Micro for Development - Firms, workers and missing markets

Question 1

labor market imperfections

Answer 1

• If labor markets are competitive, then all firms would pay the same wages for the same type of work and workers
• Empirical evidence is very different: large wage differentials across firms even after controlling for individual worker characteristics
• In so far this is the result of labor market imperfections, such as rent-sharing based on insider power, then increased competition in labor markets will be welfare improving in case there are no other distortions (1st best solution)
• However the problem may not be labor market imperfections but imperfections in other markets.
• In particular the wage differentials across firms may reflect risk-sharing if firms have limited ability to deal with risk because of imperfect credit and insurance markets
• Based on the theory of the 2nd best, more competitive labor markets (reducing wage differentials) may not be optimal because of the imperfections in other markets.

Question 2

bargaining model

Answer 2

Question 3

risk sharing

Answer 3

Question 4

rent sharing

Answer 4

Question 5

rent- vs risk-sharing

Answer 5

• volatility of employment and average wages by volatility of sales, vad, and profits
  
  • Volatility is measured as the firm-specific standard deviation of the log of annual observations for profits, vad, sales, employment and average wages
  • Firms that have seen the largest shocks in profits, vad, and sales also show the largest variation in employment and wages
  • Sales and vad are more exogenous measures of shocks than profits
  • This result is a necessary condition for risk-sharing
  • The paper focuses on volatility in wages but note that there is also significant volatility in employment
  • However the standard deviation does not distinguish between temporary and permanent shocks and does not correct for firm and worker characteristics
• issue: reverse causality
  
  • Risk- and rent-sharing: firm performance wages
  • Alternative hypothesis: wages firm performance
  • Two possible remedies:
    
    • Impact of shocks takes time: recursive system with lagged shocks
    • Instruments
  • First option is preferred:
    
    • There is evidence that impact of shocks is recursive
    • Lag structure allows a test of risk versus rent-sharing. Risk-sharing: impact shock decreases over time. Rent-sharing: impact shock persists
    • Difficult to find obvious instruments (for instance firm-specific input or output prices are difficult to measure)
• importance of risk-sharing in determining wage-differentials
  
  • One third of the combined impact of risk and rent-sharing is due to risk-sharing
  • This suggests that labor markets in Africa are not that inefficient because of rent-sharing but relatively efficient in providing informal credit to firms
  • Impact of risk-sharing is comparable to education

Question 6

construction of permanent and temporary shocks

Answer 6

• Interpretation:
  
  • changes in capital stock and changes at the sectoral level are treated as permanent giving rise to rent-sharing.
  • changes in employment or deviations from the regression line are treated as temporary giving rise to risk-sharing
• Constructed temporary shocks have indeed low persistence: first-order correlation is 0.19
• Permanent shock is scaled by the number of employees (see model).

Question 7

risk sharing and labor market imperfections

Answer 7

• Risk-sharing implies a labor market imperfection as workers do not leave the firm after a negative shock
• Production workers tend to be more mobile than non-production workers (corroborated by data on tenure)
• Risk-sharing is indeed only observed for non-production workers (table 4, regression 1 and 2)

Question 8

risk sharing and credit market imperfections

Answer 8

• Risk-sharing is a form of informal credit and unnecessary if credit markets function perfectly
• Hence, firms which are more credit constrained should use more risk-sharing arrangements
• Firms will be more credit constrained if they are facing more volatile demand shocks
• Risk-sharing is observed in firms with high demand-volatility but not in firms with low demand-volatility

Question 9

risk sharing and wage compensation

Answer 9

• Alternative explanation of correlation between wages and short-run shocks: wages are set competitively but in short-run firms face an upward sloping labor supply curve.
• However, risk-sharing implies that workers will be compensated for the volatility in their wages if they enter the labor contract voluntarily and well-informed.
• Hence, wages should be higher in firms with higher wage volatility
• Firms with greater intrafirm volatility pay higher wages to workers (Table 5). Moving from bottom 10% to top 90% of intrafirm volatility distribution increases the wage by 7%.

Question 10

policy implications risk- vs rent-sharing

Answer 10

• Better insurance markets would reduce wage volatility
• Workers would not be necessarily better off because they get compensation for wage volatility
• Employer is better off because opportunities for risk-sharing with workers are limited

Question 11

effect of education on earnings

Answer 11

Question 12

Oaxaca-Blinder decomposition

Answer 12