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Labor Laws Make Finding Work More Laborious

Friday, August 20, 2010

Policies designed to protect workers reduce the incentive to become better-educated.

Plato believed that children would never learn unless they wanted to themselves. In The Republic, he writes, “Knowledge which is acquired under compulsion obtains no hold on the mind.” It seems like school reformers are finally coming around to Plato’s views. Current efforts to improve educational outcomes include, among others, paying students directly for performance.

In a series of experiments conducted in Israel and several cities in the United States, students were offered money for improving their test scores or just reading books and wearing uniforms. The results of these experiments, reported in two new academic papers, were mixed. In Israel, students in “payment schools” were marginally more likely to pass all test requirements. In New York and Chicago, there was little to suggest that payments made any difference in scholastic achievements. The only promising results came from Dallas, where students were given $2 for every book they read, and were then required to pass a computerized comprehension test based on the books. Not only did the students improve their reading and vocabulary, but they also significantly improved their school grades.

Why the students responded to some incentives and not others is hard to explain. Why some students are more driven than others is best left to psychologists. However, these experiments highlight how little we know about the motivation, choices, and decisions that individuals face in moving up the academic ladder. After decades of research into how education affects everything in our lives, we are only now trying to understand what drives education itself.

These experiments highlight how little we know about the motivation, the choices, the decisions that individuals face in moving up the academic ladder.

The benefits of getting educated are clear-cut. A recent report by the Organization for Economic Cooperation and Development (OECD) highlights that the average earning premium associated with tertiary as opposed to upper secondary education varies from 26 percent in Denmark to 115 percent in Hungary. In other words, a person with a tertiary education earns 115 percent more than a person with only an upper secondary education in Hungary. Similarly, unemployment rates are observed to decline as educational qualifications increase. The Economist reports that during the current recession, educated people were less likely to lose their jobs in the United States. For workers without a high-school diploma, the unemployment rate peaked at 15.6 percent; for those with one, it was more than 4 percentage points lower. It is not surprising, therefore, that the demand for higher education has been steadily rising, with more than 50 percent of high school graduates now entering university-level education.

However, when comparing OECD countries, there seems to be a wide variance in the percentage of people who have attained tertiary education. While 39 percent of Americans age 25 to 64 have a tertiary education (much higher than the OECD average of 26 percent), countries such as France and Germany have rates of 25 percent, and Italy, 12 percent. Why does investment in education vary so widely across this panel, despite similarities in income-level? The disparities are even sharper when we compare the OECD countries to countries such as Ghana, Botswana, Mali, Bangladesh, and Mozambique, which had rates of less than 10 percent.

While it is impossible to account for all the microeconomic decision-making that takes place at the individual level, a possible answer lies in the strictness of labor market policies that could stifle these countries, a notion I explore in a new paper.


Labor market regulations often take the form of employment protection rules that govern the hiring and firing of workers. These were originally introduced to enhance workers’ welfare; for instance, by reducing unfair dismissals. The same provisions that protect employees, however, translate into cost for employers, leading an employer to think twice (at least) before hiring a new employee.

Theoretical economic models have shown that, in general, the effect of such laws is to reduce job flows (broadly, the sum of jobs created and jobs destroyed). In my paper, I show that these reduced job flows could have negative effects on investments in education because they reduce the expected returns on a job search; and they lower the value of education as a signaling device.

Under rigid labor market regulations, employers have a stronger disincentive to create new jobs, so there are fewer available jobs on the market. As a result, one’s likelihood of earning a productive wage is reduced. Moreover, firings under a system of strong labor market regulations are less frequent than they would be otherwise, so even workers with jobs expect to face fewer opportunities to search for re-employment. As a result, they will have less use of education as a signaling device to secure their next job.

With flexible labor markets and higher job mobility, these conditions are reversed. Job flows are higher, leading to more vacancies per unemployed worker. This yields a higher expected return on a job search for educated workers since the likelihood of finding a job is higher. Further, workers are either fired or they quit more frequently (i.e., job destruction is higher), leading to a greater use (or need) of education as a signaling device.

Put simply, imagine a developing country with rigid labor markets leading to few vacancies. For a low-income worker, the cost of getting educated may outweigh the prospective benefits since the likelihood of finding a job in this scenario is fairly low. On the other hand, for the same worker, if the likelihood of finding a job goes up when labor market restrictions are removed, the incentive to invest in education may be higher since the returns to investing in this costly activity are higher. Countries such as France, Germany, and Italy, which consistently have strict labor regulations, would do well to heed these results (see figure). It is also true in general that developing countries have stricter labor regulations than the OECD economies. 

Mathur 8.20.10

So Plato may have had it right all along when it came to education. It’s ironic that Greece (and the financial world) paid less attention to his other teachings:


Aparna Mathur is a resident scholar and Jacobs Associate at the American Enterprise Institute. AEI intern Chelsea Ursaner contributed to this article.

FURTHER READING: Mathur last examined the economic consequences of cap-and-trade in “Cap-and-Stick-It-to-All,” with Kenneth Green questioned “A Green Future for Just Pennies a Day?” and reviewed, with Alex Brill, “A Fax Tax That’s Hard to Swallow.” Her scholarly work details “The Effect of Labor Market Regulations on Educational Attainment” and how to deal with “Medical Debt.”

Image by Rob Green/Bergman Group.

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