The Gazette elaborates on the theory of the labour market since its establishment. The present column gives a summary of some of the previous publications. Utility functions are described, which take into account the disutility of labour. The needs, motives and motivation of workers are studied, following De Man and Herzberg. The views of psychology and institutionalism on the labour market are explained. The hedonistic wage theory and opportunism are modelled.
The Gazette was once, five years ago, established out of astonishment about the neoclassical paradigm (in short NCP), at least in the presentation that is used by introductory textbooks. Statements are made, which are unrealistic, even when their abstract character is taken into account. One stumbling-block is the assumption, that the value of labour can be derived directly from the value of leisure time. Here a situation is sketched, where the optimization of utility consists of an exchange (substitution) of leisure time for wage goods. Thus it is ignored, that giving up leisure time is accompanied by accepting a job. The worker is exposed to a certain amount of workload, depending on the conditions in the labour contract, which leads to feelings of discontent and displeasure, in short to an increasing disutility.
This omission is so peculiar, that it is a recurring theme in the Gazette. The present column is an attempt to summarize the findings of the various previous columns, and to extend some aspects of them. It is striking, that the workload does appear in the theories, that precede the emergence of the NCP. In the Netherlands the marxist Sam de Wolff naturally assumes in his publications, that labour leads to feelings of displeasure1. Marxism indeed stresses the social enclosure of the labour contract. But the founders of the marginalist theory, like W.S. Jevons, also assume a workload (disutility). In this view the utility of the worker can be expressed by the mathematical formula:
(1) u(e, w) = v(w) − c(e)
In the formula 1, e is the objective effort of labour, and w is the reward for the supplied labour. Therefore v(w) is a subjective pleasure, which is experienced by the worker due to w. De Wolff calls this a lust L. And c(e) is the subjectively experienced dis-utility of the worker as a result of e. This is called by De Wolff the discomfort O(e), but nowadays it is simply called the costs of e 2. The worker experiences a total utility u(e, w), which is the result of these two emotions. In this respect one is confronted with another peculiarity of the NCP, namely the assumption that utility would not be measurable in a quantitative form. In the words of experts, the NCP rejects the cardinal scaling of utility. In the past five years the reason for this assumption has deeply troubled your columnist. The textbooks even often assume, that the whole concept of utility is unsound. The only thing that matters, are the truly revealed preferences.
In itself it is defendable to keep a theory parsimonious. And indeed the concept of utility is not needed in the mathematical formulation of the neoclassical theory of equilibrium. However, many textbooks maintain, that utility can definitely not be a quantity. At most the various sources of utility can be mutually compared in a qualitative manner, and ordered according to their preference. This is called an ordinal scale. The Gazette has shown many times, that this rejection of the cardinal scale has significant disadvantages. Firstly, various other economic theories perforce assume, that methods to measure utility do exist. These theories give valuable insights. And secondly, it is useful to model the reality by means of a cardinal scale in empirical analyses and experiments. Therefore your columnist only sees advantages in thinking in terms of cardinal utility3.
At this moment, it is perhaps instructive to give a list of various theories, that apply cardinal scaling. Worth mentioning are the columns about (a) the welfare function, (b) consumer preferences in situations of uncertainty, (c) risk aversion when income is uncertain, (d) Pigovian taxes, (e) the cardinal probit method in happiness economics, (f) optimalization of economic growth, (g) behavioural economics, (h) collective bargaining, (i) signaling by applicants, (j) the principal-agent model, (k) decisions based on trust, (l) decisions affected by rewards and sanctions, and (m) total utility during a dynamic development in time. The readers sees, that here many models are mentioned, that can not be missed. Your columnist also admits, that he has a special fascination for precisely such themes.
Consider again the formula 1. De Wolff replaces the effort e by labour time. But it is clear, that the workload can have many forms, for instance also defective equipment, a harsh supervision, or monotony4. Strictly speaking there is apparently a vector e, where the situation determines which components are present. A similar remark holds for the reward w. Satisfaction does not merely arise from wage goods, but also from for instance the contacts with colleagues, the activity itself, learning from experiences, and the respect for the function. Thus the reward also becomes a vector w. Therefore the worker must make a complex judgement, when he wants to optimize his utility u(e, w). There are possibilities for substitution of various rewards j (components wj) and workloads k (components ek).
The economists have naturally always realized, that the NCP is not very realistic. Thus in 1967 the well-known Dutch economist Jan Tinbergen proposes a utility function for the workers, which expresses the variety of needs:
(2) u(t, s) = ln((1 − τ) × w(s) / g) − c(t1) − Σi=2I λi × (ti − si)²
In the formula 2, t is a vector, which expresses the properties of the worker. The vector s expresses the requirements of his job. The variable w is the monetary wage. However, the worker must hand over a fraction τ as taxes, and moreover he must provide for g family members (including himself). The notation ln() represents the natural logarithm. Furthermore c represents the costs of working, which depends on the workload t1 (such as the duration of the working day).
In the third term, the summation of properties, the talents of the worker are compared with the requirements of his function. For instance, the worker appreciates variation, but the tasks of the function are monotonous. This term expresses, that the dis-utility increases, according as the function is less compatible with the properties of the worker. The dislike obtains a weight λi from the worker. The precise form of the term is kept simple, and therefore somewhat arbitrary, without theoretical justification. The nature of this utility function is illustrated in the figure 1, which shows the indifference field in the (s2, w) plane, under otherwise constant conditions. The green e-power curve in the figure 1 is the wage curve of Tinbergen. The optimal function for the worker requires s2*.
During the twentieth century many schemes have been proposed in order to categorize the rewards and workloads in a universally applicable manner. Your columnist is enthusiastic about the scheme, that the selfmade psychologist Hendrik de Man has designed after systematic interviews with workers. It is presented in the table 1. The first three columns contribute to the satisfaction v(w), whereas the last three contribute to the costs c(e). Note that sometimes a cause leads to pleasure, whereas its opposite contributes to discontent. The approach of De Man is special, because he distinguishes between three social levels: the technical function (micro), the structure of the enterprise (meso), and the social institutions (macro). This clarifies, that the well-being can not simply be bought by means of the wage level. The utility also depends on the social environment of the workers, and even includes the national culture5.
|income||comradeship||attitude of work||division of labour||working conditions||social classes|
The method of De Man is merely deductive. But science advances. After the Second Worldwar it becomes common to do large-scale opinion polls. So much data about the opinions of the population are accumulated, that the correlation between the human preferences can be determined in a statistical manner. Thanks to such statistical files, happiness economics can develop. For instance, the Dutch economist Bernard van Praag studies the most important factors of satisfaction in the domain of labour. The individual satisfaction is measured both for the job as a whole, and for various subdomains, namely, the wage, the tasks, the perspectives for the future, the supervision, job security, freedom, and the working time. In summary, Van Praag models for each individual n the total satisfaction TT as a linear function of the seven satisfactions in the subdomains:
(3) TT(n) = α1×T1(n) + α2×T2(n) + α3×T3(n) + α4×T4(n) + α5×T5(n) + α6×T6(n) + α7×T7(n) + Y(n)
The satisfaction T in happiness economics is simply an alternative name for the experienced utility. In the old literature this is called pleasure or lust. In such analyses the interviewed persons must express their T on a discrete scale with a limited number of choice options. For instance, they can choose from the integer numbers between zero up to and including 10, where all values below 5 express degrees of discontent, and all values above 5 lust. In the formula 3 each of the parameters αj has the same value for all individuals. They hold for the average individual. The term Y(n) expresses, that each individual will differ from the average individual. This term will commonly be significant. However, as long as the seven subdomains or causes are chosen cleverly, it yet turns out that statistically significant needs are shared by all workers. The table 2 presents the values of the αj, which are derived from a British data set for the year 19966.
|sub domain j||future||wage||supervision||security||freedom||tasks||working time|
It is clear that the tasks of the job are most important for the British, followed by the wage and the quality of supervision. This supports the view, that the wage is not decisive for the job satisfaction as a whole. Furthermore the reader may observe, that in the formula 3 no explicit distinction is made between lust and discontent. These two feelings (affects) are integrated in a single scale, for each of the seven causes. Moreover, these causes are actually aggregates of various experiences. For instance, supervision in the enterprise will have aspects of comeradeship, but also of hierarchy. This integral approach has the disadvantage in comparison with the formulas 1 and 2, that it remains unclear how the average worker weighs rewards w and costs e. On the other hand, the integral approach is evidently more succinct and transparent, and therefore it is popular among occupational psychologists.
In this respect in particular the model of F. Herzberg deserves mentioning7. Herzberg elaborates on the pyramid of Maslow, which distinguishes between five layers of human motives: the physiology, security, living together, appreciation, and unfolding. Various needs can be coupled to these five motives. Herzberg proposes 12 of such needs or factors (see the table 3). He has completed an opinion survey with regard to reported incidents (i) at work. In the analyses he couples each reported (i) to a category of need. Next he has calculated the percentages of those incidents for each category, which lead to pleasure v(w(i)) and discontent c(e(i)). See again the table 3. According to Herzberg the job motivation can only originate from factors, which mainly cause pleasure. So these are performances, recognition, tasks, responsibility and promotion.
|type||motive||factor||satisfaction (%)||discontent (%)||neutral (%)|
|security||policy and management||3||31||66|
The enterprise can increase the individual productivity ap by improving the motivators (incentives, reward). The other six needs or factors merely create necessary conditions. Their level of satisfaction must be such, that the worker sees them as just. Herzberg calls this group the job hygiene. In this way Herzberg decouples v(w) and c(e). They become two measures, which can not be aggregated into a whole u(w, e), like in the formulas 1 and 2. And satisfaction and discontent are not two extreme poles on one scale, like in the formula 3. Therefore satisfaction is reduced to a convenient indicator. According to Herzberg the enterprise must not primarily make the workers satisfied, but motivate them. It is striking, that according to the study of Herzberg the wage can not motivate or incite! Here it is clear, that the management literature and the abstract science follow different paths.
Besides De Man and Herzberg, there are many others, who have developed psychological theories about job motivation. They show, that the reality is more complex and many-sided than the formula 1 suggests. The models of satisfaction and motivation provide for a practical frame of reference, but they remain subjective and controversial. Their correctness can not be proved. Moreover, individuals differ in their needs and motivations, depending on the kind of work and on the place in the hierarchy of the enterprise. For, individuals compare their satisfaction with their reference-group, which determines their expectations. Notably large-scale studies, such as the ones of Van Praag, obscure the motives of sub-cultures8.
The ideas about job motivation do find support in the social psychology. This kind of research shows that individuals function best in groups. According to the psychology the worker obtains a high wage (in comparison with his effort e), unfolding, a professional identity, social contacts, knowledge, and material security9. This covers the substance of the motives of Maslow, but not his hierachical order of motives.
The social psychology yields various insights, which help to understand the functioning of the labour market. For instance, the social psychology shows, that justice and reciprocity are important human norms of behaviour. These are called prosocial norms10. Thanks to these norms, it becomes possible to reward others (w), even when they do not directly supply a counter-effort e. Then the reward is a gift. Thus the beneficiary becomes obliged to the giver. Now the giver can claim a later service in return, and can demand that right in a convenient moment. The policy of the efficiency wage uses this human trait. The enterprise pays a wage above the average of the market, and trusts that the workers become more motivated in this manner11.
The NCP can not explain this, because there the workers act purely in an egoistic manner. They are opportunists and never feel obliged. Yet the efficiency wage is also present in the NCP, namely when information is not freely available. In that situation an enterprise does not know the productivity ap of its workers. Then there is a uniform wage, independent of the individual ap, so that poor workers receive too much. Incidentally, the hard workers will find this unfair. It is even conceivable, that the best workers find a job outside of the enterprise, which yields more than w 12. In any case the offer of gifts is an instrument of manipulation. Knowledge of the psyche is a means for managing the wage level13.
It is also interesting, that the psychology makes the Tinbergen utility function in the formula 2 credible. Suppose that a worker prefers a job with a property ti, but his enterprise imposes the property si on him. The worker will experience this cognitive dissonance in his job as a threat to his identity. This discontent motivates him to reduce the dissonance, for instance by resigning, adapting the preference ti, diminishing the weight λi of the preference, or increasing the weights λj of other preferences (j≠i)14. Apparently the utility function is itself somewhat dynamic. This is also clear from the influence of the group on the individual behaviour. The individual can simply submit to the group norms, or become convinced and truly internalize them15.
And finally, the psychology stresses, that individuals tend to cherish biases towards individuals from other groups. A bias is placing another individual in a certain category, so that he is equated with a stereotype. In principle this is useful, because it makes the world easier to understand. But it can also lead to wrong decisions. Thus the so-called statistical discrimination can occur on the labour market16. When the stereotype is negative, then the concerned individual is forced to make an extra effort, as a compensation. This leads to wage differences, which are not related to the supplied effort e.
Economists focus their attention on the income motive, namely the reward w. Here a lot of variety is conceivable, for instance by making the wage dependent on the performance, or by coupling the wage to the number of years of service. According to institutional economics, the wage structures are determined by the shared mental model of the concerned era17. The labour market is embedded in society. Therefore the needs and motives, which dominate the conscience of the workers, also continuously change. They and their employers will try to improve the institutions, whenever possible. On the other hand, the institutions themselves affect the needs and motives of all branch actors. The labour market is dynamic, but also determined by history, so that the development is not entirely free. The future depends on the followed path in time.
The evolution of the institutions on the labour market is described in a previous column about job satisfaction. It describes the development during the twentieth century, by presenting the ideas of De Man, the German sociologist F. Deppe and the Dutch political scientist M. Sie Dhian Ho18. De Man still lives in the last stage of classical liberalism, where the labour market is affected by the class struggle. But at the time of Deppe the welfare state has already been completed. The industry is based on mass production, the so-called Fordism. Besides, the ownership of the enterprises has been decoupled from the daily management. A class of managers has emerged, which exerts control as wage earners. Thanks to this development the workers acquire more power. This management layer is called the technostructure. It has its own interests, which not necessarily coincide with those of the owners.
This is sometimes called a social compromise between the factors labour and capital, because the welfare is shared in a harmonious manner. Moreover, the enterprise finally satisties the needs of participation of the workers. It marks the last stage of the international dominance by the west. However, during the seventies this compromise fails due to the increasing global competition. Sie Dhian Ho describes this phase, where the western labour markets must necessarily become more flexible and effective19. During this period the high quality of labour is fortunately maintained. In economics the principal-agent theory is introduced. She tries notably to find labour contracts, that can reconcile the interests of the workers and the enterprises. It turns out that job satisfaction, individual autonomy and motivation can be reconciled with the aim of profit.
During Fordism it has become quite clear, that the workers partly obtain their motivation from the tasks and the contacts in their team. These motives can compensate the disadvantage of a lower wage. See the formulas 1 and 2. This exchange has become a new mental model. Social psychologists and sociologists try to incorporate such insights in personnel policies (in short P&O). They develop methods, which address the needs in the tables 1 and 3. This human relations approach has risks, because in this manner the institutions can be changed artificially. Then the P&O policy restricts the technical and commercial developments. The evolution is affected. In the last stage of Fordism that sometimes went wrong, also because at the time the New Left controlled politics, the media and even parts of science. The problem is the ideology of the New Left, which is utopian (unworldly).
This error is so strange, that it deserves an illustration, as a warning. The Dutch sociologist H.J. van Zuthem tries since the sixties to rigorously reform the P&O policies20. He is ideologically allied to the critical theory (School of Francfort). They both argue, that the workers do not know their own interest. The workers must be made conscious by an elite of leaders (politization). Moreover, they want to introduce a democratic structure in the enterprises (self-governance by the workers). Van Zuthem complains, that the private property has too much power. He argues, that the then entrepreneurial culture hurts the social development. Therefore the P&O manager must form a coalition with the trade union, the churches and science, in order to enforce a socially responsible policy upon the direction. Thus a countervailing power is mobilized21.
In a previous column it has been explained, that wage differences can be understood with the hedonistic wage theory. The present paragraph translates that explanation in a mathematical model22. The starting point of this model is, that in general a worker will try to minimize the efforts e in his activities. This is apparent from his utility function, which is simplified here as
(4) u(e, w) = w − α × e
In the formula 4, α is a constant, which determines the intensity of the experienced discontent. The displeasure e can be anything, for instance machine noise. Furthermore, the productivity of the worker satisfies the functional relation ap = f(e). One has ∂f/∂e > 0 and ∂²f/∂e² < 0. That is to say, the avoidance of the discomfort will affect the productivity. Suppose that the labour market is characterized by perfect competition. The condition for the optimal equilibrium on such a market is wopt = ap. Apparently the equilibrium wage wopt is a function of e. Now, under these conditions the worker maximizes his utility : ∂u/∂e = 0. He realizes that he can mutually substitute the wage w and the dis-utility e. According to the formula 4 his optimum becomes
(5) ∂wopt/∂e = α
This simply states, what De Wolff already knew in 1929, namely that the worker equates the intensities of his lust and discomfort. A graphical presentation can clarify this choice process. Consider two workers, who have an identical productivity ap(e). This production function f(e) is shown in the figures 4a-b. Suppose that the intensity of displeasure of the workers differs, namely α(1) > α(2). Now, according to the formula 4 the iso-utility field of the worker 1 has the form, which is shown in the figure 1a, whereas the field of 2 is shown in the figure 1b23. It is generally known, that the optimal solution consists of the point, where an indifference curve touches the production function. Therefore one sees in the figures 4a-b, that the worker 1 indeed accepts a lower wage w in order to avoid the displeasure e. Their optimum differs. Apparently the personal aversions lead to wage differences!
Another interesting aspect of the formula 4 (or the formula 1) is, that there is not necessarily full employment. This is a difference with the traditional NCP, where this does occur. Suppose that a worker has a rather low productivity ap(e) and a large aversion α for the dis-utility. Then the slope ∂f/∂e of f(e) can already at the point e=0 be smaller than the slope of the indifference curves. Such a worker does not have an optimum wopt for e>0. Therefore he will reject the offered job. Then his utility becomes u=0, but at least not negative24. It is also interesting that state interventions are undesirable, at least in this model. This is a well-known hallmark of the NCP. For, suppose that the state forbids displeasures above a certain emax. Then workers with a small aversion α will not be able to reach their eopt. See the figure 4a-b. Their freedom of choice for e is curbed. The intervention would lower their optimal utility.
It is impossible to completely record the required performances of the worker in the labour contract. Therefore such contracts are incomplete or implicit. Ex post (after contracting) the applicants often are in a position to behave opportunistly. The chance for opportunism is a moral hazard. This threatens notably when one contracting party has made specific investments, because then the other contracting party can reopen the negotiations in an attempt to appropriate a part of the quasi-rent. This is called a hold-up. Such a situation can be modeled simply for the labour market25.
Suppose that a worker has a productivity ap,1, and receives a wage w1 of the same size. Then the nett profit equals zero. Suppose that his enterprise makes an innovation, so that the productivity increases to ap,2. The innovation requires an investment I in the worker, for instance for training. That innovation is profitable for the enterprise, as long as one has w1 + I < ap,2. The quasi-rent of the investment is
(6) π1 = ap,2 − (w1 + I)
However, if the contract is incomplete, then the worker can re-negotiate, as soon as the investment is done ("sunk in"). He can demand a part of π1, so that his wage rises to w2. In the NCP he makes this demand out of egoism, and not because of fairness. In the same way the enterprise must meet the demand, not as an obligation, but because of an egoistic calculation. In principle the enterprise can dismiss the worer, and hire a new one. However, that does not improve the situation, because the new worker must also be trained, and then will also act opportunistly. In the re-negotiation with the first worker the enterprise can at least save a part of those new costs I for training. Apparently, the enterprise and the worker must now mutually share this I. The enterprise writes off the first investment as a loss, and calculates his new profit as π2 = ap,2 − w2 − I.
Suppose that, thanks to the re-negotiation, the worker receives a fraction γ×I of the saved new costs for training, where γ<1 determines his institutional negotiation strength. That is to say, he receives w2 = w1 + γ×I. Apparently, regular workers can enforce a higher wage than applicants (outsiders), who have to be satisfied with the universal wage level w1. So this wage difference is not caused by differences in individual productivity before the innovation. Insertion of w2 in the formula for π2 yields
(7) π2 = ap,2 − w1 − (1 + γ) × I
An enterprise, which foresees the opportunism, will merely innovate as long as π2 > 0 holds. In other words, the innovation is only enacted as long as ap,2 > w1 + (1 + γ) × I = ap,1 + (1 + γ) × I. This means that due to the hold-up extra requirements (the term γ×I) must be imposed to the profitability. There will be less innovations than without hold-up. This under-investment is a consequence of the institutions. For, a social norm of mutual trust would discourage hold-ups26.