Saturday, September 27, 2014

Wage inequality vs. compensation inequality

Some of my fellow grad students at Clemson are doing research on wage inequality. At a seminar yesterday one of them stated that wage inequality between high skilled workers and low skilled workers, where skill is measured by educational attainment with a bachelor's or more being considered high skilled, is still increasing but since the 1990's is doing so at a declining rate. The diagram below shows what this looks like:


The Y axis is the ratio of a high skilled person's wage to a low skilled person's wage. The X axis is time. Two things could be happening to cause this trend; either the high skilled wage could be decreasing over time or the low skilled wage could be increasing over time.

My criticism of wage inequality is that it measures the wrong thing. No economic actor, neither workers nor firms, cares about wages. Firms care about the total cost of hiring a worker and workers care about the total compensation they receive for their labor. Any analysis that ignores other forms of compensation such as health insurance, paid vacation, paid sick leave, paid maternity leave, and other pecuniary and non-pecuniary benefits is incomplete and could be very misleading.

For example, let's just look at compensation as the sum of the wage and the portion of a worker's health insurance premium that is paid by the employer, W + H. Also, let's assume that the insurance premium is not correlated with skill type, but instead only varies by the personal health and family characteristics of the worker. What this means is that a firm will pay the same health insurance premium for a high skilled male who is 50 years old, makes $150K/yr, doesn't smoke, and has 2 teenage children living at home as it will for a lower skilled male in the same circumstances except the low skilled person only makes $45K/yr. I think this is a reasonable assumption, as risk pooling is done based on the risk factors of the individual, not their degree or IQ (of course if IQ is strongly correlated with healthy living this may not be true, but I don't think that is the case).

The wage inequality between these two workers, 150/45, is 3.33. If we set the portion of health care paid by the employer at H = $8K/yr, which appears to be on the low side, then the compensation ratio is 158/53 =  2.98. The addition of a fixed cost to each worker that does not depend on their wage or value added to the firm makes the low skilled worker relatively more expensive than the high skilled worker and decreases the inequality measure that real people actually care about. If health insurance costs to the firm are increasing over time, as the Forbes article linked to above shows, then over time we would expect to see inequality decreasing when total compensation is used instead of wages.

What this means is that inequality may not be as high as people think. The addition of other forms of compensation that stay relatively constant across skill levels decreases the real inequality of the two skill levels.

Some people are probably thinking that most "low skilled" people e.g. high school graduates do not get insurance, paid vacation, sick days, etc. and this is true. So let's think about adding a third category, medium skilled. These are white collar or high skilled blue collar workers who have technical degrees, associates degrees, or bachelor's degrees but are not on an executive management track and earn between $35K/yr and $80K/yr with little prospect of ever earning above the high end of that scale. They are solidly in the middle class and often receive health insurance, paid vacation, etc.

Let's use the $150K for the high skilled worker, $60K for the medium skilled worker, and $30K for the low skilled worker. Let's assume that only the high skilled and the middle skilled receive compensation other than wages. So the high skilled/medium skilled wage ratio is 150/60 = 2.5 and the medium skilled/low skilled wage ratio is 60/30 = 2.

Now let's add insurance and calculate the compensation ratios. The high skilled/medium skilled is 158/68 = 2.32 and the medium skilled/low skilled is 68/30 = 2.27. So when insurance is included the medium skilled worker has become more expensive relative to both the high skilled worker AND the low skilled worker. The addition of other forms of compensation makes medium skilled workers the most expensive workers of the firm from a value added perspective.

If this is happening it can help explain the hollowing out of middle income jobs. Middle income jobs have not recovered since the recession but both low and high skilled have. Employers may have been waiting for an opportunity to reduce their middle income workforce because of the compensation dynamics I just described above and the recession presented the opportunity to do so. Now they are reluctant to create those jobs again because they are relatively more expensive than both high and low skilled jobs due to the fixed forms of compensation that stay relatively constant across skill level.

I am not claiming that this is precisely what happened but it is one story. I would like to see some more evidence but unfortunately there is not much data available on total compensation which is why nearly all of the inequality studies use wage. But that is an incomplete measure and ignores the story I just told.

Monday, September 15, 2014

The productivity of French vs. U.S. workers

This past weekend I attended the rethinking economics conference in New York City. On Friday Sept. 12th Paul Krugman was part of a panel. I have rarely, if ever, agreed with Paul Krugman about anything but he did occasionally defend neo-classical economics against some of the more radical views and I found myself nodding in agreement. But alas the point of this post is to highlight another disagreement.

During one of his comments Mr. Krugman mentioned that French workers were just as productive as U.S. workers and used this statement as a reason for why people in the U.S. could work less without affecting our quality of life. I am not sure what he meant by this since as far as I know there is no law anywhere that mandates how many hours people have to work and thus if people want to work less they are free to do so. But aside from Krugman being Krugman and using a non sequitur to make a point, I was curious as to what he meant when he said that French workers are just as productive as U.S. workers. So I did a little research and came across some articles talking about GDP per hour worked rather than GDP per capita.

GDP per capita in the U.S. was $53,143 in 2013; in France it was $34,140 in 2013. So clearly American workers are more productive when using this measure. But workers also work a lot less in France than in the U.S. According to this article in Fortune, GDP per hour worked was $60 in the U.S. in 2011 and $57 in France. There are other articles that make a similar point. So once hours are taken into account there is not much of a difference between American and French worker productivity. At least that is what it looks like.

What the per hour productivity measures do not take into account as far as I can tell is unemployment and this is a problem. Assuming that unemployed workers are the least productive workers (which is why they are unemployed) a higher unemployment rate will increase the average productivity number because the least productive workers will not be bringing the average down.

For example, suppose both the U.S. and France have 5 workers producing $10, $20, $30, $40, and $50 worth of output per hour respectively. The average for each country is $150/5 = $30 of GDP/worker/hour. Now suppose the least productive workers become unemployed. Suppose 20% of the U.S. workers lose their job (which is 1 worker in this small example) and 40% of the French workers lose their job (which is 2 workers). The U.S. average is now $140/4 = $35 since the $10 worker lost their job and the French average is $120/3 = $40 since both the $10 and the $20 worker lost their job. Thus a higher unemployment rate biases the GDP/worker/hour number up by removing the least productive workers from the labor market and thus the official statistics.

So what were the unemployment rates in France and the U.S.? The overall unemployment rate in Dec. 2011 was 8.5% in the U.S. and 9.4% in France. The youth unemployment rate for France was nearly 23% in Dec. 2011 and was roughly 16.5% in the U.S. The youth unemployment gap is the largest and perhaps the most important since youth are usually relatively unskilled and in low output jobs. Eliminating a relatively large amount of youth from the official statistics is going to make the average larger.

It is always a good idea to take any statistic with a grain of salt before knowing how it was calculated. It might be the case that an official unemployment adjusted statistic of worker output per hour might not affect the average number too much, but the gap would certainly be larger. This makes the number cited in that Fortune article and likely the one Paul Krugman was alluding to essentially meaningless.


Tuesday, September 9, 2014

Local officials in South Carolina are squashing uberX

Below is my most recent article for The Tiger News reprinted.
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Innovation and productive entrepreneurship are crucial for economic growth, which increases the standard of living for people around the world. Unfortunately, regulators at all levels of government often stifle innovative new companies with burdensome rules and regulations that serve the interests of already established companies by keeping competition out. An example of this is happening right now in South Carolina with uberX. 
UberX is a ride sharing service that uses a mobile app to connect drivers to passengers. It recently began operating in South Carolina cities Charleston, Greenville, Columbia, and Myrtle Beach. People who want to be drivers have to pass a background check, a driver history check, and ongoing quality controls in order to be associated with the uberX app. Consumers who want to use the service simply download the app to their smartphone and then when they want a ride somewhere they can pull up the app, designate their pick up spot, and a car will arrive to take them where they want to go. Often uberX is a cheaper alternative to cabs. For example, some sample fares in South Carolina are: $29 from GSP airport to downtown Greenville, $15 from King Street to North Charleston, and $7 from USC to Williams-Brice Stadium.
Of course like any business uberX has its supporters and detractors. In South Carolina the biggest detractors so far are state and city officials. In July 2014 the Office of Regulatory Staff (ORS) filed a petition with the state’s Public Service Commission stating that uber cannot legally operate in South Carolina. Uber drivers in Greenville have reported being stopped by ORS officials who have told them that what they are doing is illegal and that they are subject to fines or even jail time. Myrtle Beach officials have said that uber is not licensed to work in the city and that they plan to cite uber drivers for operating without a business license. The common theme throughout the government crackdown is that uber drivers need the same licenses and certificates as taxi drivers.
An often stated reason for why uber should follow the same rules as taxi companies is customer safety. According to Yellow Cab of Charleston Vice President Jerry CrosbyWe still don’t know what type of report Uber does on drivers. We’re only told they do background checks, but there’s no transparency about exactly what those are.” Eastside Transportation Service President Louie Chemell adds “If you’re operating illegally and you don’t pay those fees, sure it’s going to be a whole lot cheaper”, but “there’s a lot of protection for the customer that is going to be lost.” Messrs. Crosby and Chemell may be genuinely concerned about customer safety, but that is probably not their only motive for wanting uber drivers to be forced to obtain the same licenses as taxi companies. Greenville City Attorney Bob Coler has said that if uber was to be considered a taxi company by the state they would be required to secure a certificate of necessity. This means that the Greenville city manager, not the market, would get to determine whether Greenville needed an additional transportation company. Certificates of necessity preempt the market from deciding whether a good or service is needed by preventing competition. Established companies can tell city officials that an additional company would harm their business and thus is unnecessary. If this sounds like a process that can be abused, it’s because it is just that. In 2009 Otman Benouis was denied a certificate of necessity for his taxi company after John Bacot of Yellow Cab wrote a letter to city manager James Bourey that implied that “expanding service in the area would flood the street with unsafe drivers”.
If living standards are going to continue to increase in this country innovation and the competition it creates are necessary. Competition is what sorts out the good ideas from the bad and helps society decide where to allocate scarce resources. Regulations that stifle productive entrepreneurship and market competition do not help society at large. Instead these regulations enable already established companies to maintain a government created advantage over their competition. Governor Nikki Haley, a Clemson alumna, often promotes her record on job creation. If she truly cares about jobs and expanding opportunities for South Carolinians she will use her position to bring attention to the onerous regulations in South Carolina and call for reform at the local level.

Thursday, September 4, 2014

A living wage will not help the least skilled workers

Nationwide fast food strikes over a "living" wage are back in the news. But as I wrote last year when this was occurring, a higher minimum wage hurts the poorest and least skilled workers. There are better ways to alleviate poverty and those solutions are what we should be focusing on.