More Labor Market Margins of Adjustment

By Ryan Bourne of Cato.

"Many people worry about the existence of labor market outcomes such as low pay, the absence of business family leave policies, or gender pay gaps. A typical response is to demand the government pass laws to ban these outcomes, or else to mandate business practices that avoid them. This is thought to help the affected workers.

In a recent Cato book chapter, I explained that things rarely work out so simply. Profit‐​making businesses find new ways to make up for higher labor costs or the diminished flexibility imposed upon them as new mandates are passed down. Some cut employment or hiring levels. But recent economic research finds a host of other “margins of adjustment” firms use to maintain their profitability when costly regulations are applied. These include developing novel forms of contract, tinkering with worker schedules, or altering other parts of employees’ remuneration packages to maintain the businesses’ profitability.

Here’s two clear examples from this past week alone.

Noncompetes and minimum wages

The Federal Trade Commission proposes to ban noncompete clauses in most labor contracts. A noncompete agreement precludes a worker from being employed by a rival firm, usually within a certain geographic region and for a period of time after the employee leaves her current employer.

The impetus for this ban, per President Biden, is a proliferation of these contracts beyond the high‐​paid executives and scientists who might take valuable company knowledge to rival firms. Biden claims “one in five workers without a college education is subject to non‐​compete agreements. They’re construction workers, hotel workers, disproportionately women and women of color.” By banning this type of contract, the FTC hopes low‐​paid workers will be able to access more job opportunities, increasing their options and pay.

But what if noncompetes are a response to existing government policies? Economists Michael Lipsitz and Matthew Johnson conclude that “firms that would otherwise not use NCAs [noncompetes] are induced to use one in the presence of frictions to adjusting wages downward.”

In simpler terms: their research finds that increases in minimum wages cause greater noncompete use, perhaps because a higher wage floor raises the risk of hiring an employee whose initial productivity might not justify that pay rate. The idea is that a noncompete acts as a lock‐​in device to ensure it’s worth investing in the employee. If such clauses are banned, the affected firm risks training up an initially unprofitable employee, only for her to leave just as she begins contributing positively to the business’s bottom‐​line.

Using a new survey of salon owners, Lipsitz and Johnson find that minimum wage increases bolster noncompete use and that “minimum wage increases have a negative effect on employment only where NCAs [noncompetes] are unenforceable.” Noncompetes for some low wage workers look very much like a way to manage the extra costs of a higher wage floor.

This is just one of the many ways firms might react, other than layoffs, to higher minimum wage costs. Others include: cutting workers’ hours, changing schedules, imposing more rigorous work targets, or trimming other forms of employee remuneration and benefits. Economist Jeff Clemens’ excellent Journal of Economic Perspectives article reviews the academic literature on these adjustments. Clearly, a lot of these responses have harmful effects on certain workers.

Overtime laws

Employees covered under the federal Fair Labor Standards Act, which goes back to 1938, must receive 1.5 times their regular pay for any hours worked over 40 hours per week. Numerous exemptions to this federal requirement exist, including for salaried workers who have “executive, administrative, or professional” duties with an annual base salary of more than $684 per week.

A 2020 Institute for Labor Economics summary explained that because overtime regulations increase compliance costs for businesses and create financial constraints on how employers might operate cost‐​effectively, they can reduce net employment and hours worked. But new research finds that firms also often adjust by engaging in “title inflation” — giving workers managerial job titles that notionally grant them more executive, administrative, or professional duties, such that they are considered exempt from the law.

In a new working paper this week, economists Lauren Cohen, Umit Gurum and N. Bugra Ozel examine whether firms strategically assign titles to avoid paying overtime. The answer? Yes. Examining outcomes when the wage threshold for exemptions was $455 per week, they find evidence of a 485 percent increase in the usage of managerial titles for salaried employees after this threshold is crossed (see chart). This includes calling a front desk attendant “Director of First Impressions,” a reception clerk a “Lead Reservationist,” a food cart attendant a “Food Cart Manager” and a host a “Guest Experience Leader.”

More detailed regression analysis in their paper finds such a spike in titles does not occur at other wage thresholds or for non‐​salaried workers who are ineligible for exemptions. It also only occurs in states where the federal threshold applies (some states have higher thresholds).

The economists conclude that “firms strategically use job titles to exploit regulatory thresholds to avoid paying for overtime work.” If there’s no genuine change in duties, then eligibility for exemptions should not, technically, be granted. But almost all jobs have a range of duties — allowing firms to exploit ways to avoid the costs of the regulation.

Next time someone advocates a new labor law or a tightening of some mandate and simply asserts this will benefit workers, it’s worth pondering where the businesses maintain the flexibility for offsetting adjustments to protect their profitability. A good economist must see these unseen effects. And the more that mandates accumulate to prevent these adjustments, the more likely that labor market rules will lead directly to less employment.

For more on labor market regulation, see here. For more on the economics of the minimum wage, see here."