Inverted “S” — the Complete Neoclassical Labour-Supply Function

International Labour Review, Vol. 139 (2000), No. 4 Inverted “S” — The complete neoclassical labour-supply function Mohammed SHARIF * hough extensive and rigorous, existing surveys of the labour-supply Tliterature do not distinguish between the supply behaviour of the working poor and that of the non-poor. 1 Yet the economic conditions faced by the working poor are fundamentally different from those enjoyed by the non- poor in terms of assets and human capital. The reservation wages of the working poor and the relative weights of the income and substitution effects of a wage change on their labour supply might therefore be fundamentally different as well. This implies that the minimum wage rate below which the worker quits the labour market, the quantity of labour she/he supplies at that wage rate, and her/his net response to a wage increase might differ as between the two groups. If such differences do exist, they would have important implications for labour supply theory and human resource policy. But while studies of the supply behaviour of workers in general have been widely reviewed, those focusing on the labour supply of the working poor have eluded proper documentation and deserve attention. Empirical studies do, indeed, report the supply behaviour of poor workers to be generally different from that of their richer counterparts. While the latter’s supply behaviour is graphically observed to be positively sloping from the reservation wage upwards, with a backward-bending segment in the supply curve at high wages, that of the poor is characterized by a negative relation between wage rates and the quantity of labour supplied when wages *1 Department of Economics, University of Rhode Island. 1 See Keeley (1981), Killingsworth (1983), Killingsworth and Heckman (1986) and Pen- cavel (1986). Copyright © International Labour Organization 2000 410 International Labour Review drop below a certain level. 2 Conventional neoclassical theory, however, analyses the former behaviour only, as if it were universal. In this formu- lation, the substitution effect dominates the income effect on the upward- sloping segment of the function while the income effect dominates the substitution effect on its backward-bending section; and the reservation wage rate ¾ a function of the worker’s preference and unearned income ¾ sets the lower limit to the supply curve. Using this a priori framework, the empirical studies which observe a negatively sloping supply curve for the poor characterize it as backward- bending.3 However, in seeking to explain why this backward-bending supply behaviour occurs at very low wage rates under poor economic conditions, the authors impose a hypothesis of perverse economic behaviour on poor workers, variously calling it a “target income” behaviour (Berg, 1961; Dunn, 1978), a “limited aspiration” behaviour (Mellor, 1963) or a “subsistence mentality” behaviour (Lewis, 1954). The underlying assumption is that the conventional economic postulate of “unlimited wants” for goods does not apply to the poor. Rather, the poor are held to have a “strong preference for leisure”, to be content if their minimum subsistence needs are met, and to enjoy most of their time in leisure. This implies that poor workers’ aspiration for a better living is limited to their minimum standard of subsistence; the workers set this subsistence as the target they work for, and once this target income is earned, they quit working. In essence, the authors conclude that a modest “target of subsistence” dictated by the limited aspiration of the poor is the objective of their supplying labour, hence the inverse relationship between the wage rate and their labour supply. Such a conclusion, however, ignores the fact that the working poor are observed to work unusually long hours in physically exerting jobs, yet fail to meet even their minimum needs for food. Objections have occasionally been raised against characterizing this as perverse behaviour (Rottenberg, 1952; Miracle and Fetter, 1970; Myint, 1971; Sharif, 1991b), and theoretical analyses have been provided for viewing it as a phenomenon of economic distress (Barzel and McDonald, 1973; McGregor, 1990; Sharif, 1991a and 1991b). However, these have not 2 Following Myint (1971), this is referred to as the forward-falling supply function to distinguish it from the backward-bending one. For empirical evidence on this negatively sloping supply curve in the context of industrialized countries, see Ashenfelter and Heckman (1973), Atkinson and Stern (1980 and 1981), Boskin (1973), Brown, Levin, and Ulph (1976), Burtless and Greenberg (1982), Cain and Watts (1973), Dunn (1978), Greenberg and Kosters (1973), Hall (1973), Hill (1973), Johnson and Pencavel (1982), Keeley and Robins (1980), Leuthold (1968), Masters and Garfinkel (1977), Moffit (1979), Rosen and Welch (1971), and Watts et al. (1974). Reviews of most of these studies can be found in Keeley (1981), Killingsworth (1983), Killingsworth and Heckman (1986) and Pencavel (1986). For studies in the context of developing countries, see Anderson and Frantz (1984), Bardhan (1977), Bardhan (1979), Berg (1961), Hart (1986), Huang (1976), Mellor (1963), Miracle and Fetter (1970), Myint (1971), Papola and Misra (1980), Rodgers (1975), Rosen- zweig (1984), Rottenberg (1951) and Sharif (1989, 1991a and 1991b). For a review of studies on Indian agriculture, see Bardhan (1977). 3 See Berg (1961), Dunn (1978), Huang (1976) and Mellor (1963). Inverted “S” — The complete neoclassical labour-supply function 411 received sufficient attention in labour economics and the perverse-mentality hypothesis predominates. The failure of analysts to accept as rational the negatively sloping supply behaviour of the working poor might derive from two misconceptions. The first relates to the concept of subsistence, and the second to the reservation wage. Generally speaking, the people in a society’s lowest income cate- gory at a given point in time are referred to as subsisting, and their standard of living as subsistence, irrespective of whether this really embodies the minimum decency that the standard of subsistence requires. Although this general concept is not meaningful in subsistence analysis, it does seem to have influenced the theory of labour supply. But if the lowest standard of living observed in a society at a given point in time is taken to be the subsistence standard ¾ as is done by the proponents of the “perverse mentality” theory ¾ it simply eliminates any possibility of below-subsistence living 4 and, hence, below-subsistence labour supply. This makes the upward-sloping supply ¾ starting at the lowest standard of living and ending with a backward bend at higher wages ¾ the only possible supply function. Any observed supply behaviour that does not conform to this standard postulate is characterized as perverse. But subsistence and poverty studies show that the lowest standard of living observed in a society is not necessarily the subsistence standard. Subsist- ence is a minimum standard of decent living, 5 and a large number of people in the world live below this standard. A third of the world’s population ¾ about 1.7 billion people ¾ live in absolute poverty, i.e. below the official poverty line, which is the official standard of subsistence. If those living at, and marginally above, the poverty line are counted as well, the number gets much larger. Even excluding the very young, the very old and the disabled, the overall number of these people who work for an income ¾ from employment or self-employment ¾ therefore accounts for a significant percentage of the world’s total labour force, 6 and their labour supply behaviour can obvi- ously not be analysed by the existing upward-sloping supply theory. Not only does this exclude from labour-supply analysis a significant segment of the world’s working population, but it also forces empirical researchers to look for unusual explanations when they observe something that differs from the upward-sloping supply pattern. Moreover, the perverse-behaviour analysis of the labour supply of a large portion of the world’s working population might have serious adverse implications for human-resource and economic devel- opment policies in general and poverty-alleviation policy in particular. 4 This essentially rules out the existence of absolute poverty in any society at any time. 5 See Sharif (1999), for an analysis of the concept, and Sharif (1986), for a survey of the lit- erature on it. 6 In poor households, especially in the developing countries, children start working as early as age six and old people keep on working as long as they can physically do so (Cain, 1977; Hart, 1986; Sharif, 1991a and 1991b). Thus, for the working poor, dependency has not been observed to have a statistically significant effect on labour supply behaviour (Sharif, 1989, 1991a and 1991b). 412 International Labour Review The conventional analytical assumption about the reservation wage 7 is the second misconception that accounts for the failure to accept the negative supply behaviour of the poor as rational. In this framework, the concept of a reservation wage relates to the lowest point of the upward-sloping supply curve. Implicit in this is the assumption that, at the reservation wage rate, the worker earns/receives at least a subsistence income from non-labour sources (asset or transfer income, past savings, etc.), which affords him/her the ability to quit working if the wage rate falls below that reservation level. Thus again, the possibility of below-subsistence living and that of below-subsistence labour supply are ruled out. However, if non-labour income is not available ¾ which is really the case for poor workers, especially in traditional economies ¾ the notion of a reservation wage establishing a threshold to the non-decreasing supply function is irrelevant. In such a situation, the lower limit to the non-decreasing segment of the supply curve will be given by the wage-labour combination that yields the worker’s subsistence income.

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