RAISING THE EMPLOYMENT AND PAYOF THE WORKING POOR**Low-Wage Employment - PDF document

RAISING THE EMPLOYMENT AND PAYOF THE WORKING POOR**Low-Wage Employment Subsidies versusthe Welfare StateBY EDMUND S. PHELPS*This paper is a brief for the introduction of asubsidy to any qualified firm for its use oflow-wage employees as a means to reduce theunemployment and raise the pay ofdisadvantaged workers. There would be a case VOL. 84 NO. 2 RAISING THE EMPLOYMENT AND PAY OF THE WORKING POOR(cost-effective) incentive wage to the level ofthe demand wage, the wage firms can afford topay if they are to maintain current employmentrolls. In the proto-models, though, taxes wereneutral for the natural rate (Phelps, 1968; StevenSalop, 1979).My new work emphasizes that employees'average propensity to quit (and also to shirk, tobe an absentee, etc.) is a function not only of theunemployment rate and their relative wage, asbefore, but also of the ratio of their wage (or ofthe standard wage) to their average nonwageincome, income from wealth plus net transfers.Workers' nonwage income, or unearned incomeand that of family and friends bolsters theirwillingness to quit (also, to shirk, etc.), at therisk of losing their jobs. In this asset-enrichedmodel, a payroll tax is not neutral: it has anegative impact on the demand wage (by addingto firms' costs), but less so on the requiredincentive wage (since it does not tax away anynonwage income). Both the wage andemployment fall, unemployment rising to a newand higher natural level.This enriched model, if extended toheterogeneous workers, would showunemployment to fall primarily on thedisadvantaged, since the more skilled workersmay land a lesser job when waiting for anopening in their normal work, while theunskilled have no such alternative.There is another channel through which thewelfare state has aggravated joblessness.Richard Layard and Stephen Nickell put theharm done by unemployment compensation intotheir model and estimated its effects (Layard etal., 1991). But like all pioneers, they did not gohalf far enough. As Zoega argued, the safety net(food stamps, medicaid, etc.) has a sort ofwealth effect alongside the substitution effectfrom the payroll taxes to finance them: itincreases the willingness of workers to takerisks that might cost them their jobs. Quittingfor a change of scene, shirking, and the likebecome more tempting. Hence, the requiredincentive wage is pushed up (and in some casesthe demand wage is pulled down), with obviousconsequences for the natural rate (Zoega, 1993;Phelps, 1994).The overall reward to the disadvantaged fromemployment may also be hurt: their wages mustdrop to finance their participation in a welfaresystem that they would not have been willing tobuy, being too poor. The wealth effect of thesystem, in elevating quit rates, also operates toreduce employees' net productivity (net oftraining costs) and thus to reduce the demandwage on this account as well. So the welfarestate may reduce the wages of the disadvantagedby more than would just compensate for theimposed welfare entitlements.There are also effects on self-esteem: with thesafety net only inches below, many of thedisadvantaged will see employment as far lessrewarding in utility terms, and henceemotionally. When people do not needemployment to have housing, food, and even toraise children, the meager pecuniary reward ofthe low-end jobs is devalued. The effect must bea decline in many people's morale. The reducedmorale impairs their job performance, which inturn costs them some opportunities and reducesthe profitability of investing in themselves toimprove their future opportunities. The weakmorale is contagious in a close-knit community.All this damage done to disadvantagedworkers might not matter much if disadvantagedworkers were all fairly and handsomelyrewarded in the workplace. In fact, though, thevery disadvantaged—say, the bottom tenthcontinue to do badly in the advanced economies,with unemployment rates that are extremelyhigh, especially among the young, and withwage rates that are little above the meager wageminimum instituted by law or by trade unions.In the United States, the earnings of workers atthe tenth percentile in the distribution of earnedincome in 1986 were only 35 percent of theearnings of median workers (Peter Gottschalkand Mary Joyce, 1992 table 2).Has the relative wage and the relativeunemployment rate of very disadvantagedworkers deteriorated as my analysis suggests?The position of disadvantaged males hasdeclined noticeably since the end of the 1960's,and this despite the increased numbers ofcomplementary workers having more education.It remains to be learned how 56AEA PAPERS AND PROCEEDINGSmuch of this deterioration is the effect of thewelfare state and how much the effect of otherfactors (e.g., technological change anddevelopments overseas). Though the welfarestate may not be the main culprit, it may bemaking a worsening situation still worse.II. The Argument for Low-WageEmployment SubsidiesMy theme is not mainly the familiar call forreviving the "stick," axing social programs thatdraw the disadvantaged from job-seeking intorent-seeking. It is more a call for fortifying the"carrot": for creating institutions to enlist theself-help of the disadvantaged by raising thereward to their initiative and perseverance ingaining employment. I have proposed for sometime that a system of low-wage employmentsubsidies be introduced, a subsidy to everyqualifying firm based on the stock of low-wageworkers on its rolls, in order to pull up the wagerates and employment rates of all verydisadvantaged workers (Phelps, 1985, 1990).My thesis here is that, in stimulating thedemand for low-wage labor, low-wageemployment subsidies would yield a socialbenefit exceeding the purely private benefit.Social "externalities" would flow through threechannels, which I will briefly take up.Equity.Almost nowhere in themoral-philosophic literature is it deemed justthat those with only a limited kind of labor inputto offer should receive only its reward inclassical competitive general equilibrium itsmarginal product--no matter how low. (Imaginethat unskilled labor were so abundant itsmarginal product was zero!) In many viewsabout fairness in the rewards to workers fromtheir cooperation in the economy, from autilitarian view to the diverse views of thepresent, economic justice requires the moreadvantaged to provide a subsidy, financed by atax on their own income, to the disadvantaged;its function is to allocate to the disadvantaged anincreased portion of the gain resulting from thesocial cooperationto give them a fairer shake.In some conceptions of justice, the morefortunateMAY 1994will not want to profit from economiccooperation if it would be at the expense of theless fortunate. Ayn Rand (1964) offers theimage of the bus in which the less fortunate aregiven a free ride. The more fortunate pass upany share of the gain from cooperation, contentwith the same benefit net of cost obtainablewithout cooperation. In John Rawls's (1971)world of collaborative production, though, anyeffort by the more advantaged to rebate throughthe tax/subsidy mechanism the whole of theirgain from the collaboration back to the lessadvantaged might be counterproductive: bothgroups might be better off lowering tax rates,accepting the resulting increase of inequality inreturn for the improved incentives to work morecost-effectively. In Rawls's theory of justice themore advantaged would tax themselves to makethe gain to the disadvantaged as large aspossible, no matter that there is a greater gain init for themselves, since it is not at the expense ofthe disadvantaged.A less uncompromising moral observer thanRawls would be satisfied to see a large steptaken toward that reference point: some subsidy,but not one lifting the bottom wage rate as far asit can be made to go. Certainly a subsidy simplyto avert burdening low-wage employment withthe financing of various social-insuranceprograms financed by payroll taxes would seemminimal. If a person not in the labor force andwith no visible means of supporting himself isdeemed to have a right to social health insurancefree of charge, then it would not seem right torequire a person of little productivity to pay thewhole cost of his or her insurance, especiallywhen that insurance is mandatory and would nothave been bought by poor workers.Where is the externality here? Why are taxesand subsidies needed to achieve people's notionsof what is less unjust (however incomplete theymay be}? One might think that individualeconomic actors could implement theseprinciples themselves in the way they draw upcontracts for compensation among themselves.The answer is that when an individual"producer," we may call himis contemplatingthe terms under VOL. 84 NO. 2 RAISING THE EMPLOYMENT AND PAY OF THE WORKING POORwhich he collaborates with another lessadvantaged than himself, he knows that greaterself-restraint on his own part does not translateinto a similar restraint binding everyone else inhis position, a side effect that would haveappealed to his sense of justice. Because hisunilateral action does not have that externalbenefit, he restrains himself less than he would ifit did, and the same is true of the others. Hence,people are glad to be able to vote thetax/subsidies necessary to yield a generalscale-back in the after-tax reward to theadvantaged for the sake of a general pulling upof the after-subsidy reward of the disadvantaged(see Amartya Sen,1961). Unemployment and Waste of Resources.The failure of society to arrange better pay forthose with the poorest skills and commercialbackground largely accounts for theextraordinary unemployment amongdisadvantaged workers. In the efficiency-wagetheory of involuntary unemployment,summarized earlier, considerations of employeeincentives drive wages above market-clearinglevels and thus create an equilibrium volume (orpath) of involuntary unemployment. As noted,the unemployment is widest among the mostdisadvantaged, in pyramid fashion. In a societyrich enough to put up a safety net, thewidespread availability of welfare entitlementsand access to those of family and partnersundermines the interest of the disadvantaged incareful and sustained performance at work, andthis diminished attachment to jobholdingultimately increases the shortage of jobs.This unemployment results in some resourcewaste. Up to a point, measures operating toraise the employment of the disadvantaged byraising the demand for their services couldgenerate enough tax revenue and savings inwelfare entitlements (at fixed tax andentitlement rates) to pay for the wage subsidies.Some subsidy could be justified purely onefficiency grounds. The catch is that those whowould have to finance it are already facing hightax rates to finance the welfare state and variouspublic expenditures such as national defense.Hence,there is a first-order efficiency loss from stillhigher tax rates to be weighed in the balance. Community Effects.In several ways thedismal wage rates of very disadvantagedworkers and the acute shortage of jobs attack thevitality of the whole economy. The relativelyvery low wages and shortfall of jobs available tothe more disadvantaged workers push the moresusceptible of them into intermittent criminalopportunities, which are much more plentifuland vastly better paying. For example, thesupply of illicit drugs is thus stimulated, whichoperates to turn on a demand. The result is harmto othersexternal diseconomies. A subsidy toincrease the demand for disadvantaged labor inlegitimate enterprises would be a valuable stepin the opposite direction.The plight of very disadvantaged workers alsooperates to undermine the performance andinitiative of others. When parents and olderrelatives are frequently unemployed, and henceoften dependent on welfare, a child is notprovided with the role models from which toacquire the habits of initiative and responsibilityneeded for realizing his or her potential inlegitimate business. A culture of passivity maythus develop. Also, some disadvantaged workers,lacking access to most business enterprises, mustfeel cut off from the economic mainstream, so aculture of alienation may also develop.Furthermore, as noted earlier, to be verydisadvantaged in a society rich enough to put up acomfortable safety net means that there is ratherlittle distance between the outcome one can hopefor by knocking oneself out and the averageexpectation for other people in the same situation;so a sense of powerlessnesslittle power to dobettermust overtake many of thedisadvantaged. Drug use is intensified, and theaddiction induces the user to turn into a supplierrecruiting new addicts to support the addiction.This surrender to alternative life styles spawnsinappropriate role models, making it moredifficult for children, and even friends if exposedon all sides, to stay clear of these pursuits. Thus a 58 AEA PAPERS AND PROCEEDINGSMAY 1994culture of criminality may result as well. Thenincidents of violence become common. As thebleak prospects of the disadvantaged reduceswhat they are willing to pay for their own lives,it also reduces the value they place on others'lives as well. It would be surprising if some ofthe disadvantaged, feeling they were beingshown a lack of respect by society, did not seek"respect" through the use of guns.If for no other reason than these externaldiseconomies, thus sheer self-preservation, weall have an interest in collective action toimprove the opportunities for disadvantagedworkers.III. Concluding RemarksThere exist, in reality or on paper, severalkinds of low-wage subsidy schemes (see RobertH. Haveman and John L. Palmer, 1982). TheAmerican scheme in place is the earned-incometax credit. Its drawback is that, in increasinglabor supply, it lowers the wage paid byemployers, which is costly to those not coveredby the program (workers without children),many of them just as disadvantaged, and ofsymbolic importance even to those in theprogram.Some other proposed schemes each offer acategory of workers (recipients of anunemployment benefit or other welfare benefit)the right to exchange it at a firm in return for ajob. These categorical schemes have thedrawback that they privilege some persons (theunemployed or welfare recipients) in thecompetition for jobs at the expense of otherswith no less a moral claim.A more equitable and no less feasible schemeis a graduated subsidy based on the wage paidto all employees, new and old alike, in allcategories. It would entail a large budgetaryoutlay. But the savings in welfare outlays,unemployment benefits, crime-fighting, and theincreased tax revenues flowing in mightcounterbalance the budget.In the meantime, it would be a natural step toinstitute budgetization, or fiscalization, of all ormost of the payroll taxes paidby employers on their low-wage workers, as theFrench are talking of doing. Such a step wouldat once increase the demand for such workers,lowering their unemployment rates and liftingtheir wage rates.REFERENCESGottschalk, Peter and Joyce, Mary. "Is EarningsInequality Also Rising in Other IndustrializedCountries?" Unpublished manuscript, BostonCollege, October 1992.Haveman, Robert H. and Palmer, John L., eds.Jobs for disadvantaged workers, Washington,DC: Brookings Institution, 1982.Layard, R., Nickell, S. and Jackman, R.Unemployment. Oxford: Oxford UniversityPress, 1991.Phelps, Edmund S. "Money-Wage Dynamicsand Labor-Market Equilibrium." Journal ofPolitical Economy, August 1968, 76(2), pp.678-711.. 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