19 Aug 2016

## Puzzles on Labor Demand Elasticity?

We typically think the demand curve for labor is downward sloping, right? Empirically, the modal estimate of the elasticity of labor demand is something like -0.4. (So a 10% increase in wages means a 4% drop in the number of workers employers want to hire.)

So in light of the fact that we know the demand curve for labor slopes downward, are you guys puzzled by the following considerations?

CONSIDERATION #1: The number of employed workers is much higher today than in 1800. And yet, real wages haven’t plummeted.

CONSIDERATION #2: If the U.S. were to make Puerto Rico the 51st state, the official US population would rise, and the number of employed US workers would rise. And yet, I’m guessing wages wouldn’t noticeably fall.

Does anyone think either of the above is hard to reconcile with downward sloping labor demand curves? I wouldn’t. And then, by the same token, I don’t see why Bryan Caplan thinks this is weird:

While labor demand elasticity is pretty clearly negative, virtually all estimates have an absolute value less than 2. Yet estimated effects of immigration on native wages are tiny…

How are both these results possible? The easy answer is that “wage elasticity of labor demand” and “wage elasticity of immigration” are conceptually distinct. Quite true, but they’re also conceptually related. Indeed, unless labor supply is fairly elastic, a low wage elasticity of labor demand seems to imply a high wage elasticity of immigration.

Bryan then goes on to list some possible reconciliations, but I don’t see him listing what is (to me) the most obvious direct explanation: that when you bring in more people, you are simultaneously boosting consumer demand. (At least two people in the comments at Bryan’s post said the same thing.)

If we are holding “other things” (including total population) constant, and we want to induce employers in a certain firm or sector to hire more workers, then you would need the price of the workers (i.e. wages) to go down. But that is totally distinct (right?) from increasing the population–whether through births or immigration–and then asking what needs to happen to wages, in order for employers to expand hiring.

Looked at differently, suppose a bunch of new people came into an economy with disposable income (perhaps they were landlords for tenants in another country), and none of the immigrants wanted jobs. But, they started renting apartments, buying food, going to the movies, etc. What would happen to the wages of domestic workers? Wouldn’t they go up, at least in many sectors?

So now if instead we say that the immigrants are earning an income from working domestically (in their new country), but are renting apartments, buying food, going to the movies, etc., then wouldn’t their spending still (by itself) cause domestic wages to increase, and this effect would be counterbalanced by their offering of new labor supply?

To be sure, I’m not saying the two things would automatically cancel out (though with a simple enough model, they would), I’m just saying that this would be the default starting point, I would think. It would only be where you started introducing heterogeneity in the original domestic population (land owners, skilled workers, unskilled workers, etc.) that I think you would start to get pronounced impacts on certain groups from a large influx of immigrants.

#### 12 Responses to “Puzzles on Labor Demand Elasticity?”

1. scott says:

Anybody who talks about the relation of labor supply and real wages ***without mentioning things like capital and other factors of production*** is not very smart.

Marginal value product, people.

But yes, I would imagine that the new labor supplies new demand for it’s own product. It just does not supply new capital or land for production. Obviously. So it competes with domestic labor for access to local capital and drives local wages down marginally.

• Tel says:

We covered some of this a few cycles back. In simple terms if you dump a lot of fresh labour into a country, the capital base will be unchanged in the short term therefore overall productivity should be reduced. However, with extra labour you can build more capital quite easily, in the long term.

However, there’s a bit more to it than that. In the case of the USA a lot of immigration has been low-skill and those people usually take low paying jobs like janitorial, fruit picking, etc which are the segment of the market that is low capital intensive and low productivity anyway (that’s why they are low wage jobs). Also, some would argue there’s evidence of displacement as more natural born are dropping out of the labour force.

Here’s a typical article on the displacement question…

http://cis.org/north/federal-reserve-study-shows-foreign-nurses-displace-domestic-ones

I admit it’s not a simple one either because you have simultaneous technology shifts and people moving between jobs (i.e. people will leave menial jobs if they have better opportunities because they aren’t great jobs).

• scott says:

Yep. I just wanted to remind people.

I’m tired of this “I’m gonna derive all truth in vacuo and disprove all falsehoods without any reference to external reality.” Somehow, they seem to think that this approach makes it more convincing. But if somebody writes an equation in 3 variables, IMO he probably ought to bring along two more if he wants to convincingly claim to solve for X.

I see this ‘It’s all just supply and demand — more supply of labor, lower wages,’ all the time. They’re right — but for wrong reasons, it is crystal clear that the operative issue is capital, they paint a badly distorted picture of the economy, and it becomes a way to easily ‘disprove’ them and blow them off. People have had the idea of MVP for a long time, it’s really not that hard, and it is a very good way of thinking about prices *in general*.

I’m actually kinda objecting to the same sort of thing Bob is.

• Bob Murphy says:

Scott,

(1) Anyone who writes “it’s” when he means “its” is not very smart.

(2) Yes, for the final answer, you need to include capital. But I’m trying to show why Bryan’s “puzzle” isn’t puzzling. In a world with just homogeneous labor, it’s obvious that immigration wouldn’t change overall wages, even though you’d still have downward sloping labor demand curves in individual sectors. Now if you add in capital and land factors, yes that complicates things, but it doesn’t cancel out the original analysis.

• scott says:

Agree. On both counts. đź™‚

• Tel says:

Bob is brutal on those typos.

Just ask one Thomas Piketty what it feels like… ouch!

2. Harold says:

As many commenters said, immigrant workers increase demand, as your examples demonstrate. In a free market there should also be no unemployment.

So to the extent that the market is not working, and we have unemployment, is it possible that immigration will make unemployment worse, or reduce wages?

The solution to this may be to free the market more. But IF we re to stick with the current market imperfections, is it possible that more immigration will have the adverse effects that some people fear?

3. Tel says:

There’s employment in Puerto Rico? Who knew?

Seriously though… Max Frisch: â€śWe asked for workers. We got people instead.â€ť

I totally agree, immigrants are not just boatloads of labour, you have consumption demand for food, housing, textiles. Also: culture, religion, attitudes, old grudges, ethics, property rights, tribal allegiances, and votes.

If we are holding â€śother thingsâ€ť (including total population) constant, and we want to induce employers in a certain firm or sector to hire more workers, then you would need the price of the workers (i.e. wages) to go down. But that is totally distinct (right?) from increasing the populationâ€“whether through births or immigrationâ€“and then asking what needs to happen to wages, in order for employers to expand hiring.

Conceptually distinct, but in practice what has happened in the US was about 10 million mostly low-skill people (some estimates are much higher) have come across the Mexican border illegally and continue to reside and work in the USA. This creates the situation that all employment of those people is illegal (and usually the employer knows this) thus allowing various labour laws to be routinely ignored (especially the minimum wage laws) because the people who know they are vulnerable to deportation aren’t about to ask any questions.

Now the price for labour has gone down, but selectively so. This creates a massive disadvantage for low-skilled natural born American citizens who want to get onto the first rung of the employment ladder.

You probably disagree with the minimum wage policy to begin with, so even without competition from illegal labour those low-skilled Americans would have some difficulty. But now there’s a much bigger problem… they see that law abiding people are suckers who get nowhere. They notice that you learn a whole lot of stuff in school but employers don’t want that, they are looking for experience. Also, note that the guy dealing drugs on the corner makes 10x the average wage, has a nice suit and a hot car, pulls a lot of girls.

Looked at differently, suppose a bunch of new people came into an economy with disposable income (perhaps they were landlords for tenants in another country), and none of the immigrants wanted jobs. But, they started renting apartments, buying food, going to the movies, etc. What would happen to the wages of domestic workers? Wouldnâ€™t they go up, at least in many sectors?

Yup, an example would be Chinese and Indian immigration into Sydney where the majority are coming from middle class or wealthy families, they have money backing them and can easily buy real estate. So there’s been a boom in real estate. Because the government wants to sell Australian university places they have made it slightly easier to get “Permanent Resident” status if you are a student in an Australian university and then get a job with some local company… but those students need to pay full fees to the university (effectively selling citizenship via an indirect process). The money to put those teenagers though tertiary education can’t come from the teenagers themselves, but they have family back home who pump money. Presumably at least some of those who do achieve “Permanent Resident” status will then go and bring out the older family members under some family reunion immigration scheme (it’s really complex, but you can do it).

In addition to that, you have Chinese foreign owners who buy into the Sydney real estate boom but never intend to come live here as immigrants. Maybe they visit once a year, have a quick inspection of the property and fly out again. There’s lots of arguments over where the wealth is coming from, given the rumours about corruption in China and key government connections. Since Xi started his crackdown on corruption, a lot more Chinese money moved into Australia which tells you something. It’s seen as a good place to stash your cash during interesting times.

However, the foreign owners do see a good profit opportunity renting out that property to students. I would say that the university sector has done incredibly well out of this, although exactly where those wages went is perhaps arguable but the sector as a whole is pulling in plenty of money. Also the building industry is going gang busters knocking up new apartment blocks.

Probably the bar, nightclub, coffee-shop type service sector does OK too, seems to be a lot of activity. Wage rates for that sector are pretty much fixed in Australia (yes we have national wage fixing, there’s some flexibility with tips but tipping is very small in Australia). The rural people hate the wage fixing because a coffee shop in some country town just cannot achieve the same profitability as a coffee shop in the city near a major university or business center.

4. Transformer says:

Here is my take on this :

If a person moves into a country and gets an income from abroad which he spends locally you would expect local wages to go up just like you say.

If he gets no income from abroad but take a job that pays the same amount then the effect on wages will depend upon how he affects productivity in the economy. If he is an average worker and the economy has diminishing return then his addition will lower productivity slightly and wages with it. If he is of above average productivity then he will provide a boost to total output and this will probably cause real wages to rise.

5. Major.Freedom says:

Holding money and spending constant…

6. Andrew_FL says:

If you suddenly start including Puerto Rican workers in the calculation of average wages for US workers then the average wage would decrease even though no individual’s wage fell. The only reason it might not be “noticeable” by your guess is because Puerto Rico has a population roughly one one hundreth that of the US, so it becoming part of US statistics would be a rounding error.

On your proposed reconciliation, aren’t you committing the fallacy of mistaking demand for commodities for demand for labor?

7. Transformer says:

Wouldn’t the arguments that Bob uses here mean that the demand for labor curve would not slope downwards even for a static population with no immigration ?

If each worker joining the workforce creates new demand that counteracts any downward pressure on wages then the demand for labor curve would be flat with or without immigration.

I think it is the assumption of diminishing return to scale that exists in the short run ( and the fact that we are always in the short run) that leads economists to conclude that the demand for labor will slope downwards and this standard assumption means that Bob’s argument in this post are not correct since this assumption holds whatever the reason for the change in the supply of labor.