IV Market behavior. Armin Falk IZA and University of Bonn February Falk: Behavioral Labor Economics: Market behavior 1/99

Transcription

1 IV Market behavior Armin Falk IZA and University of Bonn February /99

2 Markets So far we have talked primarily about bilateral or group interaction Do anomalies survive the market? How do behavioral factors affect market outcomes? Wages Employment Distribution of rents Efficiency Interaction of institutions with implicit agreements, fairness etc. 2/99

3 a) Monopsony and minimum wages Main idea We experimentally investigate how social preferences influence the economic effects of minimum wages in labor markets with monopsony power. Specifically we are interested in the effects of minimum wages on: Economic Outcome Employment Income distribution Individual Behavior Reservation wages of workers Wage offers of firms 3/99

4 Literature Falk, A., Fehr, E., Zehnder, C., Fairness Perceptions and Reservation Wages The Behavioral Effects of Minimum Wage Laws. Quarterly Journal of Economics 121, /99

5 Why studying the economic effects of minimum wages? Minimum wages are an important labor market instrument: Most developed labor markets are affected by MW (25 of 29 OECD countries) Standard Theory (competitive labor markets) predicts negative employment effects Potentially large (negative) effects on economic outcomes 5/99

6 w W min L s W c L d L min L c L 6/99

7 Recent studies call negative employment effects into question: Empirical evidence for zero or positive employment effects of minimum wages Card/Krueger (1994) Card (1992) Maching/Manning (1994) OECD (1998) These studies have started a big minimum wage debate: Political Discussion (USA, Switzerland) Economic Research (theoretical explanations) 7/99

8 Why studying minimum wages in a monopsony? New theoretical models that can explain positive employment effects of MW: Bhaskar/To (1998): Heterogeneous job preferences Rebitzer/Taylor (1991) and Manning (1995): Efficiency Wages Burdett/Mortensen (1998): Search Model (Dynamic Monopsony) Result: Positive employment effects of MW are possible if firms have a certain degree of monopsony power But this result raises a new question: How realistic is it to assume that labor markets are characterized by monopsony power of firms? 8/99

9 w MC L s W c W min W m L d L m L min L c L 9/99

10 Theoretical arguments for the relevance of monopsony power: - Potential reasons for monopsony power of firms: (Boal/Ransom (1997), Manning (2001/2003)) - Small number of firms (Oligopsony / Strategic Interaction) - Mobility costs - Imperfect Information about labor market opportunities (Searching) - Heterogeneous preferences for non-wage attributes of jobs Frictions in the labor market obviously exist Monopsonistic labor markets are the rule rather than the exception (perfect competition as a limit) 10/99

11 Empirical evidence for the relevance of monopsony power in labor markets: (Boal/Ransom (1997), Manning (2003)) Direct estimations of the elasticity of labor supply (ESWE) Large differences between direct and reverse regressions (0.5 < ε Nw <15) Lower values are found if IV is applied (hard to find good firm-level instruments) Estimating separations functions (Dynamic Monopsony) Lower estimated values (ε Nw 1) (but these are probably underestimated) A reasonable value for ε NW may be 2-5 (Manning 2003) 11/99

12 Indirect Evidence: Testing the predictions of monopsony Wage dispersion Employer size wage effect Positive employment effects of minimum wages 12/99

13 Why are social preferences important in this context? With monopsony power of firms economic rents may be generated These rents must be divided between firms and workers (Bargaining process!) How the rents are divided depends on the rules of the bargaining process Assumption: Firms set wages and workers can accept or reject them Appropriate assumption for non-unionized low wage labor markets Well-established results from experimental economics show, that social preferences are of great importance for exactly this kind of bargaining process 13/99

14 Stylized facts from bargaining experiments: The Ultimatum Game (Güth et al. (1982), Güth (1995), Camerer and Thaler (1995), Roth (1995)) 1 x 0 10 a 10 - x x 2 r /99

15 Results: Proposers offer considerable shares of the pie (average: 37%, modus: 50%) Responders reject low offers Explanation: Inequity Aversion (outcome-orientated fairness preferences) (Fehr and Schmidt (1999), Bolton and Ockenfels (1999)) 15/99

16 Mini Ultimatum Games (Falk, Fehr and Fischbacher (2003)) 1 1 x1 x2 x1 x2 2 2 a r a r a r a r Results: (5/5) - Game: (10/0) - Game: 44% of responders reject the (8/2)-offer 9% of responders reject the (8/2)-offer Explanation: Reciprocity (Intention-based fairness preferences) (Falk and Fischbacher (2006)) The fairness of an outcome is not only determined by the resulting payoffs but also by the set of available, yet not chosen, alternatives. 16/99

17 Why conducting an experiment? Perfect control over exogenous variables - Production functions (marginal product of labor) - Enforceability of Contracts Examination of perfect ceteris paribus changes (Introduction/Elimination of MW) - Introduction of minimum wage - Elimination of minimum wage Complete observability of endogenous variables - Employment - Wages - Reservation wages 17/99

18 Summary of Motivation Empirical evidence for positive employment effects of MW can be explained if firms have monopsony power In monopsonistic labor market economic rents are generated division of rents between firms and workers: firms as wage setters Ultimatum Bargaining For the division of rents social preferences play a crucial role 18/99

19 Introduction of the MW changes set of wage setting opportunities of firms non-trivial effects of minimum wages on reservation wages (labor supply) For a complete understanding of the effects of MW in monopsonistic labor markets it is imperative to take the existence of fairness preferences into account 19/99

20 Market Participants 6 Firms 18 Workers 2) Design of the Experiment Exogenous Matching (Monopsony) At the beginning of a period each firm is randomly matched with three workers Stage 1: Firms can offer the same wage to 0, 1, 2 or 3 workers, w [0, 1000] Stage 2: Workers accept or reject the wage offers (Strategy-Method: Reservation Wage) Supply Schedule observable 20/99

21 Two Treatments: Two Treatment Orders: Without minimum Introduction of MW wage (NO) (NO/MW) [5] With minimum wage (MW) Elimination of MW (MW/NO) [5] 21/99

22 Production Function: Production Function and Payoff Calculation Employed Workers Output Marginal Product Payoffs: Firms: Π F = Output wage employed workers Workers: Π W = wage, if employed Π W = 0, otherwise Minimum Wage: w min = /99

23 3) Predictions Standard Prediction Assumptions: Common knowledge of rationality Common knowledge of money maximizing behavior of all subjects Implications: Workers accept every positive wage offer Labor supply is horizontal at a wage of one Firms offer always the smallest accepted wage to all their workers NO-Treatment: w = 1 MW-Treatment: w = 220 (Minimum Wage) There is full employment in both treatments The minimum wage does not change employment but has strong distributive effects 23/99

24 Fairness Prediction Assumptions: Heterogeneous fairness preferences of workers Implications: Many workers reject low wage offers: Heterogeneous reservation wages Firms face an upward sloped individual labor supply (Standard Monopsony) Inefficiently low employment in the absence of the MW Introduction of MW: Binding MW: Increase of wage offers MW changes firms set of alternatives: Upward shift of labor supply The minimum wage has a small (positive) employment effect 24/99

25 4. Results Economy without Minimum Wages Reservation Wages and Labor Supply Wage Offers of Firms Employment Introduction of a Minimum Wage Effects on Employment and Labor Supply Change of Wage Offers of Firms Distributive Effects Elimination of a Minimum Wage Effects on Reservation Wages (Labor Supply) Change of Workers Earnings Employment Effects 25/99

26 Result 1a: Economy without MW Reservation wages are higher than predicted by standard theory 25% Relative Frequency of Average Reservation Wages 20% 15% 10% 5% 0% Reservation Wages 26/99

27 Result 1b: Economy without MW 250 Upward-sloping labor supply curve 200 Reservation Wage Workers 27/99

28 Result 1c: Economy without MW Stable Distribution of Reservation Wages over Time Reservation Wages of Workers over Time Period 28/99

29 Result 2: Economy without MW Firms offer high wages 300 Wage Offers of Firms /99

30 Result 3: Economy without MW Inefficiently Low Employment Levels 3.0 Average Employment per Firm Average Session 30/99

31 Result 4: Introduction of the MW Positive Employment Effect of the Introduction of the Minimum Wage 3.0 Average Employment per Firm NO MW Average Session Wilcoxon Signed Ranks Test: p-value = /99

32 Result 5: Introduction of the MW Shift of Labor Supply after Introduction of the Minimum Wage NO Minimum Wage MW Reservation Wage Worker 32/99

33 Mini-Excursus: Intentions versus Anchoring Minimum Wages and Gift-Exchange: (Zehnder (Pretest), Charness and Brandts (2001)) - Pairs of Firms and Workers (Rematched every period) - Sequential Game: Firms offer wages / Workers choose effort (c(e), with c (e) > 0) - Payoffs: Firm: (120-w) * e Worker: w c(e) Average Effort for a certain Wage Range before and after the Introduction of a MW NO MW = 50 MW Wage Range 33/99

34 Result 6: Introduction of the MW Firms offer Wages above the Minimum Wage Average Wage Offers of Firms 250 NO MW Minimum Wage Average Session 34/99

35 Result 7: Introduction of the MW Decreasing Inequality and Increasing Efficiency after Introduction of a MW Average Income of a Group 1200 Workers Firms Pred. NO Pred. MW NO MW 35/99

36 Result 8: Elimination of the MW Small Decrease in Reservation Wages after Elimination of the Minimum Wage Median Reservation Wage Median Average NO in NO/MW MW in NO/MW NO in MW/NO MW in MW/NO Wilcoxon Mann-Whitney Test Mean: p-value = Median: p-value = NO MW Introduction of MW NO MW Elimination of MW 36/99

37 Result 9: Elimination of the MW High Wages after Elimination of the Minimum Wage Average Wages of Employed Workers Elimination of MW Introduction of MW Period Wilcoxon-Mann-Whitney Test: p-value = /99

38 Result 10 No significant Employment Effects after Elimination of the MW 3.0 Average Employment per Firm NO MW Average Session 38/99

39 4. Summary and Conclusion We examine an experimental labor market with monopsony power: Labor Market without Minimum Wage Heterogeneous fairness preferences of workers High reservation wages of workers Firms are confronted with upward sloped labor supply (Classical monopsony) Inefficient low employment 39/99

40 Introduction of Minimum Wage MW changes fairness perceptions (Intentions matter!) Upward-shift of labor supply relatively small positive employment effect Firms are forced to pay higher wages Relatively small positive employment effect Redistribution of income from firms to workers Elimination of Minimum Wage Entitlement Effect Rigidity of reservation wages Employment remains constant Slightly increasing inequality of income distribution 40/99

41 Social preferences have important consequences for the economic effects of minimum wages Strong impact on reservation wages of workers Asymmetric effect of introduction and elimination of minimum wages These effects should be taken into account in future discussions Further research is necessary Endogenous matching Incomplete contracts 41/99

42 b) Fairness, efficiency wages and wage rigidities Main idea Gift-exchange variant of efficiency wages 42/99

43 Literature Fehr, E. and Falk, A Wage Rigidity in a Competitive Incomplete Contract Market. Journal of Political Economy /99

44 Design Stage 1: Firms and workers conclude contracts. Wages are settled in an oral double auction market, with wages [20, 120]. There is an excess supply of workers (7 firms, 11 workers) Unemployment benefit = 20 Stage 2 : Workers who concluded a contract choose an increasingly costly effort, with effort [0.1, 1] 44/99

45 Payoffs Firms: (120 wage) effort Workers: wage cost of effort Effort levels and costs of effort effort level e effort cost c(e) /99

46 Control treatments Double auction with complete contracts Payoffs Firms: 120 wage Workers: wage Bilateral institution with incomplete contracts stranger treatment, no competition Incomplete contracts: Negative reciprocity Payoffs Firms: 120e wage Workers: wage c(e) (Efforts see next slide) 46/99

47 Cost associated with different effort levels in the neg. reciprocity design effort level e effort cost c(e) /99

48 Standard prediction for main treatments Complete and incomplete contracts, bilateral institution wage = 20 effort = 0.1 Negative reciprocity treatment wage = 20 effort = /99

49 Competitive Prediction wage firms/workers 49/99

50 Evolution of average wages in the incomplete market (AE 1-4), the complete market (A1-2), and the Bilateral case average wage AE1-4 Bilateral A period 50/99

51 Underbidding: Workers offers and mean contract wages if contracts are incomplete wage period 51/99

52 Underbidding: Complete Market wage workers' offers mean contract wage period 52/99

53 Reciprocity in Markets: Wage-effort Relation effort to to to to to to 75 > 76 wage 53/99

54 Wage profit relation (incomplete markets) profit to to to to to to 75 >76 wage interval 54/99

55 Evolution of average wages in the treatment with negative reciprocity and complete contracts wage AE negative reciprocity A period 55/99

56 Reciprocity in Markets In the incomplete contract market, wages are on average substantially higher than predicted Underbidding of workers is not accepted by firms Firms pay voluntarily high wages, because there is a positive correlation between wages and efforts on average. When effort is exogenously fixed, wages converge towards the predicted equilibrium and firms take advantage of underbidding. 56/99

57 Market power seems to be irrelevant (comparison of bilateral and double auction treatment) Negative reciprocity gives also rise to wage rigidities 57/99

58 c) Incomplete contracts, fairness and the functioning of markets Main Idea The need to solve the contract enforcement problem may lead to implicit contracts With endogenous relations Leads markets to function quite differently from complete contracts 58/99

59 Literature Brown, M., Falk, A., Fehr, E Relational Contracts and the Nature of Market Interactions, Econometrica 72, Further literature: Brown, M., Falk, A., Fehr, E : Competition and Relational Contracts 59/99

60 Motivation In many markets obligations of the contracting parties are imprecisely specified Neutral third parties are often unable to verify whether contractual obligations have been met. In labour markets, e.g., workers submit to the authority of the employer and receive a wage. The limits of the employers authority are imprecisely specified by law, custom and social norms. Generates moral hazard problems. 60/99

61 What motivates employees to perform in the interest of the employer? Voluntary cooperation Satisfaction from work, loyalty,. Explicit incentives due to multitasking problematic Promotion incentives Implicit incentives both parties are disciplined by the loss of future rents in case of cheating Both parties earn a rent if the relation continues Threat to fire the partner disciplines If moral hazard problem is solved long-run relations emerge Hypothesis: If there is a motivation problem in the employment relation (because explicit incentives are imperfect), implicit incentives via long-term relations arise 61/99

62 There are many theories There is a large theoretical literature suggesting that reputation and relations can provide effective solutions to the moral hazard problem Strong focus on endogenous repeated interactions Gintis 1976, Klein and Leffler 1981; Shapiro and Stiglitz 1984; Bowles 1985; Bull 1987; Hart and Holmström 1987; MacLeod and Malcomson 1989, 1993 and 1998; Baker, Gibbons and Murphy /99

63 but little empirical evidence Very difficult to test in the field because exogenous variation of the moral hazard problem is difficult to find Ideal data: Exogenous c.p. variation in the degree of third party enforceability Almost impossible with field data Measurement problems (index for the degree of third party enforceability, actual efforts or rents (Krueger and Summers 1988)) Uncontrolled reasons that cause long-term relations (subtle and unobservable legal differences or asset specifity, business norms) Endogeneity problems (long-term relations affect willingness to leave contracts incomplete) 63/99

64 This is problematic in particular because there are many equilibria (Fudenberg and Maskin 1986) Infinitely repeated games (not realistic?) 64/99

65 Crocker & Reynolds (1993) examine the incentives for the parties to leave contracts incomplete; no focus on how markets function McMillan & Woodruff (1999) show that Vietnamese firms are more likely to trust its customers (give trade credit) if the customer has no or little alternatives the firm has information about the customer through prior investigation or experience the firm belongs to a network of suppliers so that cheating customers can be sanctioned Banerjee & Duflo (2000) show that in the Indian software industry, the reputation of the contracting parties affects the contracts chosen and the actual sharing of cost overruns 65/99

66 Experimental studies Experimental studies that study repeated games Even in finitely repeated games efficiency is higher compared to one-shot games Gächter and Falk (SJE 2002) Partner vs. Stranger treatments (Keser and Van Winden 2000) However: Exogenous matching. First study that endogenizes the matching is Kollock 1994 Kirchsteiger,Niederle, Potters (EER 2005) study endogenous evolution of market institutions for complete markets. 66/99

67 Focus of the paper How do markets function in which contracts are incomplete? Effort is not verifiable by third parties Effort is not enforceable 67/99

68 Main Questions General: How does contractual incompleteness affect the functioning of markets? Does it affect the bidding process in markets? Does it affect how the contracting parties initiate trade? Which enforcement policies evolve? In particular: Does enforcement problem cause the endogenous formation of long-run relations? What are the efficiency consequences and the distributional consequences? 68/99

69 Experimental design First stage 10 workers and 7 firms (identification number) Trade in an one-sided continuous auction, a firm can employ at most one worker Firms make offers including: a binding wage w [0, 100] a desired effort e [1, 10] the firm s ID Two types of offers Private offers: offer to a specific worker, unknown to anybody else Public offers: known to anybody 69/99

70 Second stage Design II Workers who have concluded a contract have to choose increasingly costly e [1, 10] e c(e) Effort choice only known by trading partners Payoff functions, cost functions etc., commonly known 70/99

71 Payoffs Firms: π = 10e w, if contract concluded 0, otherwise Workers: U = w c(e), if contract concluded 5, otherwise Efficiency solely determined by e with e* = 10 71/99

72 Treatments Incomplete contract with fixed IDs (ICF) w binding e non-binding ID fix Complete contract (C) w binding e binding ID fix Incomplete contract with random IDs (ICR) w binding e non-binding ID random 72/99

73 Total of 15 periods (plus 2 practice) Total of 14 sessions (238 participants) Experiments lasted about 90 minutes Average earnings: CHF 62,30 ($42) 73/99

74 74/99

75 75/99

76 Predictions Assumption: Money maximizing behavior and rationality are common knowledge Complete contract (C) Highest effort e = 10, just compensated (w = 23) Incomplete contract (ICF and ICR) Lowest effort e = 1, just compensated (w = 5) All treatments: Long-run relations have no value and arise only by coincidence 76/99

77 Alternative Predictions Assumption: There is a fraction of reciprocal workers (reward kind/punish unkind behavior) Robust evidence Assume, identity of the selfish and reciprocal type not revealed until t=15): ICF equilibrium with Endogenous long-run relations Private offers Firms pay a rent Non-minimal effort enforceable, higher than in ICR 77/99

78 Intuition Incentive for selfish firms to offer rents to all workers in the final period (if sufficiently many reciprocal workers exist) In t=14 firms threaten not to renew the contract; selfish workers are disciplined in t=14 because if they shirk they are fired and lose rent Why do selfish firms not extract the period 14 rent by making a bad offer? Rent in t=14 is irrelevant for worker s performance in t=14 as long as worker believes he gets a rent in t=15 If the worker believes that he will not get the rent in t=15 in case he does not get the fair offer in t=14, selfish firm has an incentive to make the fair offer also in t=14 78/99

79 Consequences for ICR Alternative Predictions II Firms pay rents also in the ICR to elicit higher e e will in general be lower than in the ICF because selfish workers cannot be disciplined No clear prediction for public vs. private offers: private offer to signal generosity? Consequences for C-condition Firms, which attempt to extract the whole rent are constrained by reciprocal workers who reject unfair offers Predominantly public offers 79/99

80 Relative share of trades initiated by private offers under complete and incomplete contracts relative share period ICF ICR C 80/99

81 Firms profits dependent on public/private offers in C and ICF C-public C-private ICF-private ICF-public period 81/99

82 In the ICF the majority of private offers are addressed to the firm s previous employee EVOLUTION OF PRIVATE OFFERS TO THE PREVIOUS EMPLOYEE RELATIVE TO ALL THE PRIVATE OFFERS Period Percent /99

83 Probability of private offer to previous trading-partner effort in previous period 83/99

84 PROBABILITY OF CONTRACT RENEWAL IN THE ICF TREATMENT Effort in previous period.125** (.052) Positive surprise.192** (.077) Negative surprise -.836** (.381) Previous length 2.449*** (.653) Constant *** (1.535) Controls for session fixed effects YES N = 488 LL= Wald c(3) = Prob =.000 Pseudo R 2 = /99

85 Cumulative frequency of trades in relations of length x C ICF period length x 85/99

86 In all periods of the ICF the denial of contract renewal imposed considerable costs on the worker TOTAL RENTS OF TRADING WORKERS Period V t e - V t u /99

87 Firm s profits dependent on paid rents in period 15 (averages) Firm profit >40 Worker rent 87/99

88 Relation between firms' profits and workers' rents in the ICR-condition Frim profit <= >40 Worker rent 88/99

89 The evolution of wages over time average wage ICF C ICR period 89/99

90 Distribution of the earnings per trade 70 earnings per trade workers firms 10 0 ICR 1 to 2 3 to 5 6 to to 15 C ultimate length of relationship in the ICF 90/99

91 Distribution of effort in the ICF- and the ICR-condition ICR ICF effort level 91/99

92 Evolution of effort in C, ICF and ICR C ICF ICR period 92/99

93 DETERMINANTS OF EFFORT AND TREATMENT DIFFERENCES BETWEEN ICF AND ICR (1) (2) (3) (4) ICF - Dummy 5.919*** (1.869) all periods all periods all periods period 15 only 1.978*** (.577) 1.332*** (.462).597 (1.691) Period.433 (.338).319* (.182).229 (.158) Period (.019) -.022* (.011) -.018* (.010) Wage.215*** (.011).203*** (.009).256*** (.033) Private offer.598*** (.199) 1.548** (.702) Private offer ICF - Dummy Constant.515 (1.610) *** (.892).829** (.362) (1.559) *** (.737) *** (1.197) N = 940 Wald c(3) = N = 940 Wald c(4) = N = 940 Waldc(6) = N = 62 Wald c(4) = Prob =.007 Prob =.000 Prob =.000 Prob = /99

94 average wage wage, ultimate duration 6 to 15 wage, ultimate duration 3 to 5 wage, ultimate duration 1 to 2 effort, ultimate duration 6 to 15 effort, ultimate duration 3 to 5 effort, ultimate duration 1 to current length of relationship average effort 94/99

95 Consequences of implicit incentives In markets with moral hazard problems the contracting parties tend to form long-term relations and this fundamentally changes the functioning of the market relative to a situation where no moral hazard problem exists The moral hazard problem is solved through appeals to fairness and the establishment of reputation in bilateral long-term relations 95/99

96 In the presence of a moral hazard Trades are initiated by private offers The parties share the gains from trade equally so that workers earn rents Rents are increasing with the total surplus from the employment relation Low effort (quality) is punished by the termination of the relationship high effort is rewarded with the continuation of the relationship Long-run relations are more productive because the parties trust each other 96/99

97 If the moral hazard problem is absent Trades are initiated by public offers No rent sharing No long-term relations most trades take place in oneshot interactions Long-term relations yield no efficiency gain Contracting parties are indifferent with regard to their trading partner 97/99

98 Conclusions Reputation formation in endogenous bilateral long-term relations constitutes a powerful solution for the problem of effort (quality) enforcement Effort enforcement is based on the firing (punishment) of shirkers and on the payment of fair wages that share the available cake equally Markets with an effort enforcement problem function in a fundamentally different manner compared to market without effort enforcement When there is an enforcement problem: markets rather resemble bilateral trading islands than competitive markets firms voluntarily restrain the set of trading partners by making private offers to the previous employee rent-sharing and long-term relations prevail 98/99

99 Third party enforcement Public offers Firms don not care about worker identity One-shot interaction No third party enforcement Private offers Offers to to previous worker in case of satisfactory e Long-term interaction Firms use excess supply to appropriate surplus Firms use excess supply to enforce high e Much competition abut contract conditions No rents Little competition Rents 99/99