The Discouraged Employer
NOVEMBER 01, 1994 by MURRAY WEIDENBAUM
Dr. Weidenbaum is Mallinckrodt Distinguished University Professor and Director of the Center for the Study of American Business at Washington University in St. Louis.
For years, economists have written about discouraged workers who drop out of the work force because they do not believe suitable jobs are available for them. Now government has created a new category—the discouraged employer, discouraged by the host of government impediments to hiring people. Currently, there are more than eight million people out of work in the United States. Yet overtime worked, per employee, is at an all-time peak.
Why are so many employers willing to pay the penalty of time-and-a-half for overtime rather than hire another person? Sadly, the answer is because the government discourages the employment of people by making hiring more difficult and more costly. Put yourself in the shoes of an employer: to increase your work force, you have to go through such complicated processes as those of the Equal Employment Opportunity Commission (EEOC), the affirmative action program, and the Americans With Disabilities Act. But, in contrast, employers do not get sued if they just ask people to work overtime.
Employers are also better off hiring only if they are absolutely certain that the new employee will work out. That is so because if the company makes a mistake and then has to fire someone, it will face wrongful termination suits and if those dismissed are women, minorities, or over 40—EEOC litigation is likely. For most new hires, employers have to obtain unemployment insurance, workers’ compensation, coverage under the Employees’ Retirement Income Security Act (ERISA), set up federal, state, and local tax withholdings, and provide family leave coverage.
If that is not bad enough, employers have to deal with two new uncertainties. One is the proposed Comprehensive Occupational Safety and Health Administration Reform Act (COSHRA) endorsed by the Clinton administration. The second uncertainty is the threat of an employer mandate under the various health-care reform proposals.
Many of these government requirements—affirmative action, personal leave, and the Clinton health plan—take effect when the company hires its 50th worker. The result is that many small businesses deliberately keep their work forces down to 49 employees or less.
Of course, each government regulation has its own justification. But when all the expenses of compliance are aggregated, the overall economic effect is great. In addition to the direct costs which are estimated to come to hundreds of billions of dollars a year, regulatory activities reduce production, innovation, and competitiveness. For example, much of the government’s social legislation has been written in a way that is oblivious to its negative impact on employment. If that undesirable side effect accompanied only one or two of these programs, perhaps it could be soft-pedaled. However, because the harm to employment is so pervasive and cumulative, it cannot be ignored.
Civil Rights Act
Of the numerous laws and regulations that discourage or slow down job creation, the most conspicuous example is the Civil Rights Act, including the affirmative action program. This law lengthens the amount of time that many jobs stay vacant. Any employer subject to affirmative action requirements who simply goes out and hires people does so at his or her peril. In order to reduce—but not eliminate—the likelihood of being sued, prospective employers must go through a lengthy and expensive process that includes advertising in specified types of media. The advertised position must stay open long enough to provide those interested with an adequate opportunity to respond.
Precise measures of the total costs imposed by civil rights laws and regulations are illusive. Nevertheless, Peter Brimelow and Leslie Spencer came up with an aggregate estimate of $236 billion a year or approximately 4 percent of the gross domestic product. Because the Brimelow- Spencer estimate is so dramatically large, it is useful to examine its individual elements. For example, the direct compliance expenses of private business necessary to respond to civil rights rules are estimated at a smaller but still substantial amount—$5-8 billion a year. Educational institutions spend $11 billion annually for the purpose. These direct costs are clearly very substantial. However, the truly huge costs imposed by these regulations—the remaining $220 billion plus—are indirect, such as the opportunities forgone because of the diversion of management time, energy, and resources.
Wrongful Termination Liability
If civil rights laws are an extremely conspicuous aspect of government’s impact on the employment process, judicial narrowing of employers’ right to fire is among the least publicized. Yet the repercussion of the resultant rise in wrongful-termination liability is very substantial. High costs have resulted from the tendency of state courts around the country to change traditional employment law and to take a more permissive attitude toward plaintiffs’ actions.
As recently as a decade ago, courts in all but 13 states continued to recognize the long- standing common-law doctrine that allowed private employers to fire “at will” workers not protected by collective bargaining agreements or specific statutes. In recent years, a virtual landslide of cases has brought the law closer to the requirement that an employee can be fired only for cause. Courts have also been allowing plaintiffs to collect punitive damages as well as lost wages when they can prove wrongful conduct on the part of the employer. Rand Corporation researcher James N. Dertouzos sums up his findings: “In a nutshell, the efforts of the state judiciaries to protect workers’ job security are altering employers’ hiring and firing practices. And one of the results is less hiring.”
Dertouzos and his colleague Lynn Karoly note that, due to the substantial costs associated with wrongful termination lawsuits, firms have responded by treating labor as a more expensive input to production. They estimate that, in the adjustment process, aggregate employment drops by 2 percent or more.
Family Leave Act
The Family and Medical Leave Act of 1993 is the most recent example of government- imposed costs on the employment process. It is fascinating to recall the debates on the bill as it wended its way through the Congress. Proponents kept asking, “How could anyone object to this obviously desirable measure which doesn’t cost anything?” Just as soon as the bill became law, the public was “reminded” that employers are required to maintain health insurance coverage for employees on leave.
The General Accounting Office estimates this cost alone at $674 million a year. One area of uncertainty is the ability of employers to recover the cost of the premiums they pay to employees who do not return from the leaves of absence mandated by the new law. Nor does this estimate cover the money involved in hiring and training temporary workers, who may be both more expensive and less productive than the employees on leave.
Research supports the thesis that the costs of mandated benefits such as employee leave are ultimately borne by the employees themselves. The result of the government’s “generosity”: the increased cost of the employee leave mandate was shifted to the women’s wages, or to their husbands’ if they had insurance. Similar effects have been shown from the passage of the 1978 Federal Pregnancy Discrimination Act, which extended comprehensive maternity coverage to insured women throughout the United States. The enactment of this government “freebie” results in lower employment, lower wages, and higher hours worked.
Mandated Health Care
The largest prospective government mandate on employment is health care. At this point, nobody knows what specific type of health “reform” will be enacted by the Congress, or even if such a bill will become law in the near future. The statisticians debate over how many millions of jobs the proposed Clinton health-care mandate would kill. It is intriguing to consider the notion of government officials blithely proceeding knowing that their proposals will eliminate a million or more private jobs.
Not surprisingly, low-wage industries (such as restaurants) would be hit especially hard by such mandates. The cost of the Administration’s proposal—and of most suggested variations—is likely to be the same for a highly paid worker as for an employee with a more modest wage scale.
The short-term effects of imposing a health-care mandate on employers differ from the long- run effects in important respects. In the short run, the great bulk of thecosts (80 percent in the basic Clinton plan) is paid by employers, which should reduce their demand for labor. In the longer run, those costs are largely shifted back to workers in the form of lower real wages and reduced nonmedical benefits. As a result, the effect on the supply of labor is likely also to be negative.
Minimum Wage Legislation
Without doubt, of all the governmental regulations affecting employment, the statutory minimum wage has been the focus of the greatest amount of professional attention. With a few, albeit conspicuous, exceptions, the great mass of the research has concluded that increases in the compulsory minimum wage cause a rise in unemployment. The segment of the work force most affected is those at or near the minimum wage. This is a group consisting primarily of teenagers and others with low skills who thereby lose the opportunity to gain their initial work experience.
On the basis of analyzing a great number of studies, the Minimum Wage Study Commission concluded in 1981 that a 10 percent increase in the minimum wage generates a 1-3 percent increase in the unemployment among those holding minimum wage jobs, mainly teenagers. A smaller adverse effect was noted for 20-24 year olds, mostly because a smaller percentage of that age group earns the minimum wage. Confidence in the commission’s estimates is enhanced by the fact that a recent study replicated the 1981 findings using panel data from all 50 states over a period of 15 years.
Several economists have demonstrated that the benefits of the minimum wage—to those receiving it—are offset by reductions in other benefits. A study of the 1967 rise in the statutory minimum wage showed that workers gained 32 cents an hour in money income, but lost 41 cents an hour in training benefits, for a net loss of 9 cents an hour in total compensation.
Studies of retail establishments in New York found that many stores responded to increases in the minimum wage by reducing commission payments, eliminating bonuses, and cutting paid vacations and sick leave. One researcher estimated that, for every 1 percent increase in the minimum wage, restaurants reduced shift premiums by 3.6 percent, severance pay by 7 percent, and sick pay by more than 3 percent.
Other Regulation of Employment
In many other ways, government imposes costs on the job creation process.
Disability Insurance. An analysis of Social Security disability insurance beneficiaries showed that they rarely return to work. Once initial eligibility is established, the program resembles an early retirement system. In recent years, fewer than one-half of one percent of the beneficiaries successfully complete a trial work period—and thus stop receiving their monthly Social Security check. It is not surprising that the more generous the benefits, the less willing are the recipients to seek employment.
OSHA. While the disability benefits reduce the supply of labor, the rules and activities of the Occupational Safety and Health Administration (OSHA) operate to reduce the demand for labor. That feat is accomplished by increasing the indirect costs of maintaining a company work force. Virtually every serious study of OSHA concludes that, although the costs are substantial, the benefits, if any, are modest.
At the present time, Congress is considering an ambitious extension of OSHA, the proposed Comprehensive Occupational Safety and Health Reform Act. This bill would amend the existing OSHA statute to require each employer of 11 or more (an estimated 1.6 million firms) to undertake two new initiatives. The first is to create a joint labor-management safety and health committee which is granted broad authority to influence workplace safety and health programs. The second is to establish and implement a detailed written safety and health program.
In addition, OSHA inspectors would no longer have to go to court in order to get the authority to order an immediate shutdown if they considered a business operation unsafe. Each inspector would have discretion to do so. Also, the pending bill would preclude any consideration of economic impact in setting job safety or health standards.
The Employment Policy Foundation has estimated that this package of changes in employment regulation would cost the American economy nearly $62 billion a year, including over $8 billion for litigation.
Workers’ Compensation. Another expensive burden on the employment process, and one whose cost is rising very rapidly, is workers’ compensation. In real terms, the cost of workers’ compensation more than doubled from 1977 to 1991. During the same period, lost work time due to injuries and illnesses rose far more modestly, from about 60 days per 100 workers per year to approximately 70 days per 100 workers. Even taking into account the rise in unit medical costs, the workers’ compensation program is an increasingly generous one—and extremely costly to employers.
Some legislation affecting jobs is so recent that it is premature to attempt to estimate the specific impacts on labor costs and on labor supply or demand. An example is the Americans With Disabilities Act (ADA), which took effect on July 26, 1992, in the case of employers with 25 or more workers (and on July 26, 1994, in the case of employers with 15 or more workers). The officials charged with carrying out the statute explain that it will take extended litigation to determine the full scope of the vague and often sweeping provisions of the law, which covers an estimated 43 million Americans. However, early experience indicates that the costs will be substantial. The Equal Employment Opportunity Commission is now receiving about 1,000 ADA claims each month—on top of its already heavy caseload dealing with other discrimination claims.
An important and overlooked factor in the continued high level of unemployment is the rising load of regulation, mandates, and payroll taxes that government is imposing on business and other employers. The direct cost of meeting employment mandates imposed by the federal government has been rising twice as fast as wages and salaries.
The indirect costs of employment regulations—many of which are both substantial and hidden— share a common characteristic: they make adding workers to the payroll more expensive. At least initially, they also create a substantial gap between the cost to the employer and the benefit to the employee.
In the words of University of Chicago law professor Richard A. Epstein, “Public discourse proceeds as if employment laws are unrelated to wage levels, job creation, or labor output . . .”
There is specific evidence to support the close—and inverse—relationship between onerous government regulation and the willingness to hire. For example, the Schonstedt Instrument Company of Reston, Virginia, a profitable, high-tech firm, deliberately keeps its work force below 50 employees. It does so in order to avoid having to file Form EEO-1 every year. An excerpt from a letter from the company’s president makes the point effectively: “. . . a friend went over 50 employees on a government contract. He gave me his EEO file . . . it weighs more than 8 pounds . . . I have kept my employment under 50.”
With rising regulation, rising employer mandates, and rising payroll taxes, the time has come to reverse that trend and to undo the serious damage that government is inflicting on the job front and on economic activity generally.