Wages, Standards, and Robust Labor Markets

This week’s EconTalk was a very interesting episode with James Besson discussing his new book, Learning By Doing: The Real Connection Between Innovation, Wages, and Wealth.

Let’s start with a common view of how the Industrial Revolution proceeded. The conventional view, or at least the mental model I have, is that throughout the period wages steadily rose commensurate with technological advances. But Besson argues that when you take a detailed look at the data from the US and UK, you don’t see this pattern. For instance, if you look at US textiles, one of the posterboard examples of early industrialization, what you see are several decades of stagnant wages despite increasing size and output of the market. It’s not until after the Civil War that you start to see increases in wages. What can account for this?

Besson claims that it wasn’t until this time the textile market became standardized enough to create a robust labor market in textile workers. How can this be, if the sector had been growing for decades before?

The key lies in the idea of human capital, the idea that through training and education workers build up internal means of production. Often the term is used rather loosely, which can mislead. Think of the new textile worker, coming in from the rural farm. She doesn’t have any training or experience, and so can’t command a high wage. She is hired and trains at the closest textile mill, learning the complicated movements of the loom. After a few years she’s mastered the equipment and become the most productive worker in the mill. We can say she’s build up substantial human capital, far more than her coworkers. But still, she hasn’t gotten a raise, and if she asks for one, she is routinely denied.

Why? Well, her human capital is firm specific. There were no standards for looms or other textile technology at this time, so her knowledge ties her to the mill she works at. The mill across the street uses totally different machinery, so she’s no better than a fresh hire off the street.

It wasn’t until historical forces led to standards in the textile that a robust labor market developed, because now workers’ human capital was transferable across firms. The threat of leaving for competitors now had bite, and wages rose to match what the workers were actually worth.

This idea is of course very relevant today, as we think about decades of stagnant wage growth for many workers in the economy. If the labor market is too fragmented, if workers’ human capital is too tied up in firm specific technologies, then firms have the upper hand in setting wages.

A modern day example of barriers to workers in the labor market are non-compete agreements. These are agreements workers have to sign when joining a firm that relinquish the workers’ ability to work at a competitor firm for some period of time after leaving their company. The idea is to protect trade secrets, so you see them often in the technology sector. However, there is an obvious side effect in that they tend to keep workers settled where they are, since leaving will keep you shut out of your industry for some years.

Differential enforcement of these non-compete agreements across states has led to researchers estimating the effects they have on innovation. While today Silicon Valley is obviously the king of the technology world, this wasn’t pre-ordained. Boston’s Route 128 was a high tech sector rival to Silicon Valley in the 80s, but Massachusetts enforces non-compete agreements whereas California does not. Without the cross pollination of ideas and incentives for workers to innovate, Route 128 stagnated while Silicon Valley raced ahead.

Unfortunately, these agreements have spread beyond the world of technology; famously, the sandwich chain Jimmy John’s forces its workers to sign a non-compete agreement. That’s right, if you work a minimum wage sandwich job you may be shut out of the sandwich labor market for several years if you leave, which is of course patently ridiculous.

What about occupational licensing? On the one hand, if having clear standards leads to robust labor markets, then having a licensing process should be a good thing right? Well, there a big difference between a certification from a standards body that a worker meets certain specifications versus a legal requirement that a worker must meet certain specifications (which almost always require some years of schooling from particular institutions). Furthermore, since these licenses are different from state to state, they inhibit labor mobility since the human capital is tied to a particular state.

All in all this was a very good episode with a lot of food for thought, and I look forward to reading the book.

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