition leads to a distribution that is fair.

12. PPA786, Class 18: Urban Labor Markets Recent Developments in the Labor Market (EPI) ▫The following charts come from “Six Years from Its Beginning, the Great Recession’s Shadow Looms Over the Labor Market,” by Heidi Shierholz, Economic Policy Institute, January 9, 2014.

13. PPA786, Class 18: Urban Labor Markets

20. Education and Earnings  Workers are paid the value of their marginal product, so more productive workers are paid more.  Education is the best way to become more productive.  The returns to education are large and have been increasing over time, leading to more inequality.

21. PPA786, Class 18: Urban Labor Markets

22. Theories of Discrimination  Discrimination can have many different causes, including  Employer prejudice  Employee prejudice  Customer prejudice  Signaling (statistical discrimination)  Discrimination is illegal regardless of the incentives that lead people to engage in it.

23. PPA786, Class 18: Urban Labor Markets Employer Prejudice  If an employer is prejudiced against people from a protected class, he/she must be compensated to hire them.  Let d indicate the profits a prejudiced employer is willing to forgo to avoid hiring a black. Then the employer keeps hiring whites until but uses a different standard for hiring blacks, namely  For equally productive workers, it follows that  Since d is positive, prejudiced employers offer a higher wage to whites than to blacks. This is clear-cut wage discrimination.

24. PPA786, Class 18: Urban Labor Markets Employee Prejudice  Now suppose employers aren’t prejudiced, but white employees are; in this case, hiring blacks raises the wage that must be paid to attract white employees.  Assume that blacks do not care about the racial composition of the workforce. (Other cases are obviously possible.)  Now if  W w at 100% white < W B, the firm hires only whites  W w at 100% white = W B, the firm hires whites or blacks, not both  W w at 100% white > W B, the firm hires only blacks  Hence this model predicts firms will practice hiring discrimination to enforce complete workforce segregation, by firm or by occupation within a firm.

25. PPA786, Class 18: Urban Labor Markets Customer Prejudice  Employers may discriminate in an attempt to satisfy the prejudices (expected or actual) of their customers.  For example, a management consulting firm that gives advice to male CEO’s who do not want women to tell them what to do might (illegally!) discriminate against female applicants.

26. PPA786, Class 18: Urban Labor Markets Statistical Discrimination  Statistical discrimination can arise when some worker characteristics, e.g. motivation, cannot be observed at the time of hiring.  Employers may assume that a person has the average unobserved traits for her (or his) group.  If past discrimination has left her group with lower values of these traits, then the employer will discriminate against her.  This is illegal; an employer cannot make decisions about an individual based on average traits for that individual’s group.

27. PPA786, Class 18: Urban Labor Markets Evidence on Discrimination, 1  Marianne Bertrand and Sendhil Mullainathan, “Are Emily and Greg More Employable than Lakisha and Jamal?” American Economic Review, October 2004.  This study sent fictitious resumes to help-wanted ads in Boston and Chicago newspapers. Each resume was assigned either a very African American sounding name or a very white sounding name.  “The results show significant discrimination against African- American names: White names receive 50 percent more callbacks for interviews. We also find that race affects the benefits of a better resume. For White names, a higher quality resume elicits 30 percent more callbacks whereas for African Americans, it elicits a far smaller increase.”

28. PPA786, Class 18: Urban Labor Markets Evidence on Discrimination, 2  Claudia Golden and Cecilia Rouse, “Orchestrating Impartiality: The Impact of Blind Auditions on Female Musicians, American Economic Review, September 2000.  A “blind” audition procedure, in which people tried out for an orchestra behind a screen, increased the number of women hired by roughly 50 percent.

29. PPA786, Class 18: Urban Labor Markets Evidence on Discrimination, 3 The Urban Institute conducted two employment audit studies: Cross et al. (1990) and Turner et al. (1991). These studies carefully selected and extensively trained the auditors and restricted the audits to relatively low-skilled, entry level jobs. Both blacks and Hispanics were significantly less likely than whites to be allowed to complete applications, to be given an interview, or to be offered a job. ▫The net incidence of discrimination against blacks was 9% in Chicago and 15 % in Washington, D.C. ▫The Hispanic-white audits found a net incidence of discrimination of 27% in Chicago and 16% in San Diego.

30. PPA786, Class 18: Urban Labor Markets Evidence on Discrimination, 4 A more recent audit study (Pager, Western, and Bonikowski, 2009) looks at discrimination against blacks and Hispanics in a sample of advertised entry level positions in NYC in 2004. Each audit team had a white, black, and Hispanic auditor, all “well-spoken, clean-cut young men, aged 22 to 26. Most were college-educated, between 5’ 10” inches and 6’ in height…. They were matched on the basis of their verbal skills, interactional styles …, and physical attractiveness.” They were randomly assigned resumes. One team had a white auditor with a criminal record. Their “dependent variable recorded any positive response in which a tester was either offered a job or called back for a second interview.”

31. PPA786, Class 18: Urban Labor Markets

33. Evidence on Discrimination, 5A There are large gaps in wages ( ≈ 25%) between black and white workers. There are large, persistent differences in unemployment rates between blacks and whites. These differences reflect differences in education, experience, and other factors that reflect this nation’s legacy of discrimination and they reflect current discrimination, if any. The role of current discrimination is difficult to isolate.

34. PPA786, Class 18: Urban Labor Markets

35. Evidence on Discrimination, 5B Many studies explore wage gaps between black and white workers, controlling for traits linked to productivity, such as education. Some studies find that these gaps are small when the controls include a measure of “cognitive ability” (as measured by the Air Force Qualification Test). But other studies find that the gaps remain large (15%) with controls for cognitive ability and years of schooling (since blacks have more schooling at any given AFQT score). ▫This result is consistent with (but does not prove) significant current discrimination in labor markets.

36. PPA786, Class 18: Urban Labor Markets Evidence on Discrimination, 6 A 2011 working paper by Fryer, Pager, and Spenkuch uses past wages to measure a worker’s productivity—a powerful new methodology. They find that discrimination accounts for at least 1/3 of the black-white wage gap. They argue that firms practice statistical discrimination when wages are first set, but then eliminate the racial gap as they observe worker’s productivity.

37. PPA786, Class 18: Urban Labor Markets Evidence on Discrimination, Conclusion This evidence builds a pretty powerful case that this country has not eliminated discrimination in labor markets. These findings are consistent with the view that, from a firm’s perspective, discrimination is often profitable. They also reflect the fact that even though our laws against labor-market discrimination appear strong, our tools for enforcing these laws are quite weak. ▫Audits are a limited and expensive tool in labor markets. ▫Proving wage or hiring discrimination is very difficult, even with good data. ▫Disparate-impact discrimination, although illegal, is easy to practice but virtually impossible to prove.