~ $ ~ "The Labor Market"
"Citywide Minimum Wage Laws"


Robert Kuttner, "Everything For Sale",1997, p68-77.

HUMANS AS FACTORS OF PRODUCTION

Economists and other students of society have long recognized that labor markets are fundamentally different from markets for products. A job or profession is, in one sense, a commodity bought and sold in a market, just as a wage or salary is a price paid by the employer. But work is also a central source of identity and livelihood, a valued (or resented) affiliation, and sometimes a calling. Its venue is not the unsentimental marketplace of a trading floor or an auction house, but an institution with complex hierarchies, friendships, collegialities, reciprocal loyalties, and an ongoing social existence. Labor is also malleable in a way that physical goods are not: there is an almost infinite range of possible combinations of effort and compensation, commitment and opportunism, and no single optimal path defined by maximum freedom of exchange.
A pure-market transaction, remember, is a single exchange at a moment in time. In the real world, that ideal case materializes in a spot market or an auction market such as a stock exchange where bidders are plentiful, prices actually change from minute to minute, and each transaction is a one-time event that clears the market of the merchandise. Long-Term price and supply contracts may occasionally override spot markets, but these are voluntary and based on the perception of mutual advantage, usually because of risk aversion. However, in product markets, long-term supply contracts are a relatively trivial departure from the price mechanism. Market theorists raise no objection, because the process of contracting is just another kind of voluntary exchange.
Labor transactions are a whole other story. Here, spot markets are the exception, and departures from market-clearing prices the norm. A few workers still get their jobs through hiring halls and daily shape-ups. But generally workers expect to be doing the same job tomorrow that they do today, for the same employer and at the same pay. Workers do change jobs, but not continually. Pay is adjusted, but not daily. Wages don't fluctuate like stock prices or prices in the fish market. Layoffs occur, but these are exceptional rather than ubiquitous. Labor's price is broadly set by markets, but in an institutional context that presumes a continuing relationship.
These long-term labor relationships are often compared to voluntary contracts in product markets, but the analogy is slippery. Sometimes there actually are explicit long-term contracts between manager and worker, or with the union on behalf of workers collectively. But major aspects of long-term labor "contracts" are tacit and customary. As long as business holds up, you can presume that you will not be fired if you do your job well, even if someone off the street would take the job at a lower wage. Your past

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dedication will be repaid during hard times in the future. None of that is written down. The result of these social and institutional aspects of the labor markets is that labor prices (wages) do not adjust smoothly and continuously. The price of labor, as economists invariably put it, is "sticky."
Presumably, labor rarely behaves like a spot market because the workplace is not just a marketplace but a social organization with a certain institutional logic and institutional imperatives. Turning it into a pure spot market would assault its viability as an institution. Even the meanest workplace has norms of fairness. If breached, these can affect morale, and hence productivity and profit. For example, different individuals in the same job category in large organizations do not have the identical "marginal productivity," yet it is customary to pay them roughly the same wage.
Not only do similarly situated workers have different productivities, but the output of any one worker fluctuates moment to moment and week to week, depending on mood, effort, morale, health. There is, however, no practical way for management precisely to adjust pay accordingly, on the model of a product market. Paying workers by the piece was one attempt to reward output with more precision. But piecework has mostly disappeared. Some students of labor markets explain the eclipse of piecework largely in terms of its damage to teamwork, morale, and quality. As labor economists have long noted, the employer is not just buying the worker's time but also her effort. Workers possess not just formal skills but what Michael Polanyi called "tacit knowledge," which can be eagerly applied to the enterprise--or resentfully hoarded.
Evidently, it has proved efficient (though not in Adam Smith's sense) for most companies to honor the social character of work, and to pay employees in ways that often diverge from their precise marginal contribution to the company's output at any given moment. That doesn't mean the firm ignores the em-

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ployee's output or effort. On the contrary, it only means there are more effective ways to induce performance than treating labor as a pure market commodity. People, unlike things, have a broad range of possible outputs. They have a capacity for learning. They notice how they are being treated, and that affects how they perform. The great political economists have all remarked on this. The most elegant and original recent statement is Albert Hirschman's modem classic, Exit, Voice, and Loyalty, which observes that "voice" -having an influence-is an alternative to the rather static choice in the market model of staying or leaving. Voice, in turn, engenders loyalty. In order to work, loyalty must be reciprocal. So voice offers a constructive and engaged alternative to sullen exit.
Labor markets violate perfect market conditions in another key respect. It is often efficient for management to pay good incumbent workers slightly above the going rate, because this implicit bonus lets workers know that they are valued and encourages effort and loyalty to the firm. A worker who perceives that his skills are "worth" eight dollars an hour on the open job market, but who is making ten dollars with the prospect of going to twelve, is likely to value his job and give his all for the company. This custom of paying a slight premium over a market-clearing wage to incumbent workers also reduces job turnover, improves communication, reduces company recruitment and training costs, and makes the firm a happier place. Employers who pay the lowest possible wage that attracts workers invariably complain about how hard it is to get good help.
A whole genre of scholarly labor-market research, known as Efficiency Wage Theory, concludes that the efficiency associated with inducing the highest available worker effort, output, and loyalty requires a substantial departure from the treatment of labor purely as-a commodity in an auction market. A related case in point is the custom seniority. Firms often raise pay with longevity, not because productivity always increases with experience-beyond a certain level, productivity often declines with age-but to reward loyal service, and to send other workers signals that they are valued and that this is a good place to work. Respect for seniority also recognizes that older workers are likely to have more costly family obligations-a social rather than a purely economic consideration. The custom of laying off by seniority, or according long-tenured workers "bumping" rights, is usually demanded by unions, but is often voluntarily offered by nonunion employers, for much the same set of reasons. It would disrupt the workplace as a social institution if younger workers could elbow out older ones.
Kindred labor-market institutions such as academic tenure and the system of apprentices and journeymen common to craft occupations, which plainly violate pure-market pricing principles, are interpreted by labor economists as facilitating the sharing of knowledge. Apprenticeship (formal or tacit) may seem rigid, but it is efficient because it assures high standards and gives journeymen the security to pass on their craft to

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novices. In academia, if a brilliant young lecturer could take his professor's chair at one-third the pay, it would save the institution money-but scholars would think twice about imparting information to their graduate students. This is one more reason why labor markets are not simple auction markets (and why professors who call for pure markets elsewhere seldom renounce tenure). As Lester Thurow has observed, "If wages really were flexible and allocated in a bidding auction, each worker would try to build his own little monopoly by hoarding specific labor skills and information in an effort to make himself indispensable." But in the real world, Thurow adds, "Employers repress wage competition and build employment security.... Lower outside wage bids are not accepted, because if they were, workers already on the job would feel threatened ......"
Recruitment patterns are also a blend of social and economic. Standard free-market theory presumes perfect information. Somehow, the right worker will find her way to the right job at the right price. But sociological studies of how workers actually find jobs and how employers actually recruit workers make a mockery of the "search theory" of economics. A classic of the genre, the sociologist Mark Granovetter's study "The Strength of Weak Ties," found that a variety of extra-market connections-somebody knows somebody's cousin; a recent recruit's classmate is in the right place at the right time-account for how people actually get jobs. The interesting part of the story occurs after the worker gets the job-more malleability. And when formerly excluded groups-Jews, blacks, Asians, women-break into a previously proscribed labor pool, it has nothing to do with changing marginal productivities but, rather, shifts in political power, law, and, finally, behavior and custom.
As a consequence of all the foregoing departures from spot-market pricing, the market price of labor at any given time is likely to be "wrong," both in the individual firm and in the aggregate economy. Some workers are being paid too much, others too little. Apparently, the logic of the workplace as a social organization demands these anomalies and renders them tolerably efficient. Efficiency Wage Theory says that this brand of pricing is the best available second best, at least for the firm.
However, in macroeconomic terms, this departure from pure-market pricing principles means that the labor market, unlike the fish market, doesn't "clear" on the basis of price adjustments. At the end of the day, there is an oversupply of product-namely, people seeking jobs. Some workers are slightly overpaid relative to their marginal product, some are working longer hours than they'd like; others find themselves working involuntarily part-time, or without jobs.
The phenomenon of the involuntarily overworked employee is also a function of imperfections in the labor market itself. Some people on the fast track say, associates in law firms or junior recruits to investment banks-might prefer to work fifty hours a week-but find themselves working eighty, to demonstrate

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diligence in competing for a few coveted partner slots. What might have been two forty-hour jobs is one eighty-hour job. In similar, less glamorous cases, such as mandatory overtime in factory jobs, involuntary overwork results from the employer's efforts to game the rules of the fringe-benefit system and minimize turnover. If the employer hires another worker, he is stuck with additional payroll taxes and fringe-benefit costs, as well as training costs. The new worker may also be hard to fire during the next downturn, because of mandated severance costs or lingering remnants of tacit contracts. So it is more "efficient" to require a smaller incumbent work force to work overtime than to take on new employees who desire work. This pattern reflects a blend of opportunism that may save money for the employer, but it is neither a perfect market nor necessarily efficient for society.
The labor market is imperfect in another key respect. Because of the macroeconomic problem of the economy's tendency to fall into periodic recessions caused by shortfalls of aggregate demand, adjusting (lowering) wages in an effort to clear the labor market is a perverse cure for unemployment. Reduced wages translate into reduced overall purchasing power-and even less demand for workers. In the early 1930s, many people at first thought we could cure the Great Depression by cutting wages. The result was deeper depression. There are other available strategies to maintain full employment, but they lie elsewhere, beyond the realm of more perfect microeconomic pricing. "The pervasiveness and persistence of unemployment," writes Joseph Stiglitz, "is, in my mind, the most telling 'critical experiment' which should lead to the discrediting of the basic competitive equilibrium model which (depending on how you view it) either predicts or assumes full employment,
Readers will likely recognize the dilemma of the imperfect labor market is a variation on the Three Efficiencies of chapter 1. In allocative (Smithian) terms, the price of labor departs significantly from the "correct" market price-the price that precisely equates supply and demand and reflects the worker's marginal contribution to the output of the firm at any given time. But the logic of the firm as a social organization seems to require this divergence. And the departure from a theoretically correct price can produce compensating efficiencies by inducing effort, knowledge sharing, work satisfaction, innovation, and loyalty.
Thus, there is not a single correct or optimal price for labor but a broad range of possible pay scales, reward systems, and strategies to induce and compensate effort. The appropriate market price fluctuates, in part because effort also fluctuates. By the same token, a Keynesian full-employment economy, coupled with education and training outlays, can produce a high growth rate, a socially tolerable income distribution, and rising living standards over time-which more than make up for the fact that some labor is priced "wrong" by Smithian lights.

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THE NEW LABOR MARKET

The alert reader will recognize that this entire prologue is slightly archaic. For what is striking about the current era is that labor, suddenly, is in fact becoming rather more like a spot market. The customary extra-market norms in worker manager relationships, long thought to be institutionally efficient, have been substantially eroded by the resurgence of market forces. During the postwar boom, when the economy was more highly regulated, unions were more powerful, and foreign trade was less important, there was far less institutional turbulence generally, and hence in labor markets. This was the era of mass production and oligopoly. If you went to work for a large, stable company like General Electric or General Motors, AT&T or United Airlines, whether as a wage worker or a salaried manager, the normal expectation was to spend your entire career there, assuming that you did your job reasonably well.
Layoffs occurred, but they were typically cyclical. Most workers furloughed during economic downturns got their jobs back. Today, however downsizing, out-sourcing, leveraged buyouts, relocations, and contingent employment are becoming the norm. Even such redoubts of long-term labor contracts as academic tenure and the civil service are under assault. Few people have anything like the presumptive employment security characteristic of the postwar era. Is this shift necessary? Is it efficient?
A generation ago, labor economists differentiated "primary" and "secondary" labor markets. Jobs in the primary labor market were characterized by career security, regularized contracts, decent pay, fringe benefits, and norms of professionalism. Often they were in occupations that were either regulated and licensed by the state, or self-regulated through professional organizations. Skill was one determinant of what was a primary-labor-market job, but not the only one. Besides the elite professions, occupations in this category also included a good many semiskilled factory jobs in stable basic industries. Despite fairly rudimentary skills that could be acquired in a few weeks, occupations such as automobile assembler could be in effect professionalized thanks to the combination of stable firms in basic industry and strong unions.
In contrast, secondary-labor-market jobs were what used to be called casual labor." They were marked by high turnover, low wages, an absence of hinge benefits, and minimal or nonexistent reciprocal obligations. Many students of labor in that era thought that, as the economy grew both richer and better bolstered by social insurance, and trade unionism became institutionalized, more and more occupations would gradually be professionalized, and converted from secondary to primary ones. But in the 1990s, the reverse is happening: oc-

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cupations that were once primary are looking increasingly like casual labor. It is startling to read standard works on labor economics written as recently as the early 1980s and to compare them with the actual job markets of the 19908. Arthur Okun, explaining why the price of labor was "sticky" rather than fluid, coined the phrase "invisible handshake." In marked contrast to Adam Smith's invisible hand, labor markets were based on a variety of contracts, formal and tacit, because they depended on myriad reciprocal obligations. As an example, Okun wrote in Prices and Quantities (written in 1979-80): "The firm simply cannot tell its senior workers to stay home and draw no pay while it is adding recruits. Such a breach of faith would have major adverse impacts on the subsequent quit rates of established workers and acceptance rates of recruits."
Economist Andrew Weiss, summarizing the Efficiency Wage view, offered this explanation for why firms often pay above a market-clearing wage: "The lower the wage, the more resources the firm would have to spend on supervision to maintain a given level of effort from its workers." The theory also explained firms' reluctance to adjust to reduced demand by cutting pay in terms of the employers' imperfect information: "If all workers were identical, or if all firms were perfectly informed about the productivity of workers ... a firm would respond to a fall in the value of the worker's output [or reduced demand for it] by cutting the worker's wage.... However, if a firm is imperfectly informed about the productivity of its workers, the firm would care about which workers would be induced to quit by a wage cut. The firm would be concerned that the workers that quit would be the ones the firm most wants to retain-workers whose productivity exceeded their wage."
These insights explained another great paradox of labor markets-the fact that firms faced with increased competition or declining demand typically adjusted the quantity rather than the price of their labor, resorting to layoffs rather than wage cuts. A rational employer, behaving as Homo economicus, would presumably extract reductions in his wages. But, typically, firms resorted instead to layoffs, damaging a small fraction of the work force instead of all employees, and giving greatest security to the faithful employees with the longest-term service to the company. Again, the social logic of the workplace trumped the market logic.
But these characterizations, reviewed in the mid 1990s, read like archeological descriptions of a lost continent. Today, employers are breaching virtually all of the conventions so carefully analyzed by the last generation of labor economists-and evidently getting away with it. With heightened competition and successive waves of leveraged buyouts, brutal downsizings have become normal. Relentless layoffs are not merely a temporary response to business cycles, but a way of life. Labor has come to be viewed not as a long-term resource but as an expendable cost center.

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Far from cherishing their experienced employees, some Fortune 500 corp, rations today literally invite their experienced workers to bid to keep their jobs by taking pay cuts. They calculate what pay levels would attract young recruits, and then ask the incumbent employee to match the lower pay. Even unionized companies have gotten around the once sacrosanct doctrine of equal pay for equal work by instituting two-tier pay scales, in which workers with seniority are grandfathered at higher wage scales while new hires perform the same job for less-not just as novices but throughout their careers. Universities have preserved the custom of tenure for an elite few, by enlarging a lower order of lecturers who will never be tenured, and who subsist on short-term contracts, low pay, heavy teaching loads, and multiple jobs.
Large corporations are pursuing strategies of retaining as few core employees as possible, pursuing the maximum possible degree of flexibility in how they take on labor. Consultants offer seminars on how to convert a large portion of the work force from permanent staff to contingent employees. At a 1994 training session sponsored by the Institute for International Research, executives from McDonald's, Manor Care, Connecticut Mutual Life, McDonnell-Douglas, H&R Block, and others offered tips on how to shift from a full-time, permanent work force to a contingent one, without sacrificing quality or productivity.
Temporary and co now the fastest-growing categories of work.(Brainpower temporary Services are not only the largest U.S. employer but also the largest private-sector trainer. This trend is driven partly by the desire of corporations under new competitive pressure to avoid paying payroll taxes and fringe benefits, but the more fundamental goal seems to be cost cutting and flexibility. The new information technology facilitates this shift. At the high end of the labor force, business consultants, stock analysts, computer experts, salespeople, etc., can do their jobs as independent contractors, with a laptop, phone, fax, and modem, from any remote location. At the low end, businesses can use temp agencies, independent consultants, or subcontractors to increase or decrease their payroll, day by day.
These strategies allow employers to escape all the implicit contracts and reciprocal obligations that characterized the labor-management regime of a generation ago. If an employee is not permanently attached to the payroll, you don't ally owe her anything beyond a day's pay for a day's work. As the labor market comes more like a spot market, employers are increasingly able to pay their workers precisely in accord with their perceived marginal productivity. Something very much like an auction market sets labor's price. If you sign on with a temp agency as, say, a computer-graphics expert, or a bookkeeper, you ill be paid precisely according to the going rate for your skill, which will not change hour to hour but may well change week to week, with the fluctuations of bor supply and customer demand. This system also allows the employer who

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relies on contract workers and consultants to trade off quality and price on a daily basis, and to pick the man or woman who precisely fills the appropriate niche. Contrary to the old worry about "supervision costs," the work quality evidently speaks well enough for itself. If the contractor or temp wants repeat business, or higher pay, she will do a good job. The more decentralized, customized, and flexible the economy becomes, the more the labor market functions like the spot market once deemed institutionally impossible.
These trends are celebrated by enthusiasts of the new information economy for their decentralization and flexibility. The computer and the Internet are said to portend a virtually frictionless market economy, in which any seller is free to connect with any buyer, worldwide. The transformation in labor relations is cheered by free-market enthusiasts in the economics profession and in the business community, for multiple efficiencies. At long last, the economy's one great holdout, the labor market, is behaving like a true auction market. If unions and the state will just go away, this shift will vastly improve the productivity of work, align contribution with reward, and allow the labor market, finally, to "clear"-solving the problem of inflation-free unemployment.
Some observers take this model to its I cal conclusion and propose an economy based on the paradigmatic "virtual corporation" a - highly entrepreneurial firm with a tiny core of own ne else as contract labor. The virtual corporation is customer-driven, with extremely low fixed costs. Its owners must be nimble and efficient, or their Firm will be displaced by even more efficient competitors. Better yet, their contractors and temporary employees must also be highly entrepreneurial, since they are being paid precisely according to the value that they can add to the enterprise. Their pay is determined in the marketplace, and it reflects the worth of their human capital.
Thus, as the labor market becomes more of a spot market, its champions, in an inversion of the New Socialist Man proclaimed by Lenin, imagine a New Capitalist man or woman, who internalizes and embodies the values of the marketplace. In this new economy, everyone is a capitalist, whether as an owner of a firm or as a free-lance. This exemplar of the new economy is worth whatever her labor will fetch in the market on a given day. People who have little to offer can expect little back, and have only themselves to blame. If you don't like the insecurity of being a contingent worker at the beck and call of a virtual corporation, then get with the program and become an entrepreneur yourself. As regulations, unions, and customary barriers fall, old and cumbersome corporations will adapt to this model--or be driven out by more flexible and dynamic competitors. The evidence is in large corporations like GE, IBM, Xerox, or GM, which are shedding labor and long-term contractual obligations as fast as they can.

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The merger movement also spurs this evolution, in two distinct but reinforcing respects. Incumbent management may feel obligated to honor a tacit social contract with loyal longtime employees; an outside owner new to the enterprise feels no such obligation. And mergers, say, between a Chase Manhattan and a Chemical Bank, create redundancies and opportunities (or pretexts) for streamlining. In the ensuing restructuring, not only will thousands of workers be laid off, but core jobs can be redefined as contingent ones, shrinking the pool of primary employees (and inflexible costs) even further.
An intriguing question is whether this new commodification of labor damages the firm, in all the ways the last generation of labor economists thought it must. How is it that employees who abruptly find themselves with little job security, and with the constant threat of being underbid by younger recruits, none the less share information, display loyalty to the firm, and get their work done? A great deal of the business-school literature on human capital contends that corporations are wise to treat their employees as valued assets. Lately, there has been an outpouring of writings congratulating at deliberately try to design work to be intrinsically satisfying, share power, and value the contributions of employees. However, a great many of these experiments last only until the next hostile takeover and the next bout of downsizing, which are of coursethe result of extreme pressures of the competitive marketplace. Innumerable corporations that once boasted of no-layoff policies, offered "family-friendly" workplaces, and a slew of generous fringe benefits, reverted to ruthless cost cutting once competitive pressures proved sufficiently intense. The market model would say this shift in strategy "must have" been efficient-otherwise managers would not have pursued it.
Charles Heckscher, a labor sociologist at Rutgers, conducted extensive interviews with middle managers at large corporations. He reported a paradox. The new climate of downsizing and cost-cutting, he found, had middle managers terrified about their own futures. But they had so internalized the values of efficiency, competitiveness, and cost-cutting that their loyalty to the company was not impaired--even though these values prefigured their own eventual dismissal. On the contrary: most had apparently convinced themselves that if they just worked more diligently, the company might achieve its competitive goals and they might be spared the ax. Security may engender commitment and diligence, but so, evidently, does insecurity.
In short, the labor market is indeed behaving more like a product market. But it remains to be seen whether this is efficient for either the economy or the society.
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