Workplace Rules: Some Theory

When I woke up this morning, I discovered that the Econ blogosphere had erupted into a debate over workplace rules. I won’t ruin your social life by linking to all of these blog posts and asking you to read them. Nor do I have something utterly novel to contribute to this debate. But I do want to use this eruption as an opportunity to do the two things I like to do on this blog: (1.) articulate some basic economic concepts and (2.) try to persuade my progressive peers that, often, progressive-sounding policies are not as good as they sound and evil-sounding laissez-faire policies are not as evil as they sound.

So: What are workplace rules? Well, they’re just that–the rules you are contractually obligated to abide by in your workplace. But when we talk about ‘workplace rules,’ we are, of course, actually talking about the workplace rules worth talking about, meaning the controversial ones. What workplace rules are controversial? In short: the ones that seem humiliating, overbearing, or otherwise sucky. We’re all okay with employers saying, “You cannot drink on the job.” What’s controversial is when they say, “You cannot pee more than thrice today,” or “You must submit to be searched before you leave, so we can be sure you are not stealing merchandise.”

When compassionate people hear about rules like these, they naturally get upset and want to do something. Often, they want their legislatures to pass laws restricting employers’ ability to impose these rules. Are these laws a good idea? What compassionate person could oppose them?

Let’s step back and do a little theory, here. First, why do employers impose sucky workplace rules? Well, in theory, some of them might just be horrible people who get a kick out of humiliating their subordinates. But really, few people are naturally that awful. More, even if they were, competitive markets punish employers for being awful just for the sake of being awful. Think about it: if you impose unnecessarily onerous and humiliating work rules that don’t bring any extra benefits on your employees, then your workers will be demoralized, they’ll be more inclined to take their skills elsewhere, and — once word gets around — you’ll have a hard time hiring new employees. Being a needlessly shitty, evil employer is costly, so if you’re a rational, ruthless profit-seeker, you’ll do otherwise.

So, again, why do employers impose sucky workplace rules? Well, a rational employer will only enforce workplace rules that boost the company’s profit. I.e., only when there is some real, tangible benefit from the rules, like making workers more productive, preventing thefts, etc.

Now, let’s imagine what economists call a ‘perfectly competitive market.’ The ‘perfectly competitive market’ is an imaginary thing that doesn’t exist in reality. But it’s a very useful imaginary thing, so let’s work with it for now. If markets are perfectly competitive, then you, a worker, must earn the value of what you produce. Think about it this way: if you produce, every hour, goods or services worth $20, but you only get paid $18 an hour, then some other employer, eager to make an extra dollar of profit per hour, will offer to pay you $19 an hour for that work…and so forth. So, in this imaginary perfectly competitive market, your compensation should be equal to what economists call your “marginal productivity” — your actual value-add.

Now suppose that you had been worth $20 an hour, but suddenly there have been a bunch of thefts at your firm. Every week, 10% of the value of what you produce has been stolen away by somebody — presumably some other employees. Now, the value to your firm of what you produce is only $18 an hour. Now, because your firm is in a perfectly competitive market, it can’t survive if it continues to pay you $20 an hour, when its weekly revenues have just been cut down by 10%. Your firm has two options: It can cut your pay to $18 an hour. Or, it can impose a new workplace rule that all employees must be searched before leaving work, to ensure that no merchandise is stolen. Furthermore, actually, all the other firms in your industry are facing the same problem. And they’ve roughly divided in half–half of them are still paying $20 an hour, but searching employees; the other half are not searching employees but are paying only $18 an hour. (To generalize this insight: in a perfectly competitive market, the costs and benefits of workplace regulations get passed on to employees.)

What do you do? Well, in a free and competitive market, it’s up to you what you do. If you’re the kind of person for whom an extra $16 a day is worth the humiliation of being searched, then you’ll go with the higher-paying firm. If it’s not worth it to you, then you’ll go with the firm without the search. If every employee in the world prefers the extra pay, then every firm will naturally offer the extra pay (with more workplace rules) in order to attract those workers. If every employee in the world thinks it’s not worth the extra pay, then employers will maximize their profits by letting the thefts slide and lowering workers’ pay. AND (and here’s the really interesting and important part) if different employees have diverse preferences, then different employers will work to meet those diverse preferences. Some firms will occupy the niche of hiring employees who put relatively more value on autonomy rather than pay, and other firms will occupy the niche that is vice versa, and workers as a whole will be better off for it. In other words, in a perfectly competitive market, the only sucky workplace rules that will be imposed upon employees are those rules that are worth the economic benefits they bring to the employees themselves.

And, in this world, laws limiting employers’ ability to impose workplace rules will, consequently, all be either harmful or redundant. If the government imposes rules saying that firms can’t search their employees, then all firms in our example above will end up paying $18 an hour and not searching. This doesn’t change the situation for those employees who chose those firms, but it does hurt the other employees, who themselves chose to opt into firms that paid an extra $2 an hour and searched employees. In other words, the employees at those firms had already voted with their feet, revealing that the workplace rule was worth the extra pay to them–and what right does the government have to contravene their preferences here?

So this is one of those things where the counterintuitive logic of economics suggests that the compassionate and humanitarian thing to do may not be what it initially seems.

***

But everything I wrote above is in the world of highly abstract theory. And I’m not actually opposing all limitations on workplace rules on the basis of this theory. In the real world, markets are not perfectly competitive. People are myopic, signing into long-term contracts without thinking about what they’ll actually feel in the future, or without being fully aware of other alternatives elsewhere. Many labor markets are dominated by a relatively small number of very large firms, and many sectors of the labor market have high unemployment — this means that in these markets, employers have way more bargaining power than their employees. People are social animals, who are attached to people and social groups in particular geographical areas, etc., which adds “frictions” that mean that labor markets are not perfectly competitive. And to the extent that labor markets are not perfectly competitive, there are gaps between our theory and the reality — and in those gaps there can be space for the government to improve human welfare by sometimes limiting employers’ power/freedom.

But theory is useful because it allows us to get a little closer to tracing cause and effect in the world. And the theory tell us that, in a theoretically perfect market, government-imposed restrictions on workplace rules would be either unnecessary or harmful, because employers would only impose rules that were ‘worth it’ to their employees. And so this theory does provide some useful takeaway ideas. (1) Insofar as the world does conform to the theory, many legal restrictions on workplace rules can be harmful and unnecessary, because market competition should pressure firms to only impose those rules that are ‘worth it’ to their employees, while government regulations can permanently and universally forbid rules that are ‘worth it’ to at least some employees. And (2) insofar as the world does not conform to the theory, one major cause of the problems employees face is imperfectly competitive labor markets, and so one way to dampen the problem of unnecessarily onerous and burdensome workplace rules is to make our labor markets more competitive, dynamic, and liquid.

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3 thoughts on “Workplace Rules: Some Theory

  1. Hi Matt, happened upon your blog recently and put it on my google reader. Glad I did; always fun to read your stuff. A few points come to mind.

    First: You’re convinced of the usefulness of this kind of ideal theory as long as we heed your two points at the end, but mightn’t this be dangerous in situations so fundamentally nonideal? Such rhetoric can mislead us even if we are trying to be careful. For example, what does more “liquidity” in labor markets mean if not uprooting communities? Perhaps as a corollary: given the known unknowns as well as the unknown unknowns in the ways that perfectly competitive markets differ from real ones, shouldn’t we place more trust in the evidence we have from practical experience with labor laws, than we do in the theory behind them?

    Second: I wonder why you don’t give the same disclaimer you give about perfect markets when discussing the rational man(ager)? Perhaps it is implied, but this character is even less realistic than perfectly competitive markets, since markets do sometimes have the capacity to balance out such idiosyncratic personalities. Do you really not believe that office managers go on power trips? It is certainly believable that any real productivity losses caused by a power-tripping manager could be outweighed by other idiosyncratic factors in any given firm for any given period of time: the long run is meaningless here. “The Office” is exaggerated but recognizable to vast swaths of the American workforce.

    Cheers,
    Sam

  2. Hey Sam,

    Good to hear from you again, and thanks for your very intelligent, critical reply. I particularly appreciate how you say that what economics describe in its language as “liquidity” is what normal people would often describe as “uprooting communities.” That’s a powerful reminder — it incandesces on the screen for me.

    But your really tough question is, in short, “How useful is this ideal theory, given reality?” And I think the theory still is useful for precisely a reason that your next question brings up. You ask, “shouldn’t we place more trust in the evidence we have from practical experience with labor laws…?” I would think we should, if we could. But the problem is that this evidence is necessarily incomplete, because when we impose restrictions on workplace rules, we can “see” the benefits that these restrictions bring, but we can’t “see” or measure the potential lost welfare of workers who might have been more productive and more well-compensated in a world in which these rules hadn’t been imposed. And the reason for that is, once we pass the laws, that other world doesn’t exist anymore. Any empirical test we could design would be overwhelmed by counterfactuals. Suppose one state adopts a new restriction on workplace rules, and empirical investigations find that there was no measurable decline in wages or employment — we still have the counterfactual question, “Might this state have seen an *increase* in its wages — driven by other economic trends — without this?”

    So the theory can tell us something relatively modest: “There are unseen welfare losses that come from these restrictions, and competitive markets should, all in all, pressure employers to only adopt the rational ones — so, when in doubt, lay off of the restrictions and try to make labor markets more competitive through growth and employment-boosting policies.”

    Your questions are well-taken, and so I’ll hasten to say that I mean to make a very modest point. I genuinely mean that this theory is useful for the marginal case, where the question is, “What side do we err on?” I’m sure I would support many specific legal restrictions on workplace rules. My sense is that you’re right that many managers are, in fact, irrational, and will be over-controlling for no good, rational reason — there’s a great social psychological literature on how having power over others can really screw us up ethically. So there’s room for the government to improve our labor markets by banning the most obvious, no-brainer, unambiguosly cruel and unnecessary managerial practices. (To use a classic example as an analogy: discriminating against certain classes of people is economically irrational and should be punished by competitive markets. But if the practice is widespread enough, that’s clear proof that markets aren’t doing the job — and so the government can do an economic and moral good by passing civil-rights acts to ban such discrimination and force a cultural change.)

    But I think the theory provides a strong, helpful case for counterintuition in the marginal case — if we’re not sure whether a limit of 10 bathroom breaks per day is managerial cruelty or actually necessary, it may be best to lay off imposing a universal rule through legislation, and hope that a disaggregated market process will figure it out.

    All best,
    M.

  3. Hey Matt,

    Point well taken on the usefulness of theory. I just read your longer piece about whether or not you are a repulsive person (which I also found very interesting and has pushed me to think and respond, perhaps later — the short answer is ‘no’ 🙂 ), and in general I too find it quite irresponsible to recommend public policy without thinking through economic theory. The unintended consequences of our actions keep me up at night (or maybe it’s the siesta).

    However, I do think that putting too much emphasis on theory can be just as dangerous as not doing it at all, because of the false sense of certainty it breeds. Also, I am somewhat more hopeful about the prospects for evaluating the practical effects of policies via comparative studies. We will never have controlled laboratory-like conditions in which to perform social experiments (if only!), but legions of statisticians do their best at teasing out what the “true” effects of a policy are by comparing similar cases and so on. If such results are unreliable (as they certainly are), the only response is that the same can be said of theory. In any case, they should be used in concert: theory can usefully help us interpret what we see and make new predictions. And conversely, if we find no convincing evidence in practice for our theoretical predictions (as has been the case for many, many economic theories), then perhaps there is something wrong with the theory.

    In short, I think that a “default” response in favor of economic theory might be giving it more credit than it’s due, and that a “default” response in favor of stopping definite harm is at least as defensible.

    Anyway, hope to continue this discussion in the future!

    Cheers,
    Sam

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