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Labor as a Quasi-Fixed Factor

Author(s): Walter Y. Oi
Source: Journal of Political Economy, Vol. 70, No. 6 (Dec., 1962), pp. 538-555
Published by: The University of Chicago Press
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T HE cyclical behavior of labor mar- borne out by the available evidence. Thus
kets reveals a number of puzzling my theory provides a unified explanation
features for which there are no for various aspects of the cyclical func-
truly satisfying explanations. Included tioning of labor markets.
among these are (1) occupational differ-
ences in the stability of employment and I. A SHORT-RUN THEORY OF

earnings, (2) the uneven incidence of un- EMPLOYMENT

employment, (3) the persistence of differ- According to the theory presented here
ential labor turnover rates, and (4) dis- cyclical changes in employment are ex-
criminatory hiring and firing policies. I plained by differential shifts in factor de-
believe that the major impediment to mands and supplies. The first two sec-
rational explanations for these phenom- tions develop a theory of factor demands
ena lies in the classical treatment of labor assuming rigid wage rates. In the next
as a purely variable factor. two sections this assumption is relaxed,
In this paper I propose a short-run the- allowing for variations in factor supplies.
ory of employment which rests on the
premise that labor is a quasi-fixed factor.
The fixed employment costs arise from
investments by firms in hiring and train- In the classical short-run model certain
ing activities. The theory of labor as a paths of adjustment are barred to the
quasi-fixed factor is developed in Part I. firm. These barriers usually postulate
In Part II, the implications of this theory the presence of fixed factors, short-run
are subjected to various empirical tests. changes in output being effected by vary-
Finally, Part III turns to an examination ing only the remaining factors.
of alternative theories and an extension Changes in the amount demanded of
of my theory to a theory of occupational any factor are composed of two parts:
wage differentials. (a) response to changes in the rate of out-
The concept of labor as a quasi-fixed put--the scale effect and (b) response
factor is, in my opinion, the relevant one to variations in relative factor prices-
for a short-run theory of employment. the substitution effect. With an assump-
Its implications are amenable to empiri- tion of rigid wage rates, the substitution
cal verification and are, in the main, effects may be neglected and attention
focused on the scale effects.
1 This paper is taken from my unpublished doc-
toral dissertation "Labor as a Quasi-fixed Factor of Consider a firm faced by a decline ill
Production" (University of Chicago, 1961). I wish product demand. The adjustment proc-
to express my indebtedness to Professors A. C. Har- ess involves a reduction in output ac-
berger, H. G. Lewis, and A. E. Rees. A reading of
two unpublished articles by Professor Gary S. Becker companied by a decline in the demand
led me to revise the theory substantially. Financial for each variable factor. There is no rea-
and clerical assistance from the Social Science Re- son to expect that the demands for Lill
search Council and the Transportation Center,
Northwestern University are also gratefully ac- variable factors will be (lecreased by the
knowledged. same proportion. The reduced demands

for variable factors led to an increase in For analytic purposes fixed employ-
the relative employment of fixed factors. ment costs can be separated into two
In a sense, the firm now employs too categories called, for convenience, hiring
much of the fixed factors and would, and training costs. Hiring costs are de-
therefore, try to substitute fixed factors fined as those costs that have no effect
for variable factors. Consequently, those on a worker's productivity and include
variable factors that tend to be most sub- outlays for recruiting, for processing pay-
stitutable for, or least complementary roll records, and for supplements such
with, the fixed factors will experience the as unemployment compensation. These
greatest relative declines in demand due costs are closely related to the number of
to any given decrease in product demand. new workers and only indirectly related
The converse holds for an increase in to the flow of labor's services. Training
product demand. Thus the variable fac- expenses, on the other hand, are invest-
tors that are most substitutable with the ments in the human agent, specifically
fixed factors will exhibit the greatest rela- designed to improve a worker's produc-
tive shifts in factor demands. tivity. The effect of training on produc-
tivity could be summarized by a produc-
FACTOR OF PRODUCTION tion function showing the increment to a
A quasi-fixed factor is defined as one worker's marginal value product in the
whose total employment cost is partially tth period, AMt, due to an investment in
variable and partially fixed. In the classi- training of K dollars per worker.2
cal short-run model all factors are classi- AMt = g(K). I
fied as either variable or fixed. Each fac-
tor may, however, possess a different de- The total discounted cost, C, of hiring an
gree of fixity along some continuum rath- additional worker is the sum of the pres-
er than lie at one extreme or the other. ent value of expected wage payments, the
From a firm's viewpoint labor is surely hiring cost, H, and training expense, K.
a quasi-fixed factor. The largest part of T
total labor costs is the variable-wages bill C= J:We(l + r) t+H+K, (2)
representing payments for a flow of pro- t=O
ductive services. In addition the firm
where Wt is the expected wage in the tth
ordinarily incurs certain fixed employ-
period, r denotes the rate at which future
ment costs in hiring a specific stock of
costs are discounted, and T denotes the
workers. These fixed employment costs
expected period of employment. The to-
constitute an investment by the firm in
tal discounted revenue, Y, generated by
its labor force. As such, they introduce
the additional worker is similarly defined
an element of capital in the use of labor.
as the present value of his expected mar-
Decisions regarding the labor input can
no longer be based solely on the current ginal value products that, in each period,
relation between wages and marginal val- consist of his marginal product without
ue products but must also take cogni- training, MtI,and the increment due to
zance of the future course of these quan- his training, AMt.
tities. The theoretical implications of la- 2 The training activity typically entails direct

bor's fixity will be analyzed before turn- money outlays as well as numerousimplicit costs
such as the allocation of old workers to teaching
ing to the empirical magnitude of these skills and rejectionof unqualifiedworkersduringthe
fixed costs. trainingperiod.
540 WALTER Y. 01
competingemployments,as, for example,
=\M At)1 r-1- (3)s |-/ training of workers to operate com-
puters or to read railroadtariffs.
Profitswill be maximizedwhen the total Rationalbehaviorimpliesthat the bulk
discounted cost of an additional worker of a firm's investment in training must
is just equal to the total discounted be devoted to specific training. If train-
revenue. ing were completely general, all returns
would accrue to the worker and none to
the firm. Upon completion of general
11 +K= E (Mt+Alf t- WO (4) training, the workerwould find that his
marginal productivity to several firms
X (1 + r)t has been increased. He could now de-
Equation (4) yields the first implication. mand a higher wage, either from a com-
In equilibriuma worker'stotal marginal peting firm or from his presentemployer.
product, Mt + AMt, must exceed the In either case, the net value of the train-
wage rate, Wt, so long as the firm incurs ing to the firm would be reducedto zero.
any fixed employment costs. Even un- Indeed, a firm could capture these re-
der perfect competition wages would be turns only if there were impedimentsto
equated to marginal value products if competitionsuch as imperfectknowledge
and only if labor is a completely variable or binding labor contracts. Thus, no ra-
factor. tional firm would underwritecompletely
At this point, a digressionon the firm's generaltraining.3If, however, trainingis
investment in training is in order. The specificto a firm,then the worker'salter-
net value of trainingto the firm is simply native marginal product remains unaf-
the present value of the expected incre- fected. In this latter case, the firm could
ment in marginal value product, AMt, weigh the expected returns from this in-
due to training. vestment against the training cost. To
simplify the analysis, I shall assume that
the firm bears all specific training costs.
V = E AMt(1 +r- (5) As will be shown in section D below, the
t =O
implicationsof the theory are not serious-
An investment in training will prove ly affected by relaxing this assumption.
profitableif the net value to the firm, V, Returning to the equilibrium condi-
exceedsthe trainingexpense,K. Concep- tion, it is clear that some expectations
tually training may be categorized as model must be formulatedsince the vari-
eithergeneralor specific.Specifictraining ables refer to future quantities. Suppose
is definedas that which increasesa work- that the firm formulates the following
er'sproductivityto a particularfirmwith- single-valuedexpectations:
out affecting his productivity in alterna- Wt = W*, Mt = M*, AtJ = AM*
tive employments.The time requiredto (6)
adapt workers to the firm's particular (for allt= 0, 1, 2, ...T).
productionprocesses,or to its accounting 3 That a firm offers general training to its em-
and marketingprocesses,exemplifiesspe- ployees does not necessarily imply that the firm
cific training. General training, on the underwrites the general training expense. The work-
er may bear the training cost by accepting a lower
other hand, is defined as that which in- wage than that which he could obtain in some alter-
creasesa worker'sproductivity in several native employment.

Substituting these expected values into the equilibrium condition, equation (9),
equation (4), the equilibrium condition is satisfied by every factor or grade of
reduces to labor. For a competitive firm, a decline
+ H+K in product demand is equivalent to a fall
M* +AM*= T in product price, P*.4 The relevant com-
(1+ r)-- t ~7)(7 parison for short-run profit maximization
is that between total expected marginal
The concept of a periodic rent, R, may value product and the expected wage
be defined as rate, representing the variable compo-
nent of the total employment cost. Thus
T the short-run equilibrium condition ap-
1:( 1+ r)-t plicable to cyclical declines in product
t=O demands becomes
The periodic rent represents the fixed M* +AM* =W*. (10)
employment costs during each period. It
is the surplus that must be earned by The employment of a quasi-fixed factor
each worker in order to amortize the will only be reduced when M* + AM*
initial fixed employment costs over the falls below W*.
expected period of employment, realizing For a completely variable factor, the
a rate of return of r per cent on this in- long- and short-run equilibrium condi-
vestment. Thus, the equilibrium condi- tions, (9) and (10), are equivalent. Any
tion may be rewritten as decline in P* will reduce the demand for
a variable factor; with falling employ-
M*+AM*=W*+R. (9) ment, the variable factor's marginal phys-
In equilibrium, the total expected mar- ical product will be increased until the
ginal value product must exceed the ex- equilibrium conditions are again satis-
pected wage rate by the amount of the fied. The decline in P* may not be suf-
periodic rent. The degree of fixity, f, of ficient, however, to warrant a reduction
a factor will be defined as the ratio of the in the demand for some other factor with
periodic rent, R, to the total employment a higher degree of fixity. In fact, there is,
cost, W* + R. A value of zero corre- for each quasi-fixed factor, a critical price
sponds to a completely variable factor at which the firm will reduce its demand
while the degree of fixity,f, of a complete- for that factor. Furthermore, the critical
ly fixed factor is designated by a value price, in relation to the long-run equi-
of unity. librium price, will be lower for factors
The periodic rent drives a wedge be- with higher degrees of fixity. Thus, a
tween the wage rate and the marginal given decline in P* may induce a reduc-
value product, the relative magnitude of tion in demand for factors with low de-
the wedge being measured by the degree grees of fixity without affecting the de-
of fixity. In the short run, any fixed em- mand for factors with higher degrees of
ployment costs associated with the ac- fixity.
quisition of a labor force in prior periods Consider next, the case of an increase
are sunk costs; as such they should not 4The term, A* + 'AI*, in eq. (9) denotes the
affect a firm's short-run decisions. expected marginal value product. For a competitive
firm, this is simply the expected product price, P*,
Suppose that the firm is initially in a times the expected marginal physical product, X*
position of long-run equilibrium; that is, + AX*.
542 WALTER Y. 01

in P*. Beginningat an initial position of larger share of the total employment

long-run equilibrium, there is no reason costs for these factors. Conversely, con-
to expect differential shifts in demand for sider the case where a reduction in the
factors with varying degrees of fixity. Al- quantity employed of some factor is
ternatively, in the initial position, the greater than that warranted by the sub-
firm may have adjusted to a prior decline sequent decline in actual prices. The re-
in P*. Specifically, assume that the short- adjustment in this case involves the re-
run equilibrium condition, (10), is satisfied employment of that factor, with addi-
by each quasi-fixed factor. The demand tional outlays for hiring and training.
for a factor will be increased if its total One might argue that the firm will simply
marginal product, M* + AM*, exceeds recall those workers who were previously
its total expected employment cost, W* laid off, thereby avoiding the hiring and
+ R. In this latter case, the argument training expenses. The Bureau of Labor
is completely analogous to that for a de- Statistics data on accessions for the pe-
cline in P*. Each quasi-fixed factor again riod 1953-58 reveal that only 39 per cent
has its unique critical price at which the of total accessions in the manufacturing
demand for it will be increased; these sector were recalls. Even in this case, re-
critical prices will be higher for factors adjustments are costlier for factors with
with greater degrees of fixity. Thus, a higher degrees of fixity since the firm
given increase in P* leads to greater rela- cannot be assured that workers who were
tive shifts in demand for the factors with laid off will be available for recall. If a
the lower degrees of fixity. readjustment in factor employments is
Up to now, changes in P* have been required by the subsequent course of ac-
treated as if they were known with cer- tual prices, it will be preferable to make
tainty. The introduction of uncertainty these readjustments in the employment
about future product prices reinforces the of factors with low degrees of fixity. Such
argument. Suppose that a firm makes ap- a policy will tend to minimize the costs
propriate adjustments in factor employ- of readjustments (reversals) in factor em-
ments in response to an increase in P*. ployments due to discrepancies between
If the subsequent increase in actual prod- actual and expected product prices.6
uct prices is less than the expected in- r In summary, certain fixed employment
crease, the firm will be obliged to reduce costs are associated with the employment
employment. The readjustment due to of labor. Firms may invest in hiring to
an error in forecasting product demand acquire particular workers-or in specific
necessarily shortens the expected period training to improve labor's productivity.
of employment, thereby increasing the The periodic rent, representing the amor-
magnitude of the ex post periodic rent.5 tization of these fixed employment costs,
The costs of these readjustments are drives a wedge between the marginal val-
greater for factors with higher degrees of ue product and the wage rate. The rela-
fixity since the periodic rent comprises a
6 The case where the readjustment involves no
5 A reduction in the expected period of employ- reversal in the direction of change in factor employ-
ment, T, increases the periodic rent, R, since the ments has not been discussed. This is the case where
initial fixed employment cost of H + K dollars must an increase (or decrease) in employment is less than
be amortized over a smaller number of periods. From that warranted by the actual price change. There is
equation (8), the elasticity of R with respect to T no a priori reason why this type of error should lead
is found to be negative, independent of HI+ K, and to differential costs for factors with different degrees
less than one in absolute value. of fixity.

tive magnitude of this wedge, measured able. If all factor demands have the same
by the degree of fixity, differs among oc- wage-rate elasticity, and if all wages fall
cupations or grades of labor. In a sense, by the same proportion, the ultimate de-
the periodic rent forms a buffer absorbing cline in the employment of high fixity
short-run variations in a factor's margin- labor will still be less than the decline in
al value product. Thus, short-run changes the employment of labor with lower de-
in product demands lead to differential grees of fixity. On the other hand, if the
shifts in factor demands, depending on elasticity of demand and/or the relative
the degree of fixity. Factors with lower fall in wages are greater for labor with
degrees of fixity will experience relatively lower degrees of fixity, there is a tendency
greater shifts in demand as the result of in the opposite direction. This could off-
any given short-run change in product set or perhaps even reverse the differen-
demand. tial shifts in employment predicted by
the fixed-cost hypothesis.
C. SHORT-RUN FACTOR SUPPLIES WViththe exception of the 1929-33 re-
In the preceding sections all factor cession, the available evidence suggests
supplies were assumed to be infinitely a widening of occupational wage differen-
elastic at fixed market wage rates. This tials in the downswing and a narrowing
assumption is surely reasonable for a sin- in the upswing.7 Even in the 1929-33 re-,
gle competitive firm. The supply curve cession, the data are consistent with a
of labor as a whole or of certain skill hypothesis that there was no change in
categories may, however, be less than in- the occupational wage structure. As will
finitely elastic or may shift over time. be shown in Part II, the wage rate of an
This section deals with the effect of vari- occupation is highly correlated with its
ations in short-run factor supplies on
degree of fixity. Thus, over a cycle, the
relative factor employments.
high-wage occupations with greater de-
Consider the extreme case in which all
grees of fixity exhibit smaller relative
factor supplies have zero elasticity and
markets adjust rapidly. In a downswing, changes in wage rates. Finally, I suspect
the demand for labor shifts to the left, that the high-wage, skilled jobs tend to
the percentage shift being smaller for fac- be most complementary with the fixed
tors with higher degrees of fixity. The factor, capital. Ceteris paribus, greater
downward shifts in demand lead to re- complementarity with the fixed factor
ductions in wage rates only; factor em- implies a lower elasticity of demand. The
ployments are determined exogenously evidence thus indicates smaller relative
by the assumed supply conditions. The changes in wage rates and lower elastici-
relative decline in wage rates will be ties of demand for factors with higher
smaller for factors with higher degrees of degrees of fixity. The observed short-run
fixity. This case is, however, inconsistent variations in factor supplies therefore
with the emergence of involuntary un- predict differential shifts in employment
employment and may be dismissed as contrary to those implied by the fixed-
unrealistic. cost hypothesis.
Granted the existence of involuntary
in cyclical downswings, 7 Phillip W. Bell, "Cyclical Variations and Trends
in Occupational Wage Differentials in American In-
the relevance of the concept of a market dustries Since 1914," Reziez of Economics and Sta-
sup)p)lycurve becomes highly (question- lislics, XXXIII, No. 4 (November, 1954), 329-37.
544 WALTER Y. 01

D. SPECIFICITY OF LABOR TO A FIRM mium increases the present value of ex-

The provision of specific training alters pected wage payments. Second, if the
the labor input. Labor no longer repre- wage premium induces longer employ-
sents an anonymous variable factor but ment tenure, the initial fixed employment
rather a differentiated stream of services costs can be amortized over a larger num-
from certain workers who have received ber of periods, thereby reducing the pe-
specific training. These workers are, in a riodic rent. Such a wage policy would be
sense, specific to the firm. profitable for the firm if the following
In section B, I tacitly assumed that inequality holds:
each factor received a wage equal to its T+kc

marginal productivity in alternative em- E (I1+ r)-

ployments. Since a worker's alternative 'Al < (1+ ~
marginal product is unaffected by specific W- (W T+k*(11)
E (I1+ r )-t
training, competitive wages should not t =O
affect the expected period of employ-
ment. Examination of equation (5), how- The equality in (11) indicates the maxi-
ever, shows that the net value of specific mum relative wage premium, AW1W,
training is increased by an extension of consistent with an induced increase in
the expected period of employment. Con- the period of employment of k periods.
sequently, it behooves a firm to initiate For a given increment of k periods the
practices that tend to minimize the turn- maximum relative wage premium will be
over of specifically trained workers. larger for factors with higher degrees of
Policies aimed at this goal are exempli- fixity or with lower initial expected pe-
fied by pension and profit-sharing plans, riods of employment. If the equality in
provision of better working conditions, (11) applies, the added wage costs would
promotion from within, and payment of just offset the savings to the firm from
wage premiums. Under some profit-shar- longer expected periods of employment.
ing plans, workers forfeit all benefits un- If, however, the inequality holds for some
less they remain with the firm for a speci- factor, that factor does not satisfy the
fied period of time. Firms may also adopt full equilibrium condition given by (9).
discriminatory hiring policies, hiring only The expected total marginal product will
those workers who possess characteristics exceed the expected total employment
associated with long employment tenure. cost. Hence the firm has an incentive to
A wage policy of paying premiums to invest further in specific training. The
specifically trained workers may prove firm may also choose to pay even higher
mutually profitable for both workers and wage premiums if by doing so it induces
firm. Consider the analysis of section B an even greater extension in the expected
where the incidence of all training ex- period of employment.
penses falls on the firm, with workers Suppose that a share of the training
bearing none of the costs. In this case, cost is borne by the worker. During the
a wage premium is clearly profitable for training period a worker might accept
the worker and should encourage longer a wage below his alternative marginal
periods of employment. From the firm's product; the difference represents his in-
viewpoint, the payment of a wage pre- vestment in specific training. The firm
mium affects total employment costs in could compensate the worker for his in-
two opposing ways. First, the wage pre- vestment by promising him a wage pre-

mium upon completion of the specific To sum up, the specificity of labor to
training. If the present value of his ex- a firm favors the establishment of policies
pected wage premiums exceeds his share to lengthen expected periods of employ-
of the training cost, the arrangement ment. To achieve lower labor turnover,
would be acceptable to a rational worker. a firm might adopt a policy by which
Consider the extreme case in which all workers were required to share specific
specific training costs are paid by the training expenses and were rewarded by
worker.8 The worker clearly prefers to subsequent wage premiums. Under such
remain with the firm since his marginal a policy, both workers and firm would
product and wages in the specific firm benefit from lower labor turnover. Final-
are higher than his alternative marginal ly, the gains from lower labor turnover
product. In this case, however, all labor are greater for factors with higher degrees
costs become variable to the firm, and of fixity. Thus a higher degree of fixity
the firm has no motive for retaining these leads not only to greater stability of em-
workers during a cyclical downswing. ployment in terms of numbers or man-
A sensible policy is to have both par- hours employed but also to lower labor
ties share the specific training expense. turnover rates.
If both workers and firm have made in-
vestments in specific training, both can
gain from longer expected periods of em- A. WAGE RATE AS INDEX OF DEGREE
ployment. The specifically trained work-
er could receive a wage above his alterna- A direct test of the theory would re-
tive marginal product but below his total quire estimates of the degree of fixity for
marginal product to the firm.9 At the different grades of labor. Since such data
same time, the firm could lower its total are not readily available,10 an auxiliary
employment cost by amortizing the fixed variable that is closely correlated with
employment costs over a longer period the degree of fixity must be employed as
of time. Short-run variations in factor a proxy. The use of an occupation's wage
supplies would tend to be smaller for rate as the proxy seems justifiable and
workers who had invested in specific derives support from the empirical evi-
training. Thus the payment of wage pre- dence presented in this section.
miums and the sharing of the specif- A study undertaken by the Interna-
ic training costs promote even greater tional Harvester Company (hereinafter
stability of employment for specifically referred to as "IH") in 1951 estimated
trained workers. fixed employment costs for three job
categories." The total fixed cost asso-
8 Firms and workers may differ in their evaluation
ciated with an annual labor turnover
of expected periods of employment and pertinent of 28,623 workers was $15.9 million, or
discount rates. As a result, the optimum investment
per worker in specific training may differ depending roughly 5.4 per cent of total wage pay-
on the incidence of these training costs. ments. The component cost items were
9 Where training is specific to a firm the situation placed in three categories. The IH esti-
closely resembles one of bilateral monopoly. From
10 The necessary data include (1) the initial fixed
the firm's viewpoint, the specifically trained worker
is differentiated from other workers. At the same employment cost, H + K, (2) the discount rate, r,
time, the worker finds that his value to his present (3) the expected period of employment, T, and (4)
employer is higher than his value to some competing the expected wage rate, W*.
employer. I wish to thank Professor Rees for point- 11International Harvester Company, "The Costs
ing out this analogue. of Labor Turnover" (mimeographed), 1951.
mates of the amount invested in each is used to recoup any lost productive
new worker are presented in the first time; the result is a substantial reduction
four columns of Table 1; my revised esti- in this cost item. "Intrawork transfers"
mates appear in the last column. represents additional training expenses
Hiring costs comprised less than 5 per due to transfers of old workers to new
cent of total fixed costs. They include the jobs within the plant.
costs of terminating, laying off, and re- Finally, the cost of unemployment
calling since each worker has a positive compensation represents the difference
probability of passing through each stage between the firm's actual contributions
during his prospective tenure with the and the minimum legal contributions for
firm. The IH study weighted each cost unemployment compensation.13 Higher
by its relative frequency. labor turnover will, in general, increase a

Costs | Common Two-Year Pro- Four-Year IH Revised IH

Labor gressive Student Apprentice Average Average

Hiring costs:
Recruiting................... $ 4.33 $ 86.38 . . . .. $ 5.48 $ 5.48
Hiring...................... 13.23 29.08 $ 28.89 13.23 13.19
Orientation.................. 1.56 1.56 1.56 1.56 1.56
Terminating ................. 3.77 3.77 3.77 3. 77 3. 77
Laying off ................... 1.21 1.21 1.21 1.21 1.21
Recalling .................... 1.30 1.30 1.30 1.30 1.30
Total ....................... 25.40 123.30 36.73 26.55 26.51
Training costs:
Training .................... 9.08 11,850.00 18,503.00 238.40 151.36
Tools and materials . . . ....... 164.76 41.19 41.19
Unfilled requisitions.......... 14.92 . ............. .............. 83. 12 24.66
Intrawork transfers........... 3.50 .............. .............. 94.14 64.49
Total ....................... 27.50 11,850.00 18, 667.76 456.85 281.70
Unemployment compensation.... 73.52 73.52 73.52 73.52 73.52
Total fixed employment cost..... 126.42 12,046.82 18, 778.01 556.92 381.73

Source: International Harvester Company, op. cit.

Training cost is by far the major fixed firm's actual contributions.14 The differ-
employment cost. Two items under this ence between the actual and minimum
heading require further explanation. legal contributions resembles hiring costs
"Unfilled requisitions" refers to the im- and is therefore included in fixed em-
plicit cost of lost output, resulting from ployment costs.
the lag between the separation and sub- Each component of total fixed costs
sequent replacement of a worker.12In the appears to rise either at the same rate as
IH study the hourly cost of lost productive 13 Actual unemployment compensation tax rates
time was the gross profits per man-hour differ widely among firms, across states, and over
of $1.84. I have revised the estimate by time. For a discussion of these differences the reader
is referred to R. A. Lester, "Financing Unemploy-
assuming that standby, overtime labor ment Compensation," Industrial and LaborRelations
12 Supplementary data in the JH study showed an
Review, XIV, No. 1 (October, 1960), 52-67.
average lag between separation and replacement of 14 An exception to this generalization arises if all
39.1 hours. The lag was longer for jobs with higher separated workers immediately obtain new jobs.
skill requirements. This is, however, rarely the case.

the wage rate of a job or faster. The data ment." The alternative hypothesis is that
in Table 1 suggest that the ratio of total the high-wage occupations will experi-
fixed employment costs to wage rate in- ence smaller rates of change in employ-
creases as one moves to higher wage jobs. ment.
If the IH estimates of Table 1 are coupled The contingency table was chosen as
with some assumptions about wage rates the experimental design for testing the
and expected periods of employment, it hypothesis. The contingency table tests
is possible to estimate degrees of fixity for the independence of two variables of
for two overlapping groups of workers. classification. The x2 statistic is the cri-
Thus, degrees of fixity of 0.073 and 0.041 terion for the acceptance or rejection of
were obtained for "All employees" and the null hypothesis. The occupations in
"Common laborers."1 The high-wage, a firm are first divided into two equal
highly skilled jobs appear to be asso- groups according to the wage rate of the
ciated with higher degrees of fixity. In occupation. The same occupations are
the subsequent empirical tests I shall again separated, by reference to the ob-
assume that an occupation's wage rate served rates of change in employment
serves as an index of the degree of fixity. over a fixed time interval, into equal
groups. All occupations thus fall into the
cells of a contingency table where the
cells identify groups of occupations with
During cyclical changes in aggregate
different wages and percentage changes in
employment different rates of change in
The marginal totals, which
employment are observed for different employment.
are fixed in advance, determine the num-
occupations even within the same firm.
ber of occupations in each cell to be ex-
This phenomenon is the subject of the
pected if in fact the null hypothesis is
first empirical test of the theory.
true. The major advantages of the con-
The basic proposition of Part I may
table over alternative test pro-
be stated as follows: those factors with tingency
cedures"6 include the following:
the highest degrees of fixity and the low-
est degrees of substitutability with the 1. No assumptions are required about the joint
fixed factor will experience the smallest probability distribution of the two variables
relative changes in employment due to of classification.
2. The design is fairly insensitive to extreme
any given change in product demand. values. Since the wage rate is an imperfect
For the empirical test occupational wage index, the possibility of a few extreme o1)-
differentials are assumed to reflect dif- servations must be acknowle(dge(d.
ferences in the degree of fixity. The hy-
pothesis submitted to a test is: "there Data for this test were taken from the
is no relation between wage rates and BES industry wage structure studies.
the observed rates of change in employ- 16 Two alternative test procedures are (1) a least-
" In arriving at these estimates I assumed ex- squares regression between the wage rate and the
pected periods of employment of 24 and 12 months percentage change in employment, and (2) a Stu-
for "All employees" and "Common labor." The dis- dent's "I" test for the difference in mean percentage
count rate was fixed at 1 per cent per month; varia- changes in employment for two groups of occupa-
tions of ? 0.5 per cent had very little effect on the tions classified by wage rates. The contingency table
degree of fixity. Finally, the IH study reported aver- design resembles a non-parametric correlation tech-
age hourly earnings for "All employees" of $1.952 nique known as tetrachoric r. This latter technique
in 1951. This figure was converted to a monthly is described in W. J. Dixon and F. J. Masey, Intro-
wage and applied to "All employees." For "Common duction to Statistical Analysis (New York: Mc Graw-
labor" I arbitrarily fixed an hourly wage of $1.50. Hill Book Co., 1951), p. 235.
548 WALTER Y. 01

Each study presents data on employ- low the median wage rate for all oc-
ment, hours, and earnings, classified by cupations. The occupations were then
occupation, sex, state, and industry, for reclassified by the observed percentage
a single year. Since two adjacent studies change in employment into two equal
are needed, attention was focused on the groups. Employment, in this context, re-
period 1928-31. For each of four indus- fers to the number of employees; the al-
tries a sample of states was selected. The ternative concept of man hours yielded
states included in the sample reported virtually identical results. The two-way
roughly the same number of establish- divisions fix the marginal totals which, in



Below Median Above Median Total

High wage ........ 40 18 58 16.345
(29.26) (28.74) (3.841)
Low wage ......... 17 38 55
(27.74) (27.26)
All wages ......... 57 56 113
High wage ........ 20 16 36 0.889
(18) (18) (3.841)
Low wage ......... 16 20 36
(18) (18)
All wages.......... 36 36 72
Men's clothing:
High wage ........ 13 7 20 4.102
(9.76) (10.24) (3.841)
Low wage ......... 7 14 21
(10.24) (10.76)
All wages ......... 20 21 41

* Source of the data and detailed breakdownby states are shown in my thesis, Appendix C,
C-5, C-6, and C-7.
t Numbersin parenthesesdenote the 5 per cent critical values.

ments covered in the two adjacent sur- turn, determine the expected numbers of
veys. The states were also grouped by occupations under the null hypothesis.
geographic region.'7 For each state, the The contingency tables for four indus-
occupations were classified as high wage tries are presented in Tables 2 and 3,
or low wage, depending on whether an where the numbers in parentheses denote
occupation's wage rate was above or be- the expected numbers under the null hy-
" In these studies the BLS attempted wherever pothesis."8For furniture and men's cloth-
possible to cover the same establishments as those ing, the x2statistic indicates that the null
covered in the preceding study of the same industry.
Hence, inclusion of only those states showing ap-
hypothesis can be rejected at a 5 per cent
proximate equality in the number of establishments level of significance. The x2 statistic is
covered tends to minimize errors arising from a shift-
18 The procedure was slightly altered for lumber
ing establishment composition within states. Geo-
graphic grouping was incorporated to minimize dif- mills. The larger number of occupations in this in-
ferential shifts in product demands. dustry permitted a three-way division.

significant at only a 10 per cent level for than their production worker counter-
lumber mills. Finally, the data for found- parts. Thus, according to the fixed-cost
ries are consistent with the null hy- hypothesis, non-production workers
pothesis. The discrepancies between ac- should exhibit greater employment sta-
tual and expected numbers of occupa- bility.
tions in the cells of the contingency tables Consider a simple model in which the
conform to the pattern anticipated by desired rate of employment in the tth
the fixed-cost hypothesis. Given these year, Et*, is a linear function of the rate
systematic discrepancies,'9 the additive of output, Xt. That is, the desired de-
nature of x2 permits a test for the aggre- mand for some factor is solely a function
gate of all four industries. For the four of the scale effect, ignoring all substitu-
industries combined, the null hypothesis tion effects.
can be rejected at a 1 per cent level. E*=a+bXt. (12)



Lowest 3d Middle 3d Top 3d

No. of employees (SE):

High wage................... 14 17 11 42 6.999
(13.57) (14.86) (13.57) (9.488)
Middle wage................. 19 15 12 46
(14.86) (16.28) (14.86)
Low wage................... 9 14 19 42
(13.57) (14.86) (13.57)
All wages..... 42 46 42 130

* Sourceof data and breakdownby states are shown in my thesis, Appendix C, Table C-8.
t Numbers in parentheses denote the 5 per cent critical values.

Thus, the evidence from the BLS studies Suppose the actual change in employ-
refutes the null hypothesis, and the alter- ment from the preceding period is some
native can be accepted. The wage rate proportion, k, of the desired change.
of an occupation is associated with its Et-Et1 = k(E*-E __). ( 13)
percentage change in employment. Low-
wage occupations, corresponding to low Substitution in (13) by the expression for
degrees of fixity, do experience relatively E* in (12) yields the following reduced
greater changes in employment. form, containing only observable quan-
Non-production workers in manufac- Et = ak+ bkXt + ( 1-k)Et-,. (14)
turing industries are more highly paid20
20 Data from the 1954 Census of Manufactures
and tend to be more specific to the firm
indicate that the average annual earnings of non-
19The contingency table design can only uncover production workers always exceeded those of produc-
an association between two variables of classifica- tion workers. The ratio of the earnings of non-
tion. The direction of this association is only dis- production to those of production workers ranged
cernible from an examination of discrepancies be- from a low of 1.47 in chemicals to a high of 2.11 in
tween actual and expected numbers. textile mill products.

The parameter, k, may be interpreted as the 10 per cent level. Furthermore, an ex-
a short-run coefficient of adjustment. amination of seasonally adjusted month-
Higher values of k imply faster short-run ly employment data for the postwar pe-
adjustments. Indeed, a value of unity riod reveals lags in the turning points of
means that actual and desired rates of non-production worker employment. The
employment always coincide. If non-pro- turning points in non-production worker
duction workers are truly specific to the employment for the "All Manufactur-
firm, they should exhibit a smaller k rela- ing" sector lagged from two to six months
tive to production workers. behind the turning points in production
The slope parameters of the reduced worker employment. The smaller short-
form, equation (14), were estimated by run coefficient of adjustment and the lags
least squares using annual data for the in turning points are entirely consistent
"All Manufacturing" sector. The anal- with the higher degree of fixity of non-
ysis was confined to the prewar period, production workers.
1920-39, because of a strong secular trend
in employment of non-production work-
ers during the postwar period2' that de-
stroyed the validity of the demand rela- Involuntary unemployment is never
tion. Output, Xt, was measured by the uniformly distributed among all workers.
Federal Reserve Board's Index of Indus- The fixed-cost hypothesis may help to
trial Production. The least-squares esti- explain some of these differences. Fixed
mates are given by equations (15) and employment costs constitute an invest-
(16), where N, and Pt, respectively, des- ment by the firm in its labor force. A
ignate non-production and production firm faced by a cyclical decline in product
worker employment. demand could protect this investment by
following a discriminatory layoff policy.
~t= a k + .0132 X +.561 1 N,-, To the extent that labor is a quasi-
(.0024) (.1100) (15) fixed factor, each new hire, whether an
(R2 = .7 79 3). addition or a replacement, entails an in-
vestment outlay by the firm for hiring
t = A + .0 722 Xt+.331 8Pt-, land training. Suppose that a firm is
(.0146) (.1340) (16) obliged to reduce the rate of employment
of some factor. At any point in time each
(RI= .72 19). firm observes a distribution of its workers
according to their expected periods of
The short-run coefficient of adjustment
employment. The average employment
for non-production workers is 0.44 while
tenure of the workers who remain em-
that for production workers is 0.67; the
ployed can be lengthened by laying off
difference is statistically significant at
the workers with the shortest expected
21 In the prewar period, the ratio of non-produc- periods of employment. Such a discrimi-
tion to production workers exhibited no secular natory layoff policy tends to reduce the
trend. From 1947 to 1958, virtually all the increase
in manufacturing employment is attributable to the -voluntary
quit rate facing the firm. The
growth in non-production worker employment. For policy tends to lower total fixed employ-
a discussion of these trends the reader is referred to rnent costs bly miniimizinigthe number of
lVintel States Bureau of Labor Statistics, ''"Not-
future neW hires tllht w(OUl(l 1)e re(ItUire(
p-o(lutiioll \Workers in I actories, 1919--56,,"AlfIt//l
lilb-r Reivie&, LXX.X, No. 4 (April, 1957), 435 -40. to replaicc o1(l workers who milight voluin-

tarily quit in subsequent periods. Thus, eral, be expected to have longer expected
an implication of the fixed-cost hypoth- periods of employment than either very
esis is that the incidence of unemploy- young or very old workers; this expecta-
ment should be highest for those workers tion has been corroborated by a study of
with the shortest expected periods of em- labor turnover in Swedish factories.22 At
ployment. Since a worker's prospective the same time, married males with spouse
employment tenure cannot be known present tend to be less mobile and should
with certainty and since labor contracts exhibit longer employment tenures than



Married, Other . Married, Other
Single Spouse Present Status Singl Spouse Present Status

14 and over ...... 9.4 3.1 8.7 12.1 5.7 11.2
14-17 ........... 10.6 7.8 4.4 9.5 * *
18-19 ........... 11.2 6.3 17.1 14.1 8.6 18.7
20-24 ........... 9.9 4.5 12.0 14.1 7.2 15.8
25-29 ........... 8.4 3.1 10.2 12.5 6.8 13.9
30-34 ........... 7.6 2.5 8.8 11.2 5.8 11.4
35-44 ........... 7.9 2.6 9.0 9.9 5.1 11.3
45-54 ........... 8.5 3.0 9.0 10.5 5.2 10.0
55-64 ........... 9.5 3.7 8.8 10.3 6.0 10.3
65-74 ........... 8.3 4.3 6.7 7.0 5.7 8.9
75 and over ...... 3.1 2.8 3.8 * 2.7 6.5
14 and over ...... 4.7 3.2 5.6 10.7 6.6 8.1
14-17 ........... 12.6 13.9 16.1 13.8 18.7 *
18-19 ........... 6.9 6.6 17.5 15.8 12.0 22.8
20-24 ........... 4.3 4.0 9.5 12.3 10.1 15.0
25-29 ........... 3.5 3.5 7.1 8.8 7.8 11.8
30-34 ........... 3.4 3.3 6.5 6.0 6.5 9.5
35-44 ........... 2.8 2.7 5.6 6.5 5.7 6.6
45-54 ........... 2.3 2.8 5.0 5.5 5.0 6.4
55-64 ........... 3.0 2.8 5.0 4.7 4.6 5.5
65-74 ........... 3.1 2.3 3.9 6.9 7.8 4.9
75 and over ...... 3.0 2.8 2.8 * * 3.3

* Base less than 3,000.

Source: Hauser, op. cit., pp. 256-57.

are rarely binding on employees, the firm either single males or males who are di-
can never exercise complete control over vorced, widowed, or separated.
the expected period of employment. Fur- Unemployment rates classified by race,
thermore, seniority rights or other union age, sex, and marital status are presented
practices may prevent a firm from follow- in Table 4 for the census year 1950.23 For
ing a discriminatory layoff policy. 2" Magnus Hedberg, "Labor Turnover, the Flow
Certain personal characteristics such of Personnel through the Factory" (Stockholm:
as age, sex, afn(1marital status are al- Swedish Council for Personnel Administration).
lege(1ly associate(1 with employment teni- 23 This fromiPhillip M. Hlau-
table is reprlodLuced
ure. 1\fi(Il(e--gaT(Iworkers wvou1(l,in geni- scr's article with his kinidpermission. The rea(ler is
552 WALTER Y. 01

both races, and in almost all age groups, tion, but the data indicate, in the main,
married persons with spouse present re- higher unemployment rates for younger
vealed the lowest unemployment rates. and older workers than for middle-aged
The only exception for males was in the workers.
"14-17" age group, while single women The sex differentials in unemployment
had lower unemployment rates in two rates cannot be explained by differences
cases. The observed differentials in male in expected periods of employment. The
unemployment rates thus conform to the volatility of female labor-force participa-
pattern implied by differences in expected tion rates suggests that unemployment
periods of employment. rates are not the appropriate variable.
The distribution by age of unemploy- Furthermore, the evidence that there are
ment rates is roughly the same, except differences in employment tenure by sex
for level, for each race-marital status is not at all convincing."6Finally, the oc-
group of the male labor force; similar pat- cupational differentials in unemployment
terns are evident in data for other years. rates are also consistent with the impli-
Unemployment rates fall over the range cations of the fixed cost hypothesis.
from fourteen to thirty-five years of age
even when marital status is held con-
stant. Beyond thirty-five years of age in- The analysis of subsection ID implies
creasing age is associated with higher un- that labor of higher degrees of fixity
employment rates although the trend is should enjoy lower labor turnover rates.
reversed in the oldest age group ("65 and Manufacturing industries vary widely in
over"). The problems inherent in defin- the skill composition of their labor forces.
ing the labor force for older workers make The high-wage industries typically em-
the interpretation of their unemployment ploy larger proportions of skilled workers
rates particularly difficult. Hauser specu- with higher degrees of fixity. Low labor
lates that this reversal in the age pattern turnover rates should, therefore, be ob-
might be attributable to a withdrawal of served for high-wage industries. Other
older workers from the labor force when factors that affect labor turnover rates
they become unemployed.24 A logical im- were held constant by a multivariate re-
plication of the withdrawal hypothesis is gression model that cannot be fully re-
that the labor-force participation rate of ported here.27 Based on annual data for
older workers will be negatively corre- sixty-four manufacturing industries from
lated with cyclical changes in employ- 1951 to 1958, the regression model re-
ment. The latter implication is not sup-
26The BLS turnover data by sex for two-digit
ported by data presented in a study by manufacturing industries reveal slightly higher turn-
Long.25 I cannot explain this contradic- over rates for females. Hauser finds (p. 244) that
females in a previous state of employment are less
vulnerable to unemployment than males. This same
referred to "Differential Unemployment and Charac- stability of employment of female workers was also
teristics of the Unemployed in the United States, found in the Philadelphia study; see United States
1940-1954," The Measurement and Behavior of Un- Department of Labor, Bureau of Labor Statistics,
employment (Princeton, N.J.: Princeton University The Social and Economic Characterof Unemployment
Press, 1957), pp. 243-80. in Philadelphia (Bulletin No. 520, April, 1929).
24 Ibid., p. 251.
This portion of the study derived from a paper
Clarence D. Long, The LaborForce under Chang-
25 I read at the winter, 1960, meetings of the Econo-
ing Income and Employment (Princeton, N.J.: Prince- metrics Society. I wish to thank Stanley Lebergott
ton University Press, 1958), pp. 323-25, Table B-2. and Jacob Mincer for their helpful comments.

vealed a partial correlation between an III. ALTERNATIVE HYPOTHESES

industry's average quit rate and its wage In this paper certain aspects of the
rate of -0.497, a value that is significant- cyclical behavior of labor markets have
ly different from zero at the 1 per cent been explained by the fixed-cost hypoth-
level. A turnover rate, defined as the esis. What are the alternative hypotheses
lower of the total accessions and total that offer explanations for the same phe-
separations rates, provides a measure of nomena? The theory that changes in fac-
average replacement demand. Using this tor employments are due to variations in
latter variable, the partial correlation relative wage rates was considered in sub-
drops to -0.195, which is significant at section IC. This theory was dismissed
the 10 per cent level. Thus, an industry's because it implied changes in factor em-
wage rate, which presumably reflects the ployments that were contrary to the ob-
average degree of fixity of the labor force, served changes.
is related to its labor turnover rate. The Another theory is contained in the
low-wage industries that employ workers Reder model.30 Although Reder's theory
is primarily addressed to occupational
with lower degrees of fixity do experience
wage differentials, it implies systematic
higher labor turnover rates.28
changes in factor employments. Accord-
The differential shifts in factor de-
ing to Reder, firms adjust to a downswing
mands over a cycle imply greater in- by raising hiring standards. As a result
equality of wage incomes during periods the average quality of workers in each
of low employment. In a recession the skill category is improved. The higher
demand for labor with high wages and standards displace some workers from
high degrees of fixity falls by a smaller each skill category. Some of the displaced
percentage than that for labor in the low- workers in the higher skill categories are
wage occupations. The greater decline of downgraded to lower skill jobs, creating
employment in the low-wage occupations even further displacement of workers in
implies larger relative declines in wage these lower skill categories. The succes-
incomes in these occupations than in the sive bumping effect sifts down through
high-wage occupations. The changes in the skill hierarchy of jobs and results in
the distribution of wage incomes during relatively greater unemployment in the
the recession of 1929-33, discovered by low-skill categories. In the upswing, firms
Mendershausen,29 indicated an increase adjust by relaxing hiring standards and
in the dispersion of wage incomes as un- upgrading workers to higher skill jobs. It
is never explicitly stated, but Reder seems
employment increased. The pattern held
to assume that all factor demands shift
despite the fact that hourly wage differ-
proportionally. If this interpretation of
entials failed to widen in this recession.
Reder is correct, there is nothing in his
28 There is, of
course, an identification problem. theory that implies differential shifts in
For example, high wage rates that result from union employment. The theory is, however,
bargaining may reduce turnover rates. Although this consistent with the emergence of differ-
difficulty is recognized, the results still appear to
verify the implication of the fixed-cost hypothesis. ential unemployment rates since unem-
29 Horst 30 M. W. Reder, "The Theory of Occupational
Mendershausen, Changes in Income Dis-
tribution during the Great Depression ("Studies in Wage Differentials," American Economic Review,
Income and Wealth," Vol. VII [New York: National XLV, No. 5 (December, 1955), 833-52, see esp.
Bureau of Economic Research, 1946]), 69-70. pp. 833-40.
554 WALTER Y. 01

ployed workers would be classified by low-skill jobs. The fixed-cost hypothesis

their previous occupational status. would also predict a widening of occupa-
There are two possible ways in which tional wage differentials in a downswing
differential shifts in employment could and a narrowing in the upswing if the
be deduced from Reder's theory. First, behavioral relation (17) holds. Unlike the
workers in high-skill jobs could perform Reder model, the fixed-cost hypothesis
the tasks of low-skill jobs while retaining involves differential shifts in D. The ad-
their old job titles. This would appear to vantage of the latter explanation over
be highly unlikely. A second possibility Reder's theory is that it can simultane-
is that hiring standards for high-skill jobs ously explain the cyclical behavior of oc-
are advanced less than those for low-skill cupational wage differentials and of rela-
jobs. The elusive nature of hiring stand- tive factor employments.
ards makes it difficult to test the latter
As a theory of the cyclical behavior of The central theme of this paper has
occupational wage differentials, Reder's been the treatment of labor as a quasi-
theory has an intuitive appeal.3" If the fixed factor. This concept of labor was
theory were stated formally, I believe suggested by J. M. Clark, who dealt pri-
that its basic behavioral relation could be marily with the social cost of unemploy-
put as follows: the relative rate of change ment.32 The theory of the demand for a
in the wage rate of an occupation, AW1 quasi-fixed factor generated implications
W, is proportional to the relative excess regarding the short-run behavior of labor
demand for or supply of that grade of markets. Differences in the degree of fixi-
labor. Algebraically, it may be written: ty for different occupations imply (1) dif-
ferential short-run shifts in employment,
AW k (D-S) (17) (2) differences in labor turnover rates,
(3) emergence of differential unemploy-
ment rates in the cycle, and (4) cyclical
where k is a constant and D and S denote
L variations in relative wage rates. The im-
the amounts demanded and supplied of
some grade of labor. plications of the fixed-cost hypothesis
In the Reder model the cyclical ad- are, in the main, borne out by the data
justments involving the upgrading and
The theory of labor as a quasi-fixed
downgrading of workers generate differ-
factor may also help to explain other phe-
ential shifts in S for different occupa-
nomena. It is sometimes argued that a
tions. In a downswing, the downgrading
firm will maintain its labor force even
of workers creates larger excess supplies
(in absolute values) in the lower skill though the wage rate exceeds the current
jobs. If the same k applies for all occu- marginal value product. If the labor has
a high degree of fixity, it is to the firm's
pations-and this must be assumed-the
differences in excess supply imply rela- advantage to maintain its labor force
rather than to risk high replacement de-
tively larger declines in the wage rates of
mands in future periods. Fixed employ-
31 Reynolds agrees with Reder's explanation of ment costs could also account for a range
the cyclical behavior of occupational wage differen- of indeterminacy in wages frequently
tials; see L. G. Reynolds and C. B. Taft, The Evolu-
lion of Wage Structure (New Haven, Conn.: Yale 32 Studies in the Economics of OverheadCosts (Chi-

University Press, 1956), p. 364. cago: University of Chicago Press, 1923), pp. 357-85.

mentioned in the literature.3 In the short The classical treatment of labor as a

run, the specificity of labor to a firm completely variable factor may be ade-
places an upper limit on the wage rate quate for a long-run analysis. To explain
equal to labor's total marginal product; the short-run behavior of labor markets,
the lower limit is determined by labor's I believe that labor should be viewed as
alternative marginal product. Under col- a quasi-fixed factor of production.
lective bargaining a short-run wage rate
34 The range of indeterminacy will be wider for
could be set and maintained anywhere factors (grades of labor) with higher degrees of fixity.
within this range.34 This range is, however, a short-run phenomenon.
The firm would not continue to invest in specific
33 Rcynolds and Taft, op. cit., 1). 1. training unless it could recoup the benefits.