Wage Differentials and Discrimination 4.

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Wage differentials
To explain the wage differentials among different industries and categories of people and job, the influence of four factors is to be taken into account. The factors areI. II. III. IV. Compensating wage differentials Difference in labor quality, Rent elements in the wage of unique individuals, Presence of non-competing group in labor market.

I. Compensating wage differentials Some of the tremendous wage differentials observed in everyday life arise because of differences in the quality of jobs. Jobs differ in their attractiveness; hence wage may have to be raised to coax people into the less attractive job. Wage differentials that serve to compensate for the relative attractiveness, or nonmonetary difference, among jobs are called compensating wage differentials. Jobs that involve hard physical, tedium, low social prestige, irregular employment, seasonal lay off, and physical risk all tend to be less attractive. The theory of compensating wage differentials provides one explanation of wage differences across individuals and across occupations. This theory suggests that wage differentials exist, in part, to compensate workers for non-pecuniary characteristics of alternative types of employment. The theory of compensating wage differentials was first expressed in detail in 1776 by Adam Smith in the Wealth of Nations, (Book I: Chapter X). Let's consider an example to illustrate this concept. Suppose that two occupations (X and Y) are initially perceived as being equivalent in all attributes (e.g., educational requirements, job stress, working conditions, and other characteristics). In this case, it would be expected that labor supply adjustments would equate wages between these two occupations (as illustrated below).

Suppose, though, that it is discovered that workers in occupation Y face a greater risk of suffering a fatal on-the-job injury than workers in occupation X (a perfectly safe occupation). This will induce some workers to migrate from occupation Y to occupation X. Migration continues until the wage difference between the two jobs is large enough to induce workers to stay in their current occupations. The diagram below illustrates this possibility.

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The wage differential w"-w' is the amount that a worker must be compensated to accept the additional risk associated with employment in the risky occupation. This compensating wage differential can be thought of as the risk premium associated with employment in occupation Y. The left-side diagram below illustrates the magnitude of this compensating wage differential.

Ceteris paribus, it would be expected that a similar compensating wage differential would exist for differences in working conditions, job stress, educational requirements, and other characteristics of jobs that make them either more or less desirable. It is expected that more pleasant jobs will offer lower wages than less pleasant jobs, holding all other job characteristics constant. Compensating wage differentials will reflect the market value of non-wage job characteristics if: 1. workers attempt to select an occupation that maximizes their utility levels, not their income, 2. workers have perfect information about all job characteristics, and 3. sufficient labor mobility exists. II. Difference in labor quality We have just discussed that some wage differentials serve to compensate for the differing degree of attractiveness of different jobs. But by looking around us we can find clearly that many high paying jobs are more pleasant, at least not less pleasant, than low-paying work. So we must look to factor beyond compensating differentials to explain most wage differentials.
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One key to wage disparities lies in the tremendous qualitative differences among peopletraceable to difference in innate mental and physical abilities, education and training, and experience. A biologist might classify all of us as members of the species Homo sapiens, but a personnel officer would insist that people differs enormously in their abilities to contribute to a firms profits. Many of the differences in labor quality are determined outside the labor force, by genetic nurture or social nurture. Another important factor is human capital, a term that denotes the stock of useful and valuable knowledge built up in the process of education and training. Doctors, lawyers, and engineers invest many years in their formal education and on-the-job training. They spend vast sums on tuition and wage forgone. Part of the high salaries of those professionals should be viewed as a return on their investment in human capital a return on the education that makes able these highly trained workers to provide very special kind of labor. III. Rent elements in the wage of unique individuals For the lucky few, fame has lifted incomes to astronomical levels, reported annual earnings for these stars, like some of the sports of film personalities, cross millions of dollars. These extremely talented people have a particular skill that is highly valued in todays economy. Outside their specialization, they might earn only one tenth as much. Moreover, their labor supply may be completely unaffected by their wage rate, indicating that their labor supply curve is completely inelastic or vertical for wages 20 or 80 or 120 percent of their high compensation levels. Economists terms the excess of these wages above their best available incomes in other occupations a pure economic rent, for they are logically the same as the rent on land which is fixed in supply. Because the labor supply of these top consultants or cricketers or musicians is completely inelastic, their efforts will respond little to tax rates of 50 or 60 or 70 percent. Even when the net reward for their services is reduced by taxes or market forces, they will continue to consult or play or sing. IV. Presence of non-competing group in labor market Even in the world of perfect competition, where people could move easily from one occupation to another, substantial wage differentials would appear. These differentials would be necessary to reflect differences in the costs of education and training or in the unattractiveness of certain occupations or as rewards for unique talents. But after accounting for all these reasons for wage differentials, we still find a large disparity in wage rate. The major reason the difference is that labor markets are segmented into non-competing groups. Instead of being a single factor of production. Labor is many different, but closely related factor of production. Doctor and mathematicians, for example, are non-competing group because it is difficult and costly for a member of one profession to enter into the other. Just as there are many different kinds of machines, each commanding a different price, so are there many different occupations and skills that compete only a general way. Once you we recognize the existence of many different sub markets of the labor market, w can see why wages may differ greatly among groups. Why is the labor market divided into so many non-competing groups? The major reason is that, for professions and skilled trades, it takes a large investment of time and money to become proficient. Human resource managers can hardly hope to become cardiovascular surgeons overnight. Nor are surgeons trained to frame a house or lay a neat roe of bricks. Hence, once people specialize in a particular occupation, they become part of particular labor sub market. They are there by subject to the supply and demand for that skill and will find that their own labor earnings rise and fall depending upon events in that occupation and industry. With this segmentation, the wages for one occupation can diverge substantially from wages in other areas.
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While the theory of non-competing groups highlights an important aspect of labor markets, we must nonetheless recognized that some competition must exist. Just as you decide weather to rent a modern computerized tractor of hire a ox to plough your field, so you must paid choose between a high-paid professional and a low-paid, less skilled worker. Similarly, if a electrician began to earn tk. 70,000 per month, one might study the trade and quit being a teacher, salesman, or customer service executive.

Wage discrimination
Earning differentials are a universal feature of a market economy. But when a difference in earnings arises simply because of an irrelevant personal characteristic such as race, gender or religion we call this discrimination. Most of the world is nonwhite. But the white minority controls most of the economic power and enjoys a disproportionately high standard of living. Within the most advances economic society, the United States, black citizens have long experienced a measurably lower level of income and wealth than other groups. Many other minority groups also earn markedly less than do white Americans. In case of ethnic or religious minority, similar evidences are available for many other countries. Half of the population is female. How is it that a woman who has the same amount of schooling as a man, the same scores, the same social background, nonetheless ends up with a salary only two-thirds of what her brother of similar abilities gets? Some earning differentials arise from differences in education, work experiences, and other factors; earnings disparities are inevitable in a market economy. But even after correction for such difference a gaps remain between the wages of some clearly identified groups( such as white male and those of other origins in USA) and also between male and female of same group. Many high-paid occupations are traditionally reserved for men and the opposite are for female in most of the developed, developing and under developed societies.

Gender wage differences The average weekly earnings of full-time female employees is significantly less than the average weekly earnings of full-time male employees. Most of this difference, however, can be explained by gender-related differences in: educational attainment, prior work experience, average weekly hours of work (on average, full-time male employees work approximately 10% more hours than full-time female employees in USA), and occupational choice.

Some studies have found that these factors account for all of the gender wage gap, while others suggest that up to 1/4 of the wage gap cannot be explained using these variables. Even if these factors account for all of the wage gap, it is still possible that discrimination may be the sources of the differences in education, employment, and occupational choice. Economists say that discrimination occurs if workers with identical productive characteristics experience receive different wages or employment opportunities due to demographic characteristics unrelated to productivity. If there is no discrimination, workers
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with the same mix of skills and abilities will receive the same pay. Discrimination occurs when factors other than worker productivity affects pay and employment decisions. As noted above, much of the gender wage gap is due to differences in occupational choice. Those occupations that are disproportionately filled by women offer lower wages, on average, than those occupations that are disproportionately filled by men. One issue that is not easy to resolve is whether this difference in occupational choice is due to differences in preferences and planned lifetime labor force activities or whether it is due to discriminatory employment practices in higher paid occupations. The index of dissimilarity provides a method of measuring the degree of gender inequality in the mix of occupations. This index provides a measure of the proportion of one gender that would have to change occupations, holding employment of the other gender constant, in order to achieve gender equality in employment. This index equals 100 if there is complete gender segregation and equals zero if there is no difference in the gender mix of occupations. While the index of dissimilarity has declined in recent decades, a substantial amount of occupation segregation remains. This occupational segregation explains a substantial component of the gender wage gap.

Racial differences in earnings The wage gap between black and white males is larger than the gender wage gap. Among the causes of this are difference in employment, labor force participation, and unemployment rates between black and white workers. Black males have lower employment rates, lower labor force participation rates, and higher unemployment rates than do white workers. Black women, on the other hand, have higher employment rates, higher labor force participation rates, and higher unemployment rates than white workers. Much of the decline in the labor force participation rate for black males in recent decades is due to an increasing number of discouraged workers. Only a relatively small portion of these differences can be explained by differences in education, work experience, or occupational choice. The evidence suggests that most of these differences are the result of either discrimination or unobserved differences in the quality of education. There is less occupational segregation between white and black workers than occurs between men and women.

Theories of market discrimination Economists argue that labor market discrimination may be the result of: employer discrimination, customer discrimination, employee discrimination, or statistical discrimination.

Employer discrimination occurs when employers are willing to pay a premium to employ workers that they favor. Women and minorities are hired only if the wage is sufficiently low to compensate for the prejudice. Under such a system, wages for the groups that are discriminated against will be lower than that of the favored groups. This means that the wages of the victims of this prejudice will be below the value of their output. In such a situation, firms that do not discriminate can increase their profit by hiring those workers who are the targets of this form of discrimination. In a competitive market, nonFor Class Room Use Only/5

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discriminating firms will have higher profits than those firms that discriminate. Thus, firms that discriminate do so at a cost to their profit. In the long run, it would be expected that this form of discrimination would be eliminated as a result of competition. Customer prejudice occurs when customers are willing to pay a higher price to buy goods and services from members of a favored group. In such a situation, segregated workplaces are likely to appear, at least for those employees that interact with customers. The significantly lower wages of black self-employed males is likely to be largely the result of customer prejudice. Customer discrimination raises product costs for those customers that discriminate and lowers the wages of the groups that are the targets of the discrimination. Employee discrimination occurs when workers avoid employment that involves interaction with those groups that are the target of their prejudice. In competitive markets, it would be profitable for firms to hire only the targets if such discrimination (due to their lower wages). However, in many occupations, there are insufficient numbers of minority or women workers available to fill such positions.. Firms rely on statistical discrimination when they have imperfect information about a potential employee's productivity. If firms cannot reliably predict the level of a worker's productivity based upon only the worker's observed characteristics, they may take into account group characteristics that are good predictors of individual productivity. When this occurs, workers with the same individual characteristics will receive different wage and employment offers as a result of the groups to which they belong. This results in observed discrimination against members of groups that have lower average levels of human capital and lower levels of lifetime labor force participation. This type of discrimination lowers a firm's costs and is profitable for firms. It is not the result of prejudice, but instead a reaction to the existence of imperfect information.

Noncompetitive models of discrimination There are two closely related noncompetitive models that are used to explain discrimination (primarily gender-based discrimination) crowding, and dual labor markets.

The crowding hypothesis is based on the assumption that too many women are "crowded" into some occupations. Male dominated occupations offer higher wages because they are less crowded. The dual labor market hypothesis refers to the distinction between the primary and secondary labor markets. Primary sector employment involves high wages and stable employment relationships. Low wages and unstable employment relationships characterize the jobs available in the secondary sector. Both of these models are based on the assumption that workers in alternative labor markets are in non-competing groups. Under this assumption, relatively high wages in one market will not cause a significant migration of workers to shift from the low-wage sector to the high-wage sector.

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