Bryan Caplan  

The Joy of Market-Clearing Wages

The Anti-Malthusian... Best... Compliment... Ever...

When people compare the U.S. and Europe, they often conclude that the U.S. is richer and more economically efficient, but that Europe is happier because they don't measure everything in dollars and cents (or even Marks and Pfennings). One of the prime examples people often point to: America's less regulated, more flexible labor markets versus Europe's highly regulated, highly rigid labor markets. (Exceptions: The UK and Holland). The U.S. sure looks more efficient, but many think of the European system as more humane.

There is a broad consensus among economists that European-style labor market regs are the main reason why European unemployment is so much higher than that in the U.S. Everyone from me to Paul Krugman agrees.

Still, you might argue that the European approach makes people happier. There is some increased risk of unemployment, but workers get higher earnings. If labor demand is inelastic, it seems like this could make most people better off. (Even this needs lots of qualifications, but I'll buy it for the sake of argument).

So what? Well, if you delve into the life satisfaction literature, you learn two fun facts.

1. Once you reach a modest standard of living, additional income does not increase life satisfaction very much. Marginal utility of wealth decreases rapidly - maybe even more rapidly than you thought. (Having been a happy grad student on $6000/year, it's not more rapid than I thought).

2. Unemployment per se has a large effect on life satisfaction. If you compare two people with equal incomes, one employed, one unemployed, the unemployed one is typically a lot less happy.

Just to get a feel for these results, Donovan and Halpern report (Chart 11) that about 80% of people in almost every occupational category is "fairly" or "very" satisfied with their lives. Manual laborers and white collar workers are nearly equal in satisfaction. Managers are a bit higher, around 90%. But the unemployed are fully 20 percentage points less likely than most workers to be satisfied with their lives.

Suppose, then, that labor market regulation could raise the incomes of manual laborers up to the level of white-collar workers. That's a big change, but the extra income would probably add at most 1 percentage point of life satisfaction. If a side effect of the regulation was increasing the unemployment rate by 5%, however, this gain would be exactly balanced by the decreased satisfaction of the unemployed. And this is true even if we ignore all of the other side effects of the regulation - from extra taxes to pay for extra workers on the dole, to higher prices from restricted supply.

If you think this is remotely accurate, you will flee in terror from any regulation that might marginally push up unemployment. Flexible labor markets are more than just efficient. Contrary to popular prejudice, they also make a lot of people happy by making it easy to find a job.

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Jon writes:

Except that the point at which more income does not increase happiness is far above the minimum wage. Grad student comparisons are not relevant, because part of their "compensation" is the training that they know will lead to higher wages.

Furthmore, minimum wages make it more difficult to underage workers or illegal immigrants for the lowest wage jobs and then claim ignorance--if you cannot pay them much lower than legal workers, you have less incentive to do so.

John F. Opie writes:

Hi -

As an American living in Europe and having held in both places jobs and been unemployed, I think I might be able to provide some insight to this:

1) Being employed in Europe is a mixed bag. First of all the taxes aren't much fun (I take home just a tad less than 55% of my wages, and that's married with kids), but on the other hand it's almost impossible to get fired. Really, really hard. Like you'd really have to work at it. Which is, if you're working, great. Only a real severe drop in profits allows employers to lay people off, usually in order to save the existence of the company, but you have to prove this to the employment office.

2) Being unemployed in Europe is a real pain. In my case I had just arrived and was looking for work, but unless you have had the proper training and have pressed all the buttons, you're gonna have a really hard time getting work, since employers, cogniscant of the fact that it's really hard to fire workers, are really hesitant to hire as a result. I was the proverbial round peg trying to get into square holes.

3) Being employed in America is also a mixed bag: easier to get the jobs, but also easier to be out on the street. But also vastly more flexible. I took home significantly more of my pre-tax income without being married and having kids (in Germany, my unmarried and not-yet-reproducing colleagues take home less than 50% of their salary) than I pay in Germany married with kids, and while Social Security might tank, at least it's not tanking *now*, unlike the German system.

4) Being unemployed in the US is fine as long as unemployment covers your costs: once that runs out, you're screwed. But that's also the incentive to go out and get a new job. Missing in Europe, where unemployment/dole seem to last forever and can be incredibly generous (like making your mortgage payments so that you don't lose your house as long as you're "actively" looking for work, whatever that means.

And I'd really, really like to disabuse you of the notion that Europeans chose to work less to improve their happiness. While all I can provide is anecdotal evidence, I know a whole lot more happier people in the US than in Europe, and I've seen more marraiges here end because the husband became unemployed that I've seen in the US among a roughly equal sample.

Nothing would make the unemployed happier than having meaningful work that pays the bills. The level of unemployment in Europe is a criminal waste of human resources and a huge drain on the ability of countries to meet the needs of their citizens.

Of course, thinking that the government should serve it's citizens rather than the other way around is probably the biggest indicator that I'm not a European...


spencer writes:

The other side of the coin is that greater flexibility makes it much easier to lose a job.

So if you make a true comparison of both sides of the coin what results do you get?

Grad student comparisons are not relevant, because part of their "compensation" is the training that they know will lead to higher wages.

Guess what, 'a job' provides the same extra compensation beyond its pay. Which is why more experienced workers earn more than novices.

Lancelot Finn writes:

I wrote a piece called "Work, Service and Worship" last fall, working from the same life satisfaction literature. As I wrote then:

When earnest Christians ask themselves how best to practice their faith in matters of work and business, finance and political economy, many feel that Christianity calls for a commitment to "social justice," or, among Catholics, "solidarity." These words are taken to signify more efforts to help the poor, through private charity but also through public welfare programs, as against the amoral self-interest and greed that (are assumed to) characterize free-market capitalism. Despite the poor performance record of socialism and social democracy, and despite the way these have usually been the cause and/or consequence of a decline in Christian religiosity, there lingers in many American church congregations an assumption that in economic matters, Christianity implies some sort of welfare state or social democracy. It is true that theoretical free-market economists have a fetish for a rational, profit-maximizing homo economicus who is both morally un-Christian and thoroughly surreal. Nevertheless, John Edwards' insight about work [he told the Democratic National Convention that "a job is about more than a paycheck; it's about dignity and self-respect"] is a clue to why capitalism has a sounder foundation in Christian theology than does welfare-state social democracy, and why, while hardly the Kingdom of God, it provides a framework in which Christians can strive to build it. For the welfare state seeks to satisfy man's material needs, but what matters more is our moral need to serve our fellow men.

And another thing: That Americans work more than Europeans is sometimes taken as offsetting the higher incomes earned by Americans; Europeans are said to "consumer more leisure." But there's another interpretation: Americans choose to work more because they like their jobs more. And they like their jobs more because, since it's easy to switch jobs, they're more able to fish around for a job they like. As further evidence for this, I think statistics show that people with higher incomes work more, suggesting that work hours may be taken as evidence of the utility derived from working at least as much as they are a response to economic necessity.

I think that economic statistics understate the difference between the utility that Americans derive, and that which Europeans derive, from current economic activity. But Europeans have other advantages. I'd sacrifice tens of thousands of dollars in money income in order to live near all those splendid castles and cathedrals.

Mike Linksvayer writes:

John F. Opie:

it's almost impossible to get fired. Really, really hard. Like you'd really have to work at it. Which is, if you're working, great.

No it isn't great. It means you have lazy and incompetent coworkers.

Randy writes:


Re; But Europeans have other advantages. I'd sacrifice tens of thousands of dollars in money income in order to live near all those splendid castles and cathedrals.

I did exactly that - joined the USAF and spent much of my career overseas.

Tim Harford writes:

My colleagues at the World Bank have produced benchmarks showing the difficulty of firing workers in 145 countries around the world, including the US and Europe. They also correlate these figures with unemployment rates.

Walker writes:

If the utility increase of additional income has a steep drop but unemployment has a large effect on happiness, perhaps funds now at the disposal of wealthier citizens could be put to better use employing people. On utilitarian grounds, society might be better off if taxation were made more progressive, and the additional funds were used to either create public sector employment or create incentives for the private sector to employ.

Lawrance George Lux writes:

Debt load would seem to hold as high a dissatisfaction rating as Unemployment. Lack of Job security regulation leads to higher Debt load per Worker. It is a Trade-off. lgl

Eric Slusser writes:

Bryan Caplan,

I see since you're arguing that unemployment per se has a large effect on life satisfaction, you're just a short step away from advocating socialized health care. After all, doesn't lack of health care per se have a large effect on life satisfaction?

Happy April Fool's Day.

asg writes:

Only if you assume the two alternatives are "socialized health care" and "lack of health care", an assumption I suspect Bryan along with anyone who does not think in terms of "if the government does not provide health care, then no one will" would take issue with.

David Thomson writes:

Let’s cease implying that Old Europe’s economy is stable and unchanging. On the contrary, the unemployment rates will probably continue to go up. This means that more of the citizenry will be unhappy and existentially challenged. Should we pity them? Heck no, they have made their bed and should sleep in it. The Old Europeans mooch off the United States. Our military effectively protects their borders.

jaimito writes:

Having lived (in the same country) under an European-type socialist regime (where I had a good job and it was impossible to sack me) and consequently under the "savage" capitalist regime that replaced it (where I changed jobs several times), my observation is that I earn about the same, but now I work harder and am afraid to lose my job. I felt more comfortable under socialism and behaved like I would not dare today, like having affaires during office hours. I was younger and happier then. Insight: None.

dsquared writes:

There is a broad consensus among economists that European-style labor market regs are the main reason why European unemployment is so much higher than that in the U.S.

There is no such consensus; the most comprehensive study of the issue was the one carried out by the OECD which found basically no relationship. What they found, IIRC, was that the employment gap between EU countries and the US was better explained by the generous unemployment benefits available in Europe, suggesting that the marginal unemployed (rather than the average) were unemployed by choice.

jaimito writes:

dsquared is right. I would add that productivity per worker is higher in some European countries than in the USA, which may be counterintuitive.

Regarding happiness, many writers have written treatises on the subject. Dickens and Dostoyevskiy wrote long psychological novels about happiness and despair. In no case I know of, unhappiness (or happiness) was related to employment, but to personal relations, illness, or failure to be promoted.

Mr. Econotarian writes:

Income and unemployment are static issues.

The lack of growth in more redistributive/regulated economies will become a bigger issue.

If growth rates remain the same, comparing the US to France 50 years from now will be like comparing the US and Brazil today...

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