The politics of economics

Traveling around Dhaka, Delhi, or Dakar in the early morning, you will sometimes notice groups of people, mostly men, crouching on the sidewalks near important crossings. They are job seekers, waiting to be picked up by someone who needs them for work, often in construction.

For a social scientist, what is striking, however, is how rare these physical labor markets are. Given there are nearly twenty million people in the greater Delhi area, one might imagine every street corner would have such an assemblage. In fact, one has to look around to find them.

Signs advertising jobs are also relatively rare in Delhi or Dakar. There are lots of ads on websites and employment portals, but most of those jobs are well out of the reach of the average rural goatherd. By contrast, in Boston the subway is full of announcements for job opportunities, but the ads challenge prospective employees to solve some seemingly impossible riddle to prove their intelligence. They want workers but they don't want to make it too easy for them. This reflects something very fundamental about labor markets.

Hiring is different from buying, say, watermelons in a wholesale market, for at least two reasons. One is that the relationship with a worker lasts a lot longer than the purchase of a bag of watermelons; you can switch suppliers next week if you don't like the melon you got. But even where the laws don't make it difficult to fire a worker, firing is unpleasant at best, and potentially dangerous if the disgruntled employee becomes enraged. Therefore, most firms will not hire just anyone willing to work for them. They worry whether the worker will show up for work on time, whether the work will be up to snuff, whether they will fight with their colleagues, insult an important client, or break an expensive machine. Second, the quality of a worker is harder to judge than that of watermelons (which professional watermelon sellers are apparently very good at assessing). Despite what Karl Marx had to say, labor is no ordinary commodity.

Firms therefore need to put in some effort to know whom they are hiring. In the case of more highly paid workers, this means they spend time and money on interviews, tests, references, and so forth. This is costly both for the firms and the workers, and seems to be universal. In Ethiopia, a study found that just applying for a midlevel clerical job took several days and repeated journeys. Each application cost the would be applicant a tenth of the monthly wage he would earn and had a very low probability of leading to a hire, one reason why few people applied. For this reason, in the case of lower-paid workers, firms often skip the interview and rely on the recommendation of someone they trust. Relatively few firms hire those who just walk in and ask for a job, even if they say they would accept a lower wage. This of course flies in the face of the standard supply-demand framework. But it is too costly to be put in a position where the employer might want to get rid of a worker. In a striking example, researchers trying to find firms in Ethiopia willing to randomize whom they hired, approached over three hundred firms before they found five that were willing to join the experiment. These were jobs where no specific skills were needed, but the firms still wanted to retain some control over whom they hired. Evidence from other studies in Ethiopia suggests percent of firms insist on work experience even for blue-collar jobs, and it is also common to ask for a referral from an employer.

This has several important implications. First, established workers are much more secure from competition from newcomers than a pure supply-demand model would have us believe. Their current employer knows them and trusts them; incumbency is a huge advantage.

From the point of view of a migrant this is bad news.

To make matters worse, there is a second implication. Think of what an employer can do to punish a worker who is not performing; at worst he can fire the employee. But firing will only be adequate punishment if the job pays enough for the worker to really want to keep it. As the future Nobel Prize-winner Joe Stiglitz pointed out many years ago, firms would not want to pay their workers the minimum the workers would accept, precisely to avoid being in the position captured by that old Soviet joke: “They pretend to pay us, we pretend to work."

This is an extract from Good Economics for Hard Times published by Juggernaut