Chapter-7: Labor Policy 7.1. The Role of Government in … · Many of these laws and regulations directly or indirectly affect wage and employment outcomes. Laws affecting labor market

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Chapter-7: Labor Policy

7.1. The Role of Government in the Labor Market

Besides directly employing labor, providing public goods, transferring income, and levying

taxes, government engages in the important task of establishing the legal rules for the economy.

Many of these laws and regulations directly or indirectly affect wage and employment outcomes.

Laws affecting labor market are so numerous that we must be highly selective. Some of these

include: labor relation law, the minimum wage, the occupational Safety & health law, and the

like.

Why does government regulate the labor market?

Broadly speaking, most regulations of the private labor market are sought for one or two reasons.

Regulation is sought either:

i. to overcome imperfections in competition that are perceived to exist, or

ii. to eliminate what are perceived to be, from the perspective of those seeking regulation,

undesirable consequences of competition.

In both cases, public support for regulation may be based on widely accepted concepts of

„fairness‟ or equity.

Government intervenes in the labor market by using various labor market legislations. In the

previous chapters, we have discussed some labor market legislations like minimum wage and

standard work time requirement. In this section, we shall look at some of the labor market

regulations such as: employment protection or job security, income security measures,

Occupational Health & Safety Regulation, and Occupational licensing.

7.2. Labor Market Legislations

Labor legislation that is adapted to the economic and social challenges of the modern world of

work fulfils three crucial roles:

it establishes a legal system that facilitates productive individual and collective

employment relationships, and therefore a productive economy;

by providing a framework within which employers, workers and their representatives can

interact with regard to work-related issues, it serves as an important vehicle for achieving

harmonious industrial relations based on workplace democracy;

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it provides a clear and constant reminder and guarantee of fundamental principles and

rights at work which have received broad social acceptance and establishes the processes

through which these principles and rights can be implemented and enforced.

But, experience shows that labor legislation can only fulfill these functions effectively if it is

responsive to the conditions on the labor market, and the needs of the parties involved. The most

efficient way of ensuring that these conditions and needs are taken fully into account is if those

concerned are closely involved in the formulation of the legislation through processes of social

dialogue. The involvement of stakeholders in this way is of great importance in developing a

broad basis of support for labor legislation and in facilitating its application within and beyond

the formal structured sectors of the economy.

When the International Labour Office assists constituents in the process of formulating or

reforming labor law, it adopts the basic approach that where labor legislation is appropriately

developed, with the support of the parties involved, it not only promotes social justice throughout

society, but also has a positive effect on economic performance and contributes to social stability

and the reduction of social conflict.

Labour market legislation is widely used both to regulate individual employment relationships

and to establish the framework within which workers and employers can determine their own

relations on a collective basis, for example through collective bargaining between trade unions

and employers or employers' organizations or through mechanisms of worker participation in the

enterprise.

The legislative regulation of the individual employment relationship typically entails the

enactment of provisions governing the formation and termination of the relationship (that is, the

conclusion of contracts of employment, their suspension and termination) and the rights and

obligations relating to the different aspects of the relationship (such as the minimum age for

admission to employment of work, the protection of young workers, equality at work, hours of

work, paid holidays, the payment of wages, occupational safety and health and maternity

protection). Provision also has to be made for enforcement procedures and supporting

institutions (such as labor inspection services and courts or tribunals).

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Regulation of the collective relations of workers and employers typically includes laying down

legal guarantees of the right of workers and employers to organize in occupational organizations,

to bargain collectively and the right to strike, as well as mechanisms for worker participation at

the enterprise level.

Legislative provisions on these matters already exist in most countries. However, there are

considerable differences between countries with regard to the extent and detail of their legislative

regulation and the degree to which the various aspects of the matters concerned are left to

workers, employers and their organizations to determine by collective agreement or individual

employment contract. In some countries with a common law background (that is, where the law

used to be based primarily on judicial decisions and custom, rather than statute law), the basic

elements of the employment relationship were traditionally regulated by the common law, with

most other matters being left to the parties to regulate by agreement. Examples of these countries

include the United Kingdom and many of the Commonwealth countries. However, over the past

century or more the legislature in such countries has tended to intervene increasingly broadly in

the field of labor law, so that in many cases the most substantive issues are regulated in some

detail, and often comprehensively by the legislation. But in certain of these countries, there is

still a tendency for the legislation to be piecemeal and for it to have to be read, understood and

interpreted against a background of common law legal rules which have not been entirely

superseded by statutory law. Moreover, in some cases, disputes or claims regarding legal rights

and obligations may need to be taken to different courts, depending on whether they arise out of

common law or statutory legislation.

In countries with a civil law tradition (which include many French and Spanish-speaking

countries), labor law has often, although not always, been set out in systematic and

comprehensive labor codes. In most of these countries, labor matters were first regulated in the

basic civil code by the provisions governing contracts. Over the years, as other legislation has

been adopted on labor-related matters, much of it has been absorbed into and modified by labor

codes. But, the basic concepts of civil law, and sometimes certain provisions of the civil code,

have in many cases continued to be applied to issues arising in the field of labor. Interpretation of

the law may therefore require reference to the provisions of both labor and civil law.

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Labour law, as comprehensively set forth in labor codes and ancillary legislation, has

increasingly come to be seen as an autonomous system of law, and as being independent of the

typically more individualist body of civil law. In those countries where labor law has been

codified, it has meant that the respective provisions are more readily accessible in comprehensive

texts based on unified and overarching concepts that seek to provide greater coherence to the

system as a whole.

Much of the developing world has been influenced by one or other of these traditions. In many

cases, labor legislation in developing countries was initially adapted from the systems of the pre-

independence colonial power. But in most of these countries the legislation has evolved very

considerably since independence. In countries influenced by the common law tradition, this

evolution has frequently entailed a partial codification, particularly on subjects such as

employment relations (including conditions of work), labor or industrial relations and safety and

health. Authority to make subordinate regulations has generally been delegated to the Minster

responsible for labor matters. In developing countries which have followed the civil law tradition

and which gained independence after the Second World War, comprehensive labor codes were

often developed and have frequently needed to be reformed to adapt them to the economic and

social realities of recent times. In these countries too, Labour Ministries have been endowed with

considerable regulatory powers. However, due to institutional limitations and economic

structure, labor markets in many developing countries are actually regulated largely through

market or informal means.

Irrespective of legal tradition, the challenge of labor law reform in recent years has been twofold:

firstly, to afford better protection for the basic rights of workers, including their trade union

rights; and secondly, to provide for a greater measure of flexibility for the social partners to

regulate the employment relationship in a manner that is more conducive to enhancing

productivity and economic growth.

In many previously planned economy, countries which have undergone the transition to market-

based economies, the challenges of legal reform have centered around the need to replace the

former state-centered forms of regulation by legislation that strengthens independent and

representative institutions capable of engaging in autonomous collective bargaining. This has

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normally involved adapting excessively invasive regulation and generally lightening the

regulatory burden.

Contemporary challenges of labor legislation

Balancing social protection and equity with the need for economic efficiency

In all countries, every epoch needs to find an acceptable and viable equilibrium in labor law

between the functions of social protection and equity and the considerations of economic

efficiency. These are the concerns underlying legislative reform, although the decisions taken in

practice are often rough and ready in the absence of any generally accepted and clearly defined

method of assessing the effects of existing legislative provisions and the changes proposed to

them.

Those involved in legislative reform, whether they represent the government, trade unions or

employers, as well as the ILO officials and experts concerned, therefore need to endeavour in so

far as possible to spell out the consequences of any proposed modification to labor legislation.

This entails trying to assess the effects (both costs and benefits) of existing provisions and

proposed reforms on the interests of workers and employers, and more broadly on those of

society in general in both the short and the long term. In assessing the effects of the various

provisions of labor legislation, recognition needs to be given to their role in correcting market

failures and advancing the public good. On the other hand, sensitivity is also needed to issues of

labor market flexibility to allow for competitive efficiency in a globalized economy. Evidently,

the difficulty with any such assessment exercise is that it can rarely be made entirely objectively

and accurately, as the necessary information to do so is generally only partially available and is

subject to different interpretations.

Tripartite participation in the process of legislative reform and review at the very least,

guarantees that the various considerations are taken fully into account and their possible effects

are assessed from a variety of points of view. Moreover, when the ILO is involved in assisting

countries in labor law reform, at their request, it reinforces the commitment to guaranteeing

fundamental principles and rights at work in compliance with the ILO Conventions that have

been ratified by the countries concerned.

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The 1999 ILO report (international labor conference) titled „Decent Work‟ clearly shows the

prevalence of gap between workers who are represented by trade unions and those who are not;

as well as between those who are covered by labor laws and those who are not. The gender

dimensions of these forms of exclusion are often particularly compelling.

Hence, those involved in labor law reform therefore have to be sensitive to the needs of such

excluded categories of workers, whose situation can normally be improved at least in part by

legislative means. With regard to the representation gap, it is important to identify any legal

barriers in national legislation to trade union membership and the recognition of trade unions by

employers for collective bargaining purposes. Consideration should also be given to legislative

approaches that help to foster a climate amenable to increased representation and collective

bargaining, with particular reference to provisions that guarantee the right to organize to all

categories of workers, afford protection against discrimination of all kinds and set forth the

conditions for the recognition of trade unions for collective bargaining purposes.

Particular attention needs to be given throughout the reform process to the promotion of equality

for disadvantaged groups, particularly in relation to gender and the representation gap. The

proportion of women working in the informal sector, or in various forms of contract labor,

atypical or precarious employment, such as home work, is often high, just as the participation

rates of women in the formal sector are often lower and they tend to suffer from occupational

segregation (in traditionally female jobs) and disadvantage in terms of their conditions of

employment (examples include part-time women workers who would prefer full-time

employment and those who receive unequal pay for work of equal or similar value). Overcoming

gender inequality clearly requires broad policy initiatives that go well beyond the legislative

framework, although the legislative dimension is also important.

ILO adopted 1998, the Declaration commits Member States to respect and promote principles

and rights in four categories, whether or not they have ratified the relevant Conventions. These

categories are:

i) freedom of association and the effective recognition of the right to collective bargaining,

ii) elimination of forced or compulsory labor,

iii) abolition of child labor and

iv) elimination of discrimination in respect of employment and occupation.

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Models of Labor Market Regulations

Countries can adopt a range of approaches to regulate the functioning of their labor market.

Mechanisms can be market based, statutory, or based on collective voice. All coexist, to varying

degrees, in every society.

i) Market Based Approach

Where there is a reliance on market based mechanisms, labor markets are often characterized as

“unregulated.” However, standing (1999) argues that this should be viewed instead as one

approach to regulating employment relations. And, indeed, it is a policy choice to use legislation

and other regulatory instruments to this end. At the heart of market based regulation is the

individual contract (either explicit or implicit) between employer and employee. There has been

a modest trend towards greater dependency on market mechanisms over the past decade or so at

least in developed countries where most of the available evidence exists (OECD 1999a).

However, there are well known arguments for public policy intervention in the labor market, as

well. These arguments pivot on the need to address market failures and injustice/exploitation.

For instance, World Bank (1995), in its World Development Report, highlighted four reasons for

public intervention in the labor market:

a) Uneven market power- workers may find themselves in a weak bargaining position. This can

raise concerns about their protection from unjust treatment. It can also have longer -term

efficiency losses.

b) Discrimination- Workers belonging to groups with little voice or power (e.g., due to age,

gender, ethnicity, etc.) may experience particular disadvantages in the labor market. This also

raises both equity and efficiency concerns.

c) Insufficient information- Workers and some employers may not have adequate information

to make informed decisions about the conditions of work. Health and safety hazards are the

classic example.

d) Inadequate insurance against risk-workers are typically un able to formally insure

themselves against labor market related risks associated, for example, with unemployment,

disability, or old age

These arguments underlie public policy interventions to support the other modes of labor market

regulation.

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ii) Statutory

Regulation is the classic notion of regulation rules and procedures established by laws and

decrees that govern aspects of the employment relationship. These can cover a wide range of

areas: for example, the establishment and protection of universal worker rights; the protection of

vulnerable groups of workers; principles for determining compensation; working conditions; and

the initiation and termination of the employment relationship.

Table-7.1: Examples of Statutory Regulations

Source: World Bank (1995)

iii) Collective Voice

The other mode of regulation, which refers to the voluntary negotiation and administration of the

employment relationship where workers (and sometimes employers) are represented collectively.

This mode of regulation can occur at different levels (e.g., enterprise, sector, or nationally) and

with various degrees of coordination. In developing countries, only minorities of workers are

covered by collective bargaining; often this minority is quite small and concentrated in the public

sector. Moreover, the reach of the collective voice mode likely has receded somewhat if union

membership trends are any indication.

Obviously, the effectiveness of different modes of regulation can vary greatly depending on the

particular circumstances. A statutory approach may achieve its intended objectives in one setting

but be inappropriate or unenforceable in another. Similarly, markets operate with varying

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effectiveness, as does collective bargaining. However, each of these modes of regulation does

have inherent strengths as well as potential risks as summarized in table 7.2 below.

Table 7.2: Some Potential Strengths and Risks of Market, Statutory, and Collective Voice Regulation

7.3 Job Security or Employment protection

Employment protection, or job security rules refer to hiring and firing arrangements. These can

cover what kinds of contracts are permitted, any special rules favoring certain groups in hiring,

occupational standards, the conditions under which workers can be terminated, requirements for

severance and advance notice of termination, redundancy procedures, and special rules for mass

layoffs. Employment protection is typically considered along a “rigidity/flexibility” continuum.

At the rigid end, non-regular contracting is restricted, hiring standards may be in force, employer

dismissal rights are controlled, and severance, notice, and administrative requirements are

substantial. At the flexible end, statutory (or collectively bargained) regulations are minimal and

market mechanisms largely determine hiring and firing.

The idea behind most employment protection rules is to enhance job security by making

dismissal costly to the employer. However, by making dismissals more costly, employment

protection regulations can also have the unintended effect of creating hiring disincentives for

employers. There are various ways in which these rules can affect labor market outcomes

including employment levels, labor dynamics (i.e., employment fluctuations), and the

composition of employment.

Theoretically, the clearest effects are on labor market dynamics – employment protection rules

can be expected to lengthen job tenure and reduce labor turnover. All other things being equal,

then, stronger job security rules will stabilize employment levels, not only reducing layoffs in

downturns but also reducing hiring in upturns. This will protect jobs for incumbent employees

but limit hiring opportunities for the unemployed. As a result, we can expect the duration of

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unemployment (as well as employment) to be positively related to the degree of employment

protection.

The impact of employment protection on the average level of employment (and unemployment)

through the business cycle, however, is more ambiguous. Whether employment rates within the

firm increase or decrease with greater employment protection depends on how the decline in

hiring compares with the decline in firing. This in turn depends on assumptions about the

persistence of labor demand shocks, the elasticity of labor demand, how firms discount future

firing costs at the time of hiring, and so on. Job security rules, however, should affect the

composition of employment in various ways: depending on the details, they can shift labor

demand to uncovered (informal) sectors, firms, or employment types.

(i) Dismissals

The key policy issue concerns how difficult and/or costly it is for employers to terminate regular

(i.e., permanent) employees for economic reasons.8 Restrictions can take various forms: (i) what

is considered to be a justifiable reason for termination; (ii) severance obligations; (iii) advance

notice requirements; and (iv) necessary administrative procedures for laying off workers. There

may also be special requirements in the case of mass layoffs. These restrictions are often found

in national or sub-national labor codes but, depending on the country, the degree of job security

can also be defined by court decisions, collective bargaining agreements, or even unwritten

industrial norms.

There are significant variations across countries in terms of the protection offered to regular

workers. Table 7.3 provides examples of statutory arrangements regarding what are legally

acceptable reasons for economic dismissals; what severance requirements exist; and what

advance notice is required. The United States has the least restrictive employment protection

laws: there are no restrictions on dismissals in the private sector, no statutory severance

obligations, and advance notice requirements only in the case of mass layoffs. In reality,

employers in the U.S. do face some constraints on their dismissal rights because of court

decisions and collective agreement provisions. As the table shows, however, other countries have

various statutory employment protections – ruling out certain reasons for lying off workers and

imposing severance and advance notice obligations. During the past decade or so, there has been

no clear trend in regulating dismissals in OECD countries; some have strengthened protections,

others have eased them, but in most cases, arrangements have remained relatively stable. In

many Latin American countries, however, job security rules have been scaled back.

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Table 7.3: Legal Arrangements for Termination, Selected Countries

Source: World Bank 2001, Social Protection Discussion Paper Series, No. 0128

(ii) Hiring and contracting

The most important policy issue here concerns the rules for employing “non-standard” workers

specifically, employees on fixed-term contracts and temporary agency workers. Restrictions in

these areas are akin to job security protections by limiting the number of workers who do not

have access to such protection. These forms of contracting typically do not involve significant

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dismissal costs. So, in theory, their effects should be similar to those stemming from job security

rules.

Table 7.4: Legal Arrangements for Fixed-Term Contracts and Temporary Agency Work, Selected Countries

Source: World Bank 2001, Social Protection Discussion Paper Series, No. 0128

The most extensive study of the labor market impacts of different contracting arrangements was

carried out by the OECD (1999), based on the experience of its member countries.

Unfortunately, there is little empirical evidence for developing or transition countries. According

to the OECD analysis, strict limitations on the use of fixed-term and temporary agency

contracting are associated with:

Lower aggregate employment rates;

Lower employment for women and young people;

Higher levels of self-employment (as a share of total employment);

No impact on aggregate unemployment levels; and

Lower flows into unemployment but longer average unemployment durations.

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As we have already noted, at least in the OECD countries, restrictions on the use of non-standard

employment reinforce job security rules that constrain employer dismissal rights. Where

regulations are strong, regular employees have job security and the economy has more stable

employment. However, there generally is less dynamism in the labor market. There is also less

opportunity for regular employment in the formal sector. This increases the vulnerability of

certain groups of workers including women and youth, and the unskilled or poorly educated who

are less likely to get these jobs. Many of these workers, then, will be relegated to either being out

of the labor force or to the informal sector. This has to be assessed against weaker job protection

rules which do not discourage formal sector jobs but accommodate a lower level of protection in

these jobs.

7.4: Income Security Measures/Income Policy/

The government may enact a number of programs to make the lifetime income of workers more

secure. Some of these programs may include: cash grants to certain group of workers, minimum

wage legislation, unemployment insurance, social security, workers compensation and the like.

The first two have been discussed under chapter -2 and chapter-3. In this section, we briefly

discuss the others.

i) Social Security- while the social security system involves a number of income security

programs, its main objective is the securing of a retirement income for workers. Individuals

currently employed are taxed, as are their employers, and these receipts are used to finance

current benefits of eligible retired individuals. As our analysis of Unemployment Insurance

indicated, it does not matter whether the tax is imposed on the employer, the employee, or both.

In all cases, the positive slope of the supply curve of labor will result in the tax burden being

shared by employees and employers. Because, currently employed workers and their employers

must pay for the benefits paid out to current retires, any change in the ratio of the number of

retired to the number of currently employed will affect the burden of payment on the currently

employed . In the number employed rises at least at fast as the number retired, then benefit levels

can be increased over time without increasing the tax burden placed upon current employees.

Studies show that in countries where social security system is enacted, the motivation of working

people to save for their retirement years has been declined.

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ii) Workers Compensation- are programs used by some country governments(eg.USA), which

attempts to provide, among other things, income security to workers who are injured on the job

or who suffer from certain occupational diseases. Such program compensate workers for injury

without requiring the employee to establish that the employer is totally (even partially) at fault.

Firms are required to buy what are essentially „no-fault’ insurance policies. In assessing the

labor market impact of worker‟s compensation, the costs of the program can be thought of as

fixed costs of employment, since the premiums are charged on a per-employee basis rather than

on a per-hour worked basis. This type of fixed costs of employment provides employers with an

incentive to work employees at the standard work and, in the long run, to adjust to changes in

demand by altering the number of employees rather than the average number of hours that each

employee works. Because, the security provided through workers‟ compensation is valued by

employees, wage levels in all covered industries are probably somewhat lower than they would

otherwise be. However, wages in some industries and occupations will be more affected than

others. Jobs with high accident risks must pay a compensating wage premium in order to attract

workers. It stands to reason that, since workers‟ compensation partially mitigates the

consequences of accidents, the compensating differentials necessary to attract workers to

physically risky jobs will not be as large as they would be in the absence of workers‟

compensation. While worker‟s compensation may give employers an incentive to increase job

safety precautions, it may have the opposite effect on workers. Because, they are partially

insured against financial loss resulting from injury, workers may be less cautions at the

workplace.

iii) Unemployment Insurance- program is intended to protect workers from the financial

difficulties of unemployment, but has several other effects as well. Unemployment benefits may

be financed through payroll taxes, but the amount of the tax, and the ways in which it is imposed

vary somewhat from country to country. Economists have devoted considerable study to the

effect of unemployment insurance on the unemployment rate. Unemployment Insurance affects

the unemployment rate in a least two ways:

a) First, unemployment insurance benefit, because they cease when a worker finds a job,

may actually subsidize leisure in much the same way as social security does.

b) Second, Unemployment insurance affects an unemployed worker‟s search strategy. The

benefits provide the workers with the financial means for continuing to search for a

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desirable job appropriate to the worker‟s skill level and long-term expectations rather

than accepting the first opportunity to work that becomes available.

In this section, we are interested in the allocative efficiency of unemployment insurance. The

question of whether employers or employees bear the burden of the tax (used to finance

unemployment insurance) is analytical one, and does not depend on whom the tax is legally

imposed on as we have seen in chapter-3. To show this diagrammatically, imagine initially, that

no unemployment insurance tax exists. The labor market would be in equilibrium at a wage rate

W* and an unemployment level of Ebt. Now assume that a payroll tax (to finance unemployment

insurance) is imposed on the employer. The demand for labor shifts downward from Dbt(before

the tax) to Dat(after the tax). The amount of the downward shift is simply the amount by which

the firm‟s costs per unit of employment are increased by the tax.

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In equilibrium, the firm‟s costs per unit of labor rise from W* to Wf, while the wage received by

workers fall from W* to Ww. Thus, we can see that the tax (Wf – Ww) is born partly by employers

(Wf - W*), and partly by employees (W* - Ww). An additional effect is a reduction of employment

from Ebt to Eat as fewer individuals choose to work at the now lower wage. Workers‟ choice of

industry and occupation may also be affected by the existence of the unemployment insurance

system. Workers value income stability or security. In industries and/or occupations that are

highly susceptible to unemployment must pay a premium or compensating differential in order to

attract workers. The presence of unemployment insurance, however, reduces the size of the

premium that must be paid to attract workers into jobs that are seasonal in nature or particularly

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sensitive to the business cycle. Thus, the unemployment tax is seen to affect not only the overall

level of wage and employment, but also the structure of relative wage across occupations and

industries.

Who gains and who loses from income Security Measures?

Identifying the gainers and losers from minimum wage legislation may be relatively

straightforward (as we have seen in Ch-3), but can be quite complicated for income security

programs. In the case of social security programs, income is obviously redistributed from the

working population to the retired population. But, present workers hope to be among the retired

someday, so the program can be loosely thought of as an attempt to require individuals through

legislation to reallocate lifetime income. This fact is not withstanding, the currently retired have

already supported a previous generations of retired persons. Their present interest is to obtain as

high a level of benefits as possible since they will never again bear the burden of the payroll tax.

The social security system involves another type of income transfer. Persons whose lifetime

earnings are low receive disproportionately high retirement benefits; income is effectively

redistributed from high-wage earners to low-wage earners.

On a superficial level, it would seem as though the only redistribution involved in the

unemployment insurance system would be from the employed to the unemployed as intended.

The system also may work so as to redistribute income in other ways. The incidence of

unemployment is very uneven across industries, but payroll tax is imposed almost uniformly

across industries. Generous level of unemployment compensation provide firms that experience

unstable or seasonal product demand with an incentive to use temporary layoffs to a much

greater extent than they would in the absence of the program. It would appear that workers and

firms in high-unemployment industries are subsidized by workers and firms in low-

unemployment industries, since workers with this firm would now be receiving unemployment

benefits in excess of the unemployment insurance taxes that they have paid. But, if the

compensating differential paid in high-unemployment industries is reduced by the existence of

unemployment insurance, workers in those industries may not actually find their total income

(inclusive of unemployment compensation benefit) increased. Even so, the reduction in the

compensating differential will lower the cost of production to firms in high unemployment

industries and raise it in other industries. Consequently, the relative prices of goods produced in

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industries with unstable and seasonal demand will be lower (and those in stable industries

higher) than would be the case in the absence of unemployment insurance/compensation.

7.5: Occupational Health and Safety Regulation

Another important and controversial area of direct government intervention into the labor market

is the regulation of occupational health and safety. This intervention may take different form

depending on the countries specific context.

Government regulation of workplace health safety is worth of discussion for several reasons.

First, studies show that work is more dangerous than generally perceived i.e. quite a lot of people

my receive injuries or die in connection with work related accidents. Second, job safety-or the

lack thereof-is an important nonwage aspect of work, which is an important determinant of labor

supply. Therefore, degrees of work place safety help explain wage differentials among

occupations. Finally, just as with such labor market interventions as the minimum wage and

affirmative action legislation, controversy exists over the appropriateness and effectiveness of

regulations of work place health and safety.

Profit-Maximizing Level of Job Safety

Competition in the product market will force a profit-maximizing firm to minimize its internal

costs of producing any specific amount output. One cost of production is the expenditure

necessary to make the workplace safe. The production of job safety normally involves

diminishing returns, which, translated into cost terms, means that each dollar of additional

expenditure yields successively smaller increase in job safety. More concretely, firms will first

use such relatively inexpensive techniques as disseminating safety information and issuing

protective gear (say, hard hats) to make the job safer; but to make further gains, they may have to

resort to such increasingly costly actions as purchasing safer equipments and slowing the work

place. Therefore, most firms experiences a rising marginal cost of job safety: successively higher

amount of direct expenses, reduce output, or both will be required to gain additional unit of jobs

safety. We depict a marginal cost of safety curve MC, in fig 7.2. Each additional unit of job

safety, measured on the horizontal axis, costs more than previous units.

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Knowing that it is costly to provide job safety, why would a firm choose to offer workers any

protections from workplace hazards? The answer is provided by the marginal benefit of safety

curve MBs (disregard the curve labeled MB‟s for now). An employer benefits from creating a

relatively safe workplace; job safety reduces certain costs that the firm might otherwise incur.

Notice, however, that as more units of job safety are produced by this firm, the marginal benefit

from job safety (MBs) to the firm falls. Just as individuals experiences diminishing marginal

utility as successive units of goods are consumed, firms find that the extra benefit (cost savings)

of job safety diminished with every increase in the amount of job safety.

Just what are these benefits to the firm? First, lower risks of injury or death enable employers to

attract workers at lower wage rates. Because workers value job safety, they are willing to accept

a lower wage for work performed in a healthful, relatively safe environment. Second, a safer

workplace reduces the amount of disruption of the production process that job accidents create.

Workplace mishaps and the absence of key employees during rehabilitation often halt or slow the

production process. Third, a safer workplace reduces the cost of recruiting, screening, and

training workers. The fewer workers injured on the job, the fewer resources will be required to

hire and train new employees. Fourth, workplace safety helps maintain the firm‟s return on its

specific investment in human capital. Job fatalities and injuries termination or reduce the firm‟s

returns on its previously financed specific, formal and on-the-job training. Finally, fewer job-

related accidents translate into lower workers‟ compensation insurance rates. Such rates are

determined by the probability and types of accidents experienced in a given firm.

To determine the profit-maximizing level of workplace safety, the cost-minimizing firm will

compare the marginal benefit of safety (MBs) against the marginal cost (MCs). In so doing, it

will use the decision rule: Provide additional job safety so long as the marginal benefit exceeds

the marginal cost. In fig 7.2, we see that the profit-maximizing level of job safety is Qs units, at

which MBs = MCs. Even in the absence of government intervention, this firm will find it cost-

effective and profitable to provide some degree of job safety (i.e. Qs units of safety).

Another observation merits comments here. The perception that some jobs, say coal mining and

construction, are inherently dangerous while others, say accounting and teaching, are innately

safe is slightly misleading. A more accurate statement is that given present technology, it is

inherently more costly to provide job safety in some occupations than others. Therefore, firms

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with similar marginal benefit schedule but different marginal cost of safety will offer differing

level of job safety.

Fig 7.2: The Optimal Level of Job Safety

Marginal cost &

Benefit of Job Safety

MCs

b

C

a MBs

d MB’s

O Q’s Qs Quantity of Job Safety

A firm with the same marginal benefits curve as that in fig 7.2 but with significantly higher

marginal cost of providing job safety than those shown by MCs would provide much less job

safety than Qs units.

Society’s Optimal Level of Job Safety

A firm‟s profit-maximizing level of job safety may or may not be society‟s optimal level of job

safety. In addressing this topic, let‟s first assume that there is perfect information and assessment

of job risk, and then examine a situation where this is not the case.

(a) Perfect Information and Assessment

If workers have full information about possible work hazards and accurately assess the

likelihood of occupational fatality, injury, or disease, then the amount of job safety offered by

employers will match the level required to maximize society‟s well-being. Where workers have

full knowledge of job risk, employers providing hazardous work environments will have to pay a

wage premium to attract a sufficient number of employees. The existence of compensating wage

differential will ensure that the employer‟s extra benefit from providing a safer workplace

(including a reduced wage premium) will match the extra benefit of job safety from society‟s

perspective. In fig 7.2, we are saying that given our assumption of perfect information and

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assessment, curve MBs depicts both the private and social marginal benefits of job safety. The

number of units of job safety shown as Qs will maximize the firm‟s profits and optimizes

society‟s well-being.

(b) Imperfect information and Assessment

Where information about job hazards is limited and/or workers underestimate the personal risk

of occupational fatality, injury, or disease, employers will provide less job safety than is socially

optimal. To demonstrate this, suppose workers mistakenly judge the job in question to be risk-

free, when in reality one of the substances handled by workers is highly hazardous. Because,

employees are unaware of the long-term danger, the job hazard will not reduce labor supply to

this occupation and employer. The market wage therefore will not contain a wage premium

required to compensate workers for the added job risk. Consequently, the firm‟s marginal benefit

from reducing the health hazard-that is, from providing a safer workplace-will be smaller than it

would be if workers had full information about the job danger. Extra units of job safety will fail

to reduce the wages paid by this firm because the labor market has not dictated payment of a

wage premium to compensate workers for their true risk. From the firm‟s perspective, the

marginal benefit from providing job safety is less than it would be if full information about the

long-term health consequences of the job were known.

The marginal benefit schedule of job safety as viewed by the firm in this situation is shown in fig

7.2 as curve MB‟s. The firm compares MB‟s with its marginal cost of providing safety (MCs) and

settles for Q’s units of job safety. The result is that job safety is underprovided from society‟s

viewpoint. Suppose the true marginal benefits of each added unit of safety are those shown as

MBs rather than BM’s. Given full information and accurate assessment by workers of the job

danger, the firm‟s relevant marginal benefits curve would be MBs, and both the profit-

maximizing and socially optimal level of job safety would be Qs units. As we can observe by

extending a vertical line upward from Q’s to MBs, and observing the triangle abc, the Q’sQs units

of job safety generated marginal benefits to society that exceed the marginal cost costs MCs. But

under conditions of incomplete information or underestimation of risk by workers, and,

therefore, no market wage premium, the firm has no incentive to provide these extra units. From

its perspective, the marginal benefit is less than the marginal cost. We conclude that a firm‟s

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profit-maximizing level of job safety may not always conform to society‟s optimal level of job

safety. In the above example, society‟s welfare loss from this inefficiency is area abc.

7.6: Occupational Licensing

In many occupations, individuals must be licensed by a country or state in order to work. The

occupations covered by licensing requirements are many and varied, ranging from high-income

professionals such as doctors and lawyers, pharmacists, craft occupations such as electricians and

beauticians. In many instances, licensing of occupational groups is held to be necessary to

protect consumers against incompetents who might do irreparable damage. In these

circumstances, governmental licensing may be the most efficient way to minimize the costs of

obtaining information needed by consumers to make optimal buying decisions. Sometimes, the

occupational groups themselves, not consumers, generate the demand for licensing. These groups

may wish to restrict access to licensees as a way to obtain economic rent for licensees.

Depending on the country, licensing may require among other things:

Payment of large fees,

The passing of exams, or completion of specific educational or experience requirements.

Regardless of the mechanism used, analysis the impact of licensing is the same and is quite

straightforward: restrict supply. Specifically, the requirement that, say, real estate agents be

licensed will reduce the supply of agents below what it would otherwise be. In the market for the

licensed occupation, the effect is to raise the equilibrium wage above the competitive equilibrium

wage that would exist in the absence of licensing.

Fig 7.3 demonstrates how occupational licensure can confer economic rent. Suppose the pre-

licensing equilibrium wage and employment level are $8 and 10,000 workers respectively. Next,

assume that licensing has the effect of restricting the total number of licensed workers to 7,000.

In effect, the post-licensing labor supply curve is SgS1, compared to the old curve of SSo. Notice

that licensing increases the market wage to $11 an hour and that total employment falls from

10,000 to 7,000. The $11 wage attract another 4,000 workers (= 14,000-10,000) who would like

to work in this occupation. These 14,000 workers see 7,000 licensees, and those who get licensed

receive increases in economic rent of $3 for every hour worked. As a consequence, the

government‟s action raises the total rent to those employed by $21,000(7,000 x$3). This can be

determined by noting that the total rent was area Saf prior to the licensing. Following licensing,

22

the total economic rent increases to Sbcg. Thus, the gain in rent is abce- and the loss of rent to

the workers displaced by the licensing is area gef.

FFiigg..77..33:: RReenntt PPrroovviissiioonn tthhrroouugghh OOccccuuppaattiioonnaall LLiicceennssiinngg

WWaaggee (($$)) SS11

SSoo

$$1111bb cc

$$88 aa ee ff

gg

DD

SS

00 77 1100 1144 LLaabboorr ((„„ iinn 11,,000000ss‟‟))

From this, one can notice those occupational licensures that restrict labor supply create an

efficiency loss for society-in this case, triangle gcf. The 3,000 additional employees who would

have been employed in this occupation would contribute more the value of society‟s output in

this employment (as shown by segment cf of the demand curve). Additionally, the true efficiency

loss to society may be greater than area gcf. To secure the licensing law and thus the added

economic rent, this particular occupational group most likely had to spend large amount for

political lobbying, public relations adverting, and other activities. From society‟s perspective,

these expenditures diverted resources away from potentially higher-valued uses, adding to the

overall efficiency cost of the occupational licensing.

To summarize, occupational licensure of the type restricting labor supply increases the market

wage, confers economic rent to the licensees, and causes economic inefficiency. We might add

that it is possible that the competition for the limited number of licenses will cause the new

licensees to expend dollars in an amount equal to the expected rented. Thus, those who are

automatically granted licenses when the law is passed and those who train potential licensees

will be the major beneficiaries of the law.

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Conclusion:

It is always useful to ask who gain and who would lose form any particular proposed form of

intervention. The application of economic analysis of this question often help us to understand

whether existing and proposed legislations draws its support, as well as helping us to foresee or

explain the unintended consequences of labor market regulation. The scope of labor market

intervention is much broader than what is presented under this section. Besides, the regulatory

environment is sometimes subject to rapid change; hence the programs and regulations presented

under this chapter as example are included not only because those programs are important in

themselves, but also as a device to demonstrate the ways in which labor market intervention can

be examined from an economic perspective. As we have seen, evaluation of a particular

government program requires examination of both intended and unintended impacts. The

question of whether the intended impact of labor market regulation is desirable can indeed be the

subject of economic analysis, but such analysis must involve a logical treatment of conditions

that would exist in the absence of the regulation in question. Whether or not a particular

government activity achieves its intended impact is a separate question. Where government

program do achieve their intended impacts, the benefits of these programs should be compared to

their costs, inclusive of unintended impacts.

References:

1. Bellante and Jackson (1983), 2nd edn. Labor Economics: Choice in Labor Markets,

McGraaw-Hill, Ch-15.

2. Compbell R. McConnel and Stanly L.Bruce((2009), 8th edn., Contemporary Labor Economics,

McGraw-Hill, Ch-13.

3. ILO (1998), Declaration on Fundamental Principles and Rights at Work, International Labor

Office, Geneve.

4. World Bank/WB/(2001),Labor Market Regulation: International Experience in Promoting

Employment and Social Protection Social Protection , Discussion Paper Series, No.

0128.