Revision on Labour Market Failure

Markets fail when they do not reach an efficient and/or equitable outcome from society’s point of view. At AS level, you will have studied many examples of possible market failure ranging from the provision of public and merit goods through to externalities and the welfare consequences of monopoly power in markets. At A2 level, you are asked to explore some issues relating to labour market failure. This revision note flags up a few of them:

A perfectly competitive market requires:

1. Free movement i.e. no barriers to labour mobility 2. Perfect information among buyers and sellers 3. No one seller or buyer able by their own actions to influence / distort the market price

Here are some of the imperfections in the labour market which might lead to market failure:

Example Causes Consequences Policy Action

Labour immobility Occupational: Can lead to (1) Investment in education and training (1)Occupational (i) Skills mismatch for (a) Structural to boost the human the new jobs available unemployment (2)Geographical capital of the labour (ii) Loss of skills and (b) Inflexibilities in the force motivation through long labour market (2) Employment term unemployment (c) Persistent labour subsidies for the long (iii) Barriers to entry in shortages in some term unemployed certain occupations e.g. areas and labour (3) Extra spending on professional bodies surpluses in others (modern) Geographical (d) Rising wage and apprenticeships income inequality (i) Regional house price (4) Financial differences (e) Deepens regional assistance for some economic divide groups to get on the (ii) Family and social housing ladder inc ties (f) Unemployment – grants and part-own, has economic and (iii) Language barriers part rent schemes social costs (iv) Differences in living (5) Encourage costs relocation of public & private sector

businesses out of congested regions

Relevant reading on this

Tutor2u revision presentation on labour immobility

Wealth gap widest in 40 years (Joseph Rowntree Foundation Report)

Example Causes Consequences Policy Action

Disincentives to Low wage earners often (a) Keeps Reform of the income find and take paid find that the effective unemployment higher tax system work marginal tax rate for than it would have e.g. lower 10% earning extra pay is low been (1) The Poverty Trap starting rate (i) Loss of ‘means- (b) Limits the growth (abolished by Labour (2) The tested’ welfare benefits of the active labour in 2008) Unemployment Trap supply (ii) Extra income tax on Higher income-tax free higher earnings (c) Contributes to allowances growing relative (iii) Extra national Reduction in rate of poverty insurance payments benefit withdrawal as (d) People can get income rises (iv) Costs of finding caught into long term child care Better integration of income poverty from taxes and benefits (v) Costs of travelling to which it is hard to and from work escape Make work pay e.g. through a national The result is that the (e) Social costs of minimum wage incentive to find a new economically inactive job or work extra hours people Opportunities for can be worse …. improving (f) Damages the long qualifications and skills Poorest groups might term growth potential to boost wage actually face higher tax of the economy potential rates than the rich (g) Higher welfare Increase availability state bill for the and lower cost of child government care

Some reading on this issue

Breadline living traps children (BBC news, 2006)

Liberal Democrats attack benefits culture (BBC news, 2006)

Example Causes Consequences Policy Action

Discrimination in Information failure – (a) Widening gaps in Legislation the labour market failure to appreciate or pay and earnings Equal Pay Act by employers deliberately to under- between different value the contribution groups e.g. the Race Relations Acts Race made by certain groups persistent gender pay National Minimum Gender gap Often built on deeply Wage Age held prejudices (b) Loss of economic Employment laws efficiency if the right Ethnicity Employers are unable to relating to rights of people for the job are directly observe the people at the Sexual preference prevented from productive ability of workplace progressing in their Other forms of individuals and therefore careers (Many of these pieces discriminatory easily observable of legislation are behaviour characteristics such as (c) Many of those enforced at European gender or race may be discriminated against Union level) used as proxies may choose to leave the labour market – possible brain drain effects (d) Widening inequality within society

Wage Wage

Supply BF Supply WM

We We

MRPL Wm

MRPL MRPL MRPL Dis

Ed Ee Ee Em Employment of Black Females Employment of White males

Race employment gap gets smaller (BBC news, April 2008)

Many minorities live in poverty (BBC news, April 2007)

Female apprentices earning less (BBC news, April 2008)

Example Causes Consequences Policy Action

Monopsony power Major (dominant) Some degree of Role for trade unions of employers employers in an industry worker exploitation if to act as a counter- or a local town might their pay / earnings balance to the

use their ‘buying power’ are well below the monopsony power of to drive wages below a value of their marginal an employer level that might exist in product

a more competitive May contribute to market. National minimum relative poverty and a wage legislation to weakening of work create a statutory pay incentives floor

Because the minimum wage is a pay floor, the monopsonist cannot pay a wage below it, so the NMW effectively becomes the marginal and average cost curve for hiring workers up to employment level Emin. Thereafter to hire additional staff, the wage rate must be bid up, again creating a divergence between the average and marginal cost of labour. The effect on the diagram is that with an appropriately set rate, the profit maximising level of employment after a minimum wage is higher (E2) and the wage rate paid to labour has also increased (W2). So in this particular example, making certain assumptions, a minimum wage might actually boost total employment and secure higher factor rewards for workers in occupations and industries where there is some monopsonistic power among the buyers of labour.

Wage Rate (W)

Marginal Cost with NMW Labour MRPL Supply (ACL) NMW National Minimum Wage Wq

Demand = MRPL

Eq E2 Employment of Labour (E)

Example Causes Consequences Policy Action

Skills gaps in the Free market may not Limits the growth of Tax credits for labour market provide inadequate productivity in an businesses investing in incentives for the economy recognised and acquisition of skills accredited training Creates labour programmes Information failure shortages of skilled workers especially Encourage training - workers may not in key industries / consortia (joint fully understand the public services ventures between private costs and firms in the same benefits of investing Lower productivity industry) in their own has a negative education / training effect on living Expansion of the standards government modern - They may feel that apprenticeship scheme they are under- May damage the rewarded for international More investment into training competitiveness of public sector education the economy – shift of focus for - lack of funding – some students many people on low - Less towards higher quality incomes cannot find innovation vocational the money to help - Higher programmes including pay for the costs of labour the new National acquiring new skills turnover Diploma - decline of students costs for Tax those firms that taking science firms do not train subjects at school Lower real wages More open policy Free-rider problem damages towards inward government tax - Businesses that migration of skilled revenues train up workers workers may find that they Higher business

leave – giving a costs has a negative free ride to their effect on their next employer productivity - Called “poaching externalities”! - There are costs of employees quitting – including hiring and re-training expenses