Thursday, September 25, 2008


Professors' Gary S. Becker and Richard Posner articles on the economics of discrimination (here and here) gave me an interesting motivation to discuss some economic aspects of discrimination which is a popular question into the economic analysis.

The Framework of Labor Market

Discrimination is a relatively young and still fresh theme in economic analysis. It has been pioneered by professor Becker's The Economics of Discrimination (link). The analytical foundations of the economic analysis of discrimination can be found in the attempt to measure discrimination in the labor market and elsewhere by the empirical analysis. In a simple, two-variable model of labor market determined by wage and quantity of labor, there is not a unique equilibrium of demand and supply in the labor market. The demand for labor is downward sloping, reflecting the fact that lower wage (the price of labor) tends to induce the demand for labor. For example, if the wage for software engineer drops from 8 EUR per hour to 6,5 EUR per hour, then Google, for example, will certainly not feel reluctant to hire more skilled software engineers. It should be noted that the slope of labor demand curve is much flatter than demand curves in partial equlibrium models usually behave. The reason is that firms hire labor supply in order to maximize profits and firm's utility function. However, there is no simple marginal rate of substitution between labor and other means of production and that labor suppliers' knowledge, skills and profession determine the result of firm's production function. Also, there is not a unique picture of labor supply, since workers possess different preferences regarding the allocation of time between leisure and consumption. For example, productivity gains by Google engineers may induce them either to increase the amount of leisure time they consume or to allocate even more time to research and product development. In economics, to sketch a brief picture of labor market, we use regression analysis to depict labor demand and supply curve where the wage as an endogenous variable is determined by the inclination of demand curve and the quantity of labor as an exogenous variable. Since a decreasing wage rate induces the demand for labor, demand curve is, expectedly, downward sloping. On the other hand, labor supply is upward-sloping since employees are not reluctant to supply more free time when the rate of real wages is increasing. Even though labor market is a partial equilibrium model of employer-employee preferences, discrimination has often resulted in a two-sector labor market where skills and knowledge are traded in separate markets as shown by the picture.

How Discrimination is Motivated?

There are two types of discrimination in the labor market. First, employers discriminate when they hire labor supply with higher wage rate, even though other labor supplier are cheaper relative to their productivity than labor suppliers hired by the employer. In this case, discrimination is motivated by employer preference of future employees by race, religion, sex or other human charateristics. An employer who discriminates has a comparative disadvantage compared to employers who do not discriminate since first employer's profits are lower due to the fact that first employer's competitor scores better on productivity performance and profit while his relative market-clearing price of labor is lower. Employer discrimination can be enforced with strong cultural and institutional background. In former socialist economies, such as Slovenia, regulated and rigid labor market protected the premium of insiders while it, at the same time, increased entry and career barriers to future employees. Thus, with the lack of productivity convergence and high tax burden, employers in Slovenia are reluctant to hire high-skilled labor supply because of (1) high bargaining power of trade unions and because (2) age-determined income distribution favors older workers compared to younger workers even though older workers in infant industries do not posses high human capital skills as college graduates do. Consequently, human capital premium has been replaced by age premium. In job advertisment, employers often put experience ahead of knowledge and ideas, thus restricting job and career prospects to labor market entrants. On the other hand, employee discrimination occurs when employees, for example, refuse to work with minority workers, demanding real compensation. Regulated labor market structure is, most notably, a cause of employee discrimination since workers possessing more bargaining power tend to discriminate workers with weaker concentration of bargaining power, thus requesting higher premium enabled by the formal (trade union) or informal (intra-market nets) monopoly of existing labor supply. Nonetheless, the attempt to exterminate labor market discrimination by the exercising regulation results in information asymmetry, giving privilege to inside workers' privileges such as seniority and their bargaining power over the medium term (see: Lindbeck, Snower 2002).

Competitive Markets, Economic Freedom and Flexibility

For example, in the old American south, African Americans were often discriminated by local employers (link). Thus, the old South was put in a comparative disadvantage in comparison with Northern and Western states which faced higher productivity growth rates and profits. The situation led to a gap between northern-western and southern states; the latter having lower living standards because of the productivity lag as a partial result of labor market discrimination. The deregulation of labor market is essential to less discrimination since economic freedom such as freedom of trade, enterprise and labor, leads employers to relatively less beneficial discriminatory hiring preferences unless employers prefer lower profit. In Europe, where labor markets are more regulated than in countries such as the United States, Singapore, Denmark and Australia, regulated labor markets lead to lower productivity performance, except that age and experience-based discrimination substituted racial or sexual discrimation at the workplace. Consequently, the standard of living in European welfare states is significantly lower than in the United States. For example, cost decreases in child care, as a result of competition, put more mothers into the labor market in the United States and Canada (link) while the percentage of mothers in the labor market, while having child-care liabilities, is significantly lower in Europe, reflecting regulated and rigid labor market designed by the intervention of trade unions. In freer labor markets where employers have fewer discrimination preferences, firms score higher on productivity, human capital and profits, advantaging employers with non-discriminatory hiring practices while putting employers with discriminatory hiring (related to race, skin color, religion, sex or any other characteristic) in a serious relative disadvantage.


Ryanaldo said...

The American South failed to develop on pace with the north and west from the beginning of colonialism. they favored chasing the cheapest labor(slavery) and free trade. the north favored protectionism and prospered. The South had giant plantations, many slaves, and many poor whites. the bulk of the north had many more moderately successful smaller farms, successful craftsmen, and better paying industry. The areas where workers were most exploited and slums arose were the areas where immigrants arrived and stayed, and where there was the greatest amount of trade: principally along new york city between 1870 and 1920.

Rok Spruk said...

It is a good discussion in economic history of the United States. In my opinion, exercising protectionism had deprived the U.S economy from trade spillovers and thus impaired output growth in the long run perspective. Also in Confederate States of America in 1861, the Southern local authorities imposed an embargo on cotton trade. Looking at the economic data and variables in the old American South prior to the beginning of the civil war, real factor productivity was in a constant relative decline compared to the North. The Confederacy and the South in general had an undiversified trade structure, relying solely on cotton revenues and bond revenue from European import industrial and financial markets. The relative disadvantage in real labor productivity (due to enslaved labor force) and the lack of openness towards trade and immigration flows , which (by contrast) are the main explanatory variables of the economic progress of Northern states, explain the majority of factors and impacts why Southern economy had not been enjoying a solid rise in output per capita compared to the states in the North.

nickysam said...

There has been much debate centred around gender wage differentials and discrimination and one of the key questions to emerge whether competitive markets can bring an end to the unequal market outcomes for men and women or if some form of anti-discrimination law is necessary.There has been extensive research in recent years relating to competition and gender gaps in selected industries.

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Mike said...

Consequently, the standard of living in European welfare states is significantly lower than in the United States.

I am not sure if I would even state that standard of living is better in U.S. than in Europe ... but to state significantly? None of the data support your idea.

cost decreases in child care, as a result of competition, put more mothers into the labor market in the United States and Canada (link) while the percentage of mothers in the labor market, while having child-care liabilities, is significantly lower in Europe, reflecting regulated and rigid labor market designed by the intervention of trade unions.

That is true while women are in phase of delivering the baby and imediate after-care but i am not sure about long-run where more women stay at home in North America and take care of their children than is case in Europe. Europe's anti-obsession with children is advantage in this case.

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