Category Archives: macroeconomics

Francis Fukuyama and Charles Murray on “Inequality and Populism”


Still waiting for the growth dividend of the education boom

Was @MBIEgovtnz misreported on the effects of job protection laws and unions? @EricCrampton

News reports have it that the regulatory impact statement on the new employment law amendments by the new government says that:

The bill aims to strengthen collective bargaining through a range of measures, including guaranteed rest and meal breaks, reasonable union access to a workplace, and bringing back the 30-day rule where a new worker has to be given the same conditions as a collective agreement.

MBIE officials found that the cost of the proposals would mainly fall on employers, including from higher wages and compliance costs, and from a potential fall in productivity.

The MBIE papers identified the following risks associated with the bill:
• reduced employment due to changed incentives on employers to hire new workers • an increase in industrial action and protracted bargaining due to the need to conclude agreements and include pay rates in collective agreements
• an increase in partial strikes by removing an employer’s ability to deduct pay for partial striking
• lower productivity due to less flexibility (mainly from the need for guaranteed meal breaks)

These predictions must be a misreporting of an earlier draft by a junior analyst, perhaps they were not a recruit with a background in economics. The predictions of the effects of employment protection laws and union bargaining seem to be wrong for the former and seriously out of date for the latter.

Let us begin with what are the standard predictions of the effect of employment protection laws. They lower wages and have an ambiguous effect on employment because there is both less hiring and less firing. The only unambiguous effect is on the duration of unemployment because fewer vacancies are posted but once you get a job, you keep it for longer.

To give a summary of the literature that appears to be unknown to the junior analyst writing this early draft, graduate textbooks in labour economics show that a wide range of studies have found that:

1. Employment law protections make it more costly to both hire and fire workers.

2. The rigour of employment law has no great effect on the rate of unemployment. That being the case, stronger employment laws do not affect unemployment by much.

3. What is clear is that is more rigourous employment law protections increase the duration of unemployment spells. With fewer people hired, it takes longer to find a new job.

4. Stronger employment law protections also reduce the number of young people and older workers who hold a job. They are outside looking in on a privileged subsection of insiders in the workforce who have stable, long-term jobs and who change jobs infrequently.

The impact of the introduction of trial periods on employment will be ambiguous because the lack of a trial period can be undone by wage bargaining.

  • If you have to hire a worker with full legal protections against dismissal, you pay them less because the employer is taking on more of the risk if the job match goes wrong. If they work out, you promote them and pay them more.
  • If you hire a worker on a trial period, they may seek a higher wage to compensate for taking on more of the risks if the job match goes wrong and there is no requirement to work it out rather than just sack them.

The twist in the tail is whether there is a binding minimum wage. If there is a binding minimum wage,  either the legal minimum or in a collective bargaining agreement, the employer cannot reduce the wage offer to offset the hiring risk so fewer are hired. The introduction of trial periods will affect both wages and employment and employment more in industries that has low pay or often pay the minimum wage.

Trial periods are common in OECD countries. There is plenty of evidence that increased job security leads to less employee effort and more absenteeism. Some examples are:

  • Sick leave spiking straight after probation periods ended;
  • Teacher absenteeism increasing after getting tenure after 5-years; and
  • Academic productivity declining after winning tenure.

Jacob (2013) found that the ability to dismiss teachers on probation – those with less than five years’ experience – reduced teacher absences by 10% and reduced frequent absences by 25%.

Studies also show that where workers are recruited on a trial, employers have to pay higher wages. For example, teachers that are employed with less job security, or with longer trial periods are paid more than teachers that quickly secure tenure.

If employers take on more of the risk of a job match going wrong, they will pay recruits less. They can have a promotion round 6 or 12 months where pay is topped up if there is a good match. If minimum wage laws prevent starting salaries going low enough, there will be fewer job vacancies. But higher up the wage scales, the main effect of employment protection laws is to lower wages because the employer expects a wage discount to compensate for taking on more risk of an unsuccessful job match.

Consider, as an example, if there is a requirement to pay redundancy pay. Employers can easily undo this legal requirement by reducing wages. Another similarity is where employers pay completion bonuses on an offshore posting. They back-load compensation to make up for uncertainties about the willingness of the worker to last the posting. Because wages are lower for the duration of the posting, employees expect a big bonus. Also, there is self-selection, recruits are more likely to be those intending to stay for the whole posting. Both the employer and the employee split the greatest surplus from higher quality and longer lasting job matches arising from offering a completion bonus.

The analysis by the Ministry of the potential effects of unions is out of date. There are now doubts as to whether there is any union wage premium at all. The union wage premium is certainly withering away.

John DiNardo and David Lee compared business establishments from 1984 to 1999 where US unions barely won the union certification election (e. g., by one vote) with workplaces where the unions barely lost. If 50% plus 1 workers vote in favour of the union proposing to organise them, management has to bargain for a collective agreement in good faith with the certified union, if the union loses, management can ignore that union.

Most winning union certification elections resulted in the signing of a collective agreement not long after. Unions who barely win have as good a chance of securing a collective agreement as those unions that win these elections by wide margins.

Importantly, few firms subsequently bargained with a union that just lost the certification election. Employers can choose to recognise a union. Because the vote is so close, a particular workplace becoming unionised was close to a random event.

This closeness of the union certification election may disentangle unionisation from just being coincident with well-paid workplaces, more skilled workers and well-paid industries. Unions could be organising at highly profitable firms that are more likely to grow and pay higher wages independent of any collective bargaining. The unions are possibly claiming credit for wage rises that would have happened anyway.

DiNardo and Lee found only small impacts of unionisation on all outcomes they examined:

  • The estimated changes for wages of unionisation are close to zero.
  • Impacts on survival rates of the unionised business and their profitability were equally tiny.

This evidence of DiNardo and Lee suggests that in recent decades in the USA, requiring an employer to bargain with a certified union has had little impact because unions have been unsuccessful in winning significant wage gains after unionisation. These findings by DiNardo and Lee suggests that there may not be a union wage premium at all since the early 1980s, at least in the USA.

In another paper DiNardo found a substantial union wage premium before the Second World War by studying the share price effects of unionisation. One of the differences back them that there was far more violence associated with strikes.

We find that strikes had large negative effects on industry stock valuation. In addition, longer strikes, violent strikes, strikes won by the union, strikes leading to union recognition, industry-wide strikes, and strikes that led to wage increases affected industry stock prices more negatively than strikes with other characteristics.

New Zealand and U.S. unions are similar in that both are on their own in bargaining with employers for a wage rise. Options for outside arbitration do not exist in New Zealand; there are some forms of compulsory arbitration in the USA. These US result sends a message to New Zealand that unions are a bit of a relic in terms of wage bargaining. MBIE seems to have missed that literature?

In summary, job protection laws reduce wages. For the low paid, they may also reduce employment rates if minimum wage rates are binding. Unions are a dinosaur that do not matter much anymore.


The new corporate tax landscape

Brexit will lower company tax rates everywhere

Brexit will turn the British Isles into one great big offshore tax haven. The post-referendum plans for a 15% company tax rate (and the Australian plans for a 25% company tax rate) will put pressure on New Zealand to follow suit.

A common argument against a much lower company tax in New Zealand is the clipping of the ticket argument. A lower company tax rate in New Zealand is said to mean no more than the higher after-tax dividends are taxed at a higher tax rate in the home country of the foreign investor. Less company tax is paid in New Zealand but more tax is paid back home for no net gain to the investor.

The 12 ½% Irish company tax rate attracted investment

The strongest evidence against this is the Irish were relentlessly bullied by the rest of the European Union over its 12 ½% company tax. The other EU finance ministers rightly feared a loss of investment to Ireland. This 12.5% rate applied initially to exports, then manufacturing and then trading profits. The fiscal bounty of the Celtic Tiger years allowed the Irish to finesse these complaints based on EU laws about fiscal discrimination by phasing their 32% general company tax rate down to 12 ½ %.

Our Minister of Finance certainly would not welcome the plans (Senate permitting) for a 25% company tax rate in Australia by 2026. Rather than rubbing his hands in anticipation of more tax revenues on dividends repatriated from New Zealand subsidiaries in Australia, Mr. English will worry about loss of domestic and offshore investment to a more competitive neighbouring tax jurisdiction.

Source: OECD Stat.

The first big country low company tax rate

The British already have the lowest company tax of any major economy with the 20% company tax rate that started on 1 April 2016 (see graphic). This rate will fall to 19% on 1 April 2017, and 17% on 1 April 2020. Brexit will take that rate down to 15% at a date to be determined.

No Minister of Finance welcomes the prospect of a leading world economy and Europe’s key financial centre having by far the 2nd lowest company tax rate of any developed economy by 2020. They will worry about lost investment rather than expect a higher local tax take.

High company tax rates lower wages

Too many people mistakenly believe that company taxes are paid by shareholders through lower dividends. With capital highly mobile across borders, countries with high company tax rates attract less investment because of the lower after-tax returns relative to competing destinations.

This capital flight means lower wages in high company tax jurisdictions because their workers have less capital to work with. A lower company tax means higher wages because of more investment.

Even the USA is under pressure

The US got away with a very much above average company tax rate (38%) because its economy is so large relative to the rest of the world but it too is under pressure from footloose capital and corporate inversions. The US company tax system is so full of holes that if all tax loopholes were closed, its federal company tax rate could be cut from 35% to 9% with no net loss of revenue.

Leading US tax economist Laurence Kotlikoff estimated that this tax reform would increase wages by 8%, output by 6%, and the amount of capital invested by 17%. Australian Treasury modelling found that a 10-percentage point cut in their company tax rate would increase wages by 1.4% to 3%.

The race is on

The British company tax rate is now well below anywhere else bar one. That will force other countries, other big economies, to reconsider their position. New Zealand should not be left behind in harvesting the large wage increases that flow from a much lower company tax rate.