Labour Market Failure

A2 Economics

Market Failure – The Labour Market

• What is market failure?

• The failure of the market mechanism to reach a socially efficient and equitable allocation of scarce resources

• Failure can lead to

– Welfare losses for society

– A misallocation of resources

– Worsening of economic performance

• Higher unemployment

• Slower growth

– Social problems – negative externalities

High marks at A2 for finding links between micro and macro topics!

The most important market in the economy?

Potential causes of market failure

• 1. Labour immobility and skills gaps

• 2. Disincentives to work – “traps”

• 3. Discrimination in the labour market

• 4. Monopsony power of employers

• There are other causes – but time only allows me to focus on these four and then on different options for government intervention

Labour immobility

• Occupational immobility– (i) Skills mismatch

– (ii) Loss of skills and motivation from long term unemployment

– (iii) Artificial barriers to entry

• Lawyers• Medics• Accountants

Geographical immobility

• (i) Regional house price differences

• (ii) Family and social ties

• (iii) Language barriers

• (iv) Differences in living costs

• Which is the world’s most expensive city to live in?

World’s most expensive cities in 2008

1. Moscow2. Seoul3. Tokyo4. Hong Kong5. London6. Osaka7. Geneva8. Copenhagen9. Zurich10.Oslo11.New York

Skills gaps

• Market often under-provides skills training

• The free-rider problem

• Lack of finance for people wanting to invest in ‘human capital’

Evaluation: Why does immobility matter?

• (a) Structural unemployment – has economic and social costs

• (b) Makes the labour market less flexible

• (c) Persistent labour shortages in some areas and surpluses in others– Creates inflationary pressures on wages

– Forces up the costs of infrastructure projects e.g. Olympics

– Depresses income in regions of high unemployment

– Hits the provision of public services e.g. NHS dentists

• (d) Rising inequality / relative poverty

• (e) Deepens the regional economic divide

• (f) Damages the potential output of the economy

Disincentives - Traps

• For many people there are deep-rooted disincentives to look for and accept paid work

• Poverty trap

• Unemployment trap• The two are linked …. And you wont be penalised for assuming that

they are the same!

Poverty Trap

• Earning extra income may have little positive effect on a person’s disposable income

– You earn more money…. But

1. Start paying income tax and national insurance

2. Start to lose income-related welfare benefits

3. Add in costs of childcare and travel to work expenses

• Result is that the effective marginal rate of tax might be very high (perhaps > 75%)

• Paradox: Poorer people face higher tax rates than the rich

• Consequences: Fewer people in work ►risk of poverty

Discrimination in the labour market

• Race

• Gender

• Height

• Weight

• Age

• Ethnicity

• Religion

• Sexual preference

• Other forms of discriminatory behaviour

Labour market discrimination

Discrimination

• Often reflects deep-seated prejudice– Glass-ceilings

• But also the result of information failures– Difficulties in measuring and monitoring people’s

contribution at the workplace

– So employers fall back on prejudice as a proxy

• Requires legislation and enforcement

• And changes in social values and tolerance

Using analysis diagrams in the exam

Employment of group A

Wage

MRPL

MRPL Dis

Lab Supply

We

Wd

EeEd

Using analysis diagrams in the exam

Employment of group A

Wage

MRPL

MRPL A

Lab Supply

Employment of group B

Wage

MRPL

MRPL B

Lab Supply

We

Wd

EeEd

We

Ee

Wm

Ew

Monopsony power

• Major (dominant) employers in an industry or a local town might use their ‘buying power’ to drive wages below a level that might exist in a more competitive market.

• Examples:

• Gang masters

• Public sector employers

• Employment agencies

• Major employer in a local town

• National health service

• Royal Mail

Monopsony analysis

Employment of labour (E)

Wage rate £

Marginal revenue product

Average cost of labour

Marginal cost of labour

E1

£180

£350

Workers may get paid less than their MRPL

Employment of labour (E)

Wage rate £

Marginal revenue product

Average cost of labour

Marginal cost of labour

E1

£180

£350

How a minimum wage might create jobs!

Employment of labour (E)

Wage rate £

Marginal revenue product

Average cost of labour

Marginal cost of labour

E1

£180

£350

How a minimum wage might create jobs!

Employment of labour (E)

Wage rate £

Marginal revenue product

Average cost of labour

Marginal cost of labour

E1

£180

£350

Pay Floor = £220Pay Floor

How a minimum wage might create jobs!

Employment of labour (E)

Wage rate £

Marginal revenue product

Average cost of labour

Marginal cost of labour

E1

£180

£350

Pay Floor = £220Pay Floor

E2

Government intervention & market failure

• Intervention justified because

1. Market failure causes loss of efficiency

2. On grounds of equity

3. Key evaluation is whether the intervention works!

Government intervention

• Policies to protect the rights of trade unions to be recognised at work

• Investment in education and training– Modern apprenticeships– Incentives to stay on in sixth form

• Legislation– National minimum wage– Immigration points system– Licensing of gang masters– Equal Pay Act and other laws to protect people’s rights at work

• Reform to taxation and benefits systems

• Measures to make housing more affordable

• In the exam

• Avoid being excessively political / extreme in your answers

• Always have costs and benefits of each policy to hand for evaluation

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