Modern Labor Economics

Until the first half of the last century, labor was considered homogeneous. That is, an hour of one person’s labor was, for purposes of study, the same as an hour of that of another. The focus was on the allocation of production between labor and capital, workers and machines, as opposed to the allocation among workers. Those “forensic economists” who apply “total offset” or “net discount rates” to “determine” the “present value of lost earnings,” base their “techniques” on this obsolete brand of thinking. While agreeing that wages are determined by supply and demand, they fail to consider why the demand for, let’s say, petroleum engineers, relative to their supply, would be expected to change in the same manner as, say, the relative demand for home health aides.

The graph below was taken from this year’s Economic Report of the President. It demonstrates that the average real earnings (i.e., net of inflation) of those with a college education or better have increased more rapidly than inflation, while those with less than a college education have not. This differential growth rate associated with education is but one of many reasons why the notion of “total offset” or of a “net discount rate” is absurd. It is not only absent from the economics literature, but it contradicts what is obvious. It is analogous to arguing that the earth is flat, when, quite simply, it is not.


Today, labor economists recognize that the demand is not for workers, per se, but for tasks to be performed. Each worker has skills. If there is a demand for tasks to be performed, there is, then, a demand for workers who have the skills to perform those tasks. The wage is then determined by the demand for such skills and the supply of workers who possess them. This is not difficult to understand, yet the implications are enormous. All Ph.D.s in economics have studied price theory. Price theory teaches that, if the relative price of an input falls, the demand for complementary inputs rises, and the demand for substitutes falls.

For example, the price of computing power has fallen continuously since computers were first introduced. Workers who have skills that are complemented by computers, such as those capable of abstract thinking, find that the demand for their services has increased. Given the supply, their wages rise. Workers who have skills for which computers are substitutes, such as those performing routine tasks capable of description in a computer program or tasks that computers allow to be sent “offshore,” find that the demand for their services has fallen. Given the supply, their wages fall. Many such workers then seek employment performing manual tasks for which computers are not yet substitutes. This increases the supply of workers with the skills necessary to perform such tasks, causing their wages to fall as well. Faced with falling demand, younger workers may find it worthwhile to invest in developing new skills that will enable them to perform those tasks which employers demand. Older workers may find it not worthwhile to make that investment, as their time to benefit from that investment is shorter.

Retaining a “forensic economist” armed only with a simplistic “labor/capital” model taught to college freshmen is like employing an air force armed only with rubber-band-powered toy airplanes. They are simply irrelevant.

Unlike the simplistic rules of thumb used by “forensic economists,” real economics, like any science, explains the world we live in. Specifically, economics explains the world jurors live in. Each juror makes economic decisions as they allocate limited income, time, wealth and other resources every day among unlimited possible uses. The principles of labor economics explain such decisions regarding education, work versus leisure, spending versus saving/investing and many others of relevance to the economic impact of injury or death. Jurors know that the new guy doesn’t make as much as the old hand on the job and that lawyers earn more than high school dropouts. They can understand why the unemployment rate for Ph.D.s is less than two percent, while that of high school dropouts is over ten. It makes sense to them that people typically obtain education early in life. The forensic rules of thumb contradict facts known to jurors. They can lose confidence rather quickly upon realizing the opposing expert is assuming the earth is flat.

 

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