The Economic Effects of Employment Law in Californiagreenspun.com : LUSENET : Unk's Wild Wild West : One Thread |
For educational use onlyThe Economic Effects of Employment Law in California: The Unintended Consequences of Good Intentions
September 1995
Introduction By Steven Hayward*
Shortly before Californians prepared to observe the Labor Day weekend holiday, the U.S. Department of Commerce delivered the bad news that once again California workers had experienced nearly the slowest personal income growth in the nation. Personal income in California grew at a paltry 2.1 percent in 1994, the third-slowest rate of growth among all 50 states.1 At this rate, Californians are not even keeping up with the low 2.4 percent inflation rate. Moreover, this marks the fourth year in a row that personal income growth in California has badly trailed the national average, especially our neighboring states of Nevada, Arizona, and Oregon, each of which have been among the states enjoying the fastest personal income growth.
Much ink has been used in recent years analyzing and describing California's woeful economic condition, but one major factor that has tended to be overlooked is employment law. Employment law, as will be explained below, is intended to protect workers from arbitrary and capricious behavior by employers, and although it no doubt serves this laudable goal in many cases, employment law today has the unintended effect of significantly diminishing job opportunities and income growth for workers in California. In 1992 the RAND Corporation's Institute for Civil Justice concluded that employment law in California diminished employment by as much as 4 to 5 percent.2 The study published here, by labor market economists Richard Vedder and Lowell Gallaway of Ohio University, examines the same issue through a labor market economic model they have developed over the last decade. This study, which is an excerpt from a forthcoming national study of this issue, not only confirms the RAND findings, but also argues that the burden of lost job opportunity and diminished potential income is not borne equally: the evidence suggests that low income groups suffer disproportionately from this employment climate.
The authors estimate that wrongful termination litigation has resulted in more than 170,000 jobs lost in California since 1970, and an income loss since 1970 of more than $6 billion. But this is not the most worrisome finding of their analysis. Most of this loss in job opportunities and income is experienced by lower income individuals-the very people who are supposed to be best served by the employment law protections. This study finds that employment related lawsuits may increase overall income inequality by as much as 10%, as measured by the U.S. Census Bureau's "Gini Index." To quote the authors: "The introduction of the wrongful termination concept has had the effect of substantially increasing the degree of inequality in the distribution of income in the United States."
How Employment Law Has Changed
This is a technical, econometric study. It is frequently difficult for the layperson to follow. A brief introduction to the recent evolution of employment law in California, however, provides a common sense vista on the issue, and puts the statistical analysis of Profs. Vedder and Gallaway in deeper perspective.
The legal relation between employer and employee has always been governed chiefly by the "employment-at-will" doctrine. Even today, the California Labor Code reads: "An employment, having no specified term, may be terminated at the will of either party on notice to the other." But-and this is a very big "but"-numerous rulings by activist judges and several legislative statutes have placed so many qualifications on the employment-at-will doctrine that it has lost nearly all of its force and clarity.
Beginning with a series of cases in the early 1980s, the California Supreme Court, led by Chief Justice Rose Bird, ruled that an employer's conduct could give rise to an "implied contract," or an "implied covenant" for guaranteed future employment.3 In other words, it has become commonplace that employees can expect that acceptable job performance transforms the job into a property right.
The result of these cases was to unleash an avalanche of wrongful termination lawsuits. In the wake of these changes in the law, labor law expert Maureen McClain explained,
"fired employees sued companies to challenge the reason they were fired or the manner in which they were fired. Employees laid off for economic reasons sued, claiming the layoff was a pretext masking the real, improper reasons for discharging. . . Other workers sued companies, alleging all kinds of injuries including breach of contract, fraudulent hiring practices, misrepresentation, conspiracy, assault and battery, defamation, infliction of emotional distress, negligent supervision, unfair denial of promotions or pay raises, discriminatory treatment, and something called 'constructive discharge.' Virtually every employment decision employers made became a potential lawsuit."4 (Emphasis added.)
California has not been alone in experiencing this phenomenon. According to an American Bar Association study, between 1984 and 1985 the number of state and federal court decisions involving employment-at-will issues increased by 37.1 percent.6 More important than the sheer number of wrongful termination suits is the fact that plaintiffs win the majority of such suits, and that the average damage award is large. A 1991 survey by the Bureau of National Affairs found that terminated employees win 65 percent of wrongful termination suits that reach a jury.6 This same study reported that the average award for a winning plaintiff was $927,109. Much larger awards are frequently reported in the press. In 1984, for example, the president of a retail chain, who was terminated after only six months on the job, received $6.2 million. But even this figure pales, Maureen McClain wrote, "compared to a jury verdict in 1985 of $61.5 million to an executive who alleged he had been wrongly discharged and defamed by his employer, even though his employment contract gave the employer the right to terminate him if he lost one third of his sales force, and he was discharged after four of his seven salespeople had left."8 Juries have been so sympathetic to terminated employees that one study found that from 1980 to 1988, jury awards actually exceeded settlement demands by employee's lawyers by 187 percent.8
Again, common sense sheds light on why such verdicts have become routine. Because the law now requires that employers have a "reasonable" justification or "good cause" for an at-will termination of an employee, lawsuits on the issue require a detailed (and usually costly) investigation into the basis of the employer's decision. Neither "reasonable" nor "good cause" are terms of clarity or precision in law, and open the door wide for subjective judgments by juries who usually have little understanding of the requirements and difficulties of managing a business. Not surprisingly, jurors, who are more often drawn from the ranks of employees than employers, have a tendency to sympathize with other employees. As McClain explains the way such cases work: "One of the greatest difficulties with these cases was that disgruntled former employees were able to tell their story to a jury of 12 individuals who judged the employers business decision-even though explained and defended at trial-in hindsight and by standards not necessarily reasonably related to the realities of the business world at the time the termination occurred."9
This new legal environment has resulted in employers having to make the workplace more bureaucratic, formal, and less convivial in order to avoid liability.10 This is the ultimate irony, and the ultimate affront to common sense: the law that is supposed to improve the quality of the workplace instead has the effect of adding extra tension and difficulty to employment relations. Employers of all sizes are now not only counseled to adopt severe bureaucratic hiring and employee review procedures, but they are also counseled not to offer praise to employees for a job-well-done, as such praise might be taken later by a jury as evidence of an "implied contract" of permanent employment. Employment law experts recommend that job review and evaluation forms "avoid an excessive number of positive job performance categories" for the same reason. In other words, the law has created a set of absurd and unproductive incentives for employers to emphasize negative reinforcement over positive reinforcements in communicating with employees regarding job performance.
Surveying this sorry scene, common sense will suggest that risk-averse managers will be less likely to offer employment to marginal applicants, who in California tend to be less educated, low income, and minority. Profs. Vedder and Gallaway's finding that employment law actually widens income inequality does not seem so remarkable when the broader background is understood.
Even California judges have begin speaking out about the distorted and unbalanced state of the law. In a 1993 case, a California Appeals Court that felt bound to uphold a multimillion dollar wrongful termination award nonetheless expressed its misgivings about applying the law:
"Although, under the present state of the law, we can find no error with the jury's verdict in this case or the trial court's affirmance of the amounts in issue, it is quite clear to this court that there is a desperate need for legislative action in this regard. This area of the law is quickly running out of control and the citizens of California will be the ultimate victims and losers. Court-made law, imposed without public hearings or a public debate of the issues, cannot be dictated in this regard by this court. But, it is clear that commerce in California cannot flourish with such multimillion dollar verdicts readily available. Legislative caps or limits have been imposed in certain areas of medical malpractice and workers compensation. If the Legislature fails to act in this area, we can see that, in due course, business enterprises will flee the state."10 (Emphasis added.)
LAWS, LITIGATION AND LABOR MARKETS: SOME NEW EVIDENCE
By Richard Vedder and Lowell Gallaway* Ohio University*
I. INTRODUCTION
In this study, we argue that changes in the legal environment have adversely affected working Americans. We estimate that the increase in employment costs associated with the erosion of the concept of "employment at will" has cost well over one million jobs nationwide- 171,000 in California alone-between 1970 and 1990.
We estimate that workers lost nearly $300 billion in income between 1970 and 1990 from state governments restricting the freedom of contract in the private sector. The estimated loss of income for California alone approaches $6 billion. The erosion of the concept of "employment at will" that led profit-maximizing employers to hire workers according to the marginal contribution they made to the firm's revenue has interfered with the orderly operation of labor markets and imposed a significant cost on American society that literally is in the hundreds of billions of dollars annually.
When adverse employment shocks appear in labor markets, the individuals most impacted tend to be those who are relatively less educated and skilled, with lower incomes. They disproportionately are members of ethnic or racial minorities. Thus the adverse economic effects of litigation-related developments in the past generation are disproportionately distributed across classes of peoples as well as space, unfortunately hurting those with limited ability to absorb losses in income and jobs.
The legal environment in which Americans work and earn income has undergone a dramatic transformation in recent decades. The unfettered right of businesses to utilize labor resources has been challenged. Labor used to be considered a variable cost of production, but today, to quote labor economist Walter Oi, it is a "quasi-fixed" factor whose use by entrepreneurs is increasingly proscribed by laws and regulations. This increases the possibility that employees will be kept on the payroll (against the employer's will) whose marginal contribution to the firm's revenue (marginal revenue product) is less than the incremental cost to the firm of the worker (marginal labor cost). When this occurs, employers lose money. To avoid this loss, we would argue that generally risk-adverse employers are increasingly reluctant to take on new employees. Retreat from employment-at-will potentially costs workers jobs and income.
An important caveat is in order. The ability of researchers to quantify and measure the economic effects of change have been limited. Regulatory changes are inherently hard to measure. Court actions have been taken that impose costs on businesses that are sometimes secret as a consequence of agreements made between litigants as part of a court or out-of-court settlement. As a consequence of these considerations, it is difficult to measure precisely the impact that the changing legal environment has had on the American people.
In this study, we wish to look at some aspects of this issue, drawing on a few strands of quantitative evidence that can be used to measure some effects that changing laws and the litigation explosion have had on the economic well being of the American population. The resulting evidence is neither a comprehensive measure of the extent of the problem nor is necessarily pristinely accurate. It does suggest, however, that the impact of legal changes in modern times has been profound, adversely affecting job opportunities and incomes for millions of Americans, a disproportionately large proportion of whom are less affluent workers, many of them minorities.
We make certain assumptions about human behavior:
People are "utility maximizers" trying to increase their satisfaction in life; People prefer more income to less, and want to have job opportunities; People in general are "risk averse," preferring to have steady, certain streams of income to highly volatile income streams, even if the cost of steadiness is some modest loss in average income over time; Other things equal, the amount of labor that a firm will hire will fall if the cost of that labor rises, because of the first two principles stated above. The outline of our investigation is simple. Initially, we will analyze the impact of the deterioration in the concept of "employment at will" on the workings of the labor market, including considerations of the number of jobs lost, declines in the volume of wage payments, and the effect of this alteration in legal doctrine on the distribution of income in the United States. Then, we will turn to a discussion of the effect of changes in the circumstances under which worker compensation is provided to members of the American labor force.
II. THE ECONOMICS OF THE WRONGFUL-TERMINATION DOCTRINE
The growth in legal constraints on employer decision-making in the realm of dispensing with the services of employees has been remarkable. As of a quarter century ago, the legal position of almost all employers was clear in this respect. They could dismiss an employee at will. At that time, only one state, California, accepted a legal doctrine that constrained employer prerogatives in making dismissal decisions, and it was a narrow restriction at that. However, by 1980, an additional thirteen states had moved in this direction and, by the end of the 1980s, it is easier to count the states without such constraints, there being only five. The peak period of growth in the adoption of these doctrines was 1977-1985. During that time, 36 states ventured into these legal waters for the first time. In addition, during the 1980s, 32 states modified their view of the dismissal decision in the direction of accepting a more expansive interpretation of the constraints on the employment-at-will principle.12 What has emerged is a rather extensive body of law focused on the notion of wrongful termination of the employment relationship.
There are predictable economic effects associated with the increasing acceptance of the wrongful-termination doctrine. In effect, it creates for workers some degree of property right in their existing jobs. These additional rights tend to increase the costs to employers of hiring labor. For example, the potential threat of legal action resulting in liability awards to aggrieved employees now becomes a part of the cost calculus that employers must make when considering the hiring of new workers. Also, the threat of such actions by employees makes it more difficult for employers to adjust their usage of labor in an efficient manner to fit changing market conditions. To a certain extent, the labor input into the productive process no longer can be treated as a variable input. Rather, it has acquired some of the characteristics of a fixed input.
The presence of additional labor costs associated with the employment relationship requires a response by employers. There are two options open to them. One is through changes in the level of workers' compensation. Added labor costs perceived by those who hire labor may be passed on to employees by downward adjustments in labor compensation. The other possibility is to reduce the number of workers hired. The mix of these two options will depend on the nature of the elasticities of demand for and supply of labor. This is spelled out in the Technical Appendix. Using what we view as a reasonable set of these elasticities, also described in the Technical Appendix, it appears that about 85 percent of any additional labor cost arising out of the emergence of the wrongful-termination doctrine will be passed on to employees in the form of reduced wages and benefits for workers. The remainder represents what can be thought of as "net uncompensated costs" to the employer and will negatively affect the willingness of employers to hire workers.
Our approach to analyzing the economic impact of the wrongful-termination doctrine will be to attempt to identify the effect of these laws on the compensation of labor. If this is known, it is possible to infer the total cost of the wrongful-termination doctrine, as well as the portion that will have an impact on the number of workers hired by employers. Based on a regression analysis of data covering the period 1970-1989 which explains the real compensation of labor in terms of a time trend in compensation and a measure of the growth in the prevalence of some form of the wrongful-termination doctrine, we estimate that, by 1989, growth in the application of the wrongful-termination notion had depressed the compensation of workers in the United States below the estimated time trend by 7.47 percent. The details of the analysis are provided in the Technical Appendix.
Assuming that this represents the 85 percent portion of the additional costs of this new legal environment that are passed on the workers, the total costs perceived by employers is estimated to be 8.79 percent of the normal compensation of labor. The difference between 8.79 and 7.47, 1.32 percentage points, represents an increase in the real net cost of labor for employers. How much of an impact this has on employment depends on the long-run elasticity of demand for labor. Again, see the Technical Appendix for an explanation of our choice of a value for this measure, which is - 0.83. Applying this elasticity to the estimated net increase in the real cost of labor and adjusting for the fact that only 90 percent of the states have some version of wrongful-termination in place, we calculate that the reduction in employment associated with this increase in labor cost is equal to 1.235 percent of existing employment. This is the cost of the wrongful-termination doctrine in terms of lost jobs.
Using 1993 employment data for the individual states, we have calculated the loss of jobs for the 20 year period between 1970 and 1990 as the result of wrongful-termination for those states where it is present. The total loss of jobs for the entire United States is approximately 1,325,000. Among the states, the major losers is California, with 171,000 fewer jobs.
Job losses are only one dimension of the picture. The lower levels of employment created by the advent of the wrongful-termination notion also involve lower levels of worker income, as measured by their total compensation. The total amount of such lost income nationwide is $42.0 billion. Once more, the major loser among states is California, where the lost income is about $6 billion dollars.
Wrongful Termination and the Growth of Wages
This is only a small part of the story of the economic impact of the wrongful-termination doctrine. In addition, there is the matter of the reduction in worker compensation. We estimate that this amounts to $251.2 billion for the United States in 1993, almost exactly six times the losses associated with employment reduction. This provides some insight into one of the most intriguing problems of recent years, the marked slowing of the rate of growth in real wage rates in American society. Between 1970 and 1989, real compensation per hour in the United States increased by about 22 percent.13 By contrast, in the twenty years prior to 1970, real compensation per hour increased by slightly more than 80 percent. A significant contributor to this slow-down in real wage growth is the emergence of the wrongful-termination idea. The year-by-year impact of the increasing use of this legal approach is shown in Figure 1, which describes the deviation from the estimated trend line in real compensation that can be attributed to the changing legal circumstances surrounding the employment relationship. This will not account for all of the retardation in the rate of increase in real wage levels, but neither can it be ignored.
Wrongful Termination and the Distribution of Income
One of the most intriguing aspects of the growing prevalence of the wrongful termination doctrine is its potential impact on the distribution of income. How does it affect lower income people? Does the additional job protection offered by wrongful termination improve their relative economic position or do the job and income losses already documented make them worse off in a relative sense?
Figure 1: Percent Deviation in Real Compensation From Trend Attributable to Litigation
To explore this matter, we use a statistical model that we developed several years ago to explain variations in a standard measure of the equality of the distribution of income.14 Disparities in the distribution of income are usually quantified by use of the concept of the Gini coefficient, which ranges from zero (perfect equality) to one (perfect inequality). The Gini for family units reported by the Census Bureau shows a pronounced decline at the beginning of the post-World War II period (through about 1968), followed by increases over the last quarter century. In 1947, this measure stood at .376. By 1968, it had fallen to .348, but then began to rise, reaching a level of .401 in 1989.15
In our earlier investigation of the behavior of the Gini coefficient over time, we emphasized the effects of public policy attempts to redistribute income through direct transfers to those in the lower portions of the income distribution. Our conclusion in that analysis was that relatively low levels of income transfers reduced the Gini coefficient but that, beyond some threshold level (reached in the early 1970s), they led to increases in measured income inequality. The implication of this is clear. There are distinct limits to the extent to which public policy can reduce the level of economic inequality in a society and that well-intended attempts at creating a more egalitarian world may have the unintended consequence of making things less equal.
This raises the possibility that the legal doctrine of wrongful termination also may have the unintended consequence of increasing measured income inequality. Given the magnitude of the employment and wage effects already identified, this possibility must be given serious consideration. Therefore, we expanded our earlier model by including as an independent variable the time series data detailing the number of states at any time who had embraced some form of the wrongful termination doctrine. For this analysis, we extended the time series back to 1953.
The statistical results are described in the Technical Appendix. They are impressive. The total explanatory power of the model rises remarkably and the variable measuring the prevalence of the wrongful termination doctrine is highly significant, in a positive direction, indicating that changes in the legal interpretation of the nature of the employment relationship have contributed to the rising income inequality of recent years.
Table 1 Comparison of Actual and Hypothetical Gini Coefficients Assuming Zero Incidence of the Wrongful Termination Doctrine, United States, 1977-1989
Year Actual Gini Hypothetical Gini 1977 .359 .361 1978 .363 .360 1979 .363 .359 1980 .365 .358 1981 .365 .357 1982 .369 .359 1983 .380 .365 1984 .383 .358 1985 .389 .357 1986 .392 .358 1987 .393 .358 1988 .395 .358 1989 .401 .363
Quantitatively, the impacts have been substantial. They first become noticeable, in a measurable sense, in 1977. Table 1 compares actual values of the Gini coefficient with values estimated by assuming that no state had adopted some variant of the wrongful termination idea. By 1989, the impact of wrongful termination is to increase the Gini coefficient by more than ten percent.16 Apparently, the introduction of the wrongful termination concept has had the effect of substantially increasing the degree of inequality in the distribution of income in the United States.
This analysis can be extended by substituting the percentage of all income claimed by those in the bottom quintile of the income distribution for the Gini coefficient in the regression analysis. Details of the results are reported in the Technical Appendix. Again, the statistical results are impressive, roughly matching those obtained with the Gini coefficient. This analysis has the advantage of allowing us to estimate the impact of the growth in the use of the wrongful termination doctrine on the mean family income of those in the bottom quintile of the income distribution.17 Such estimates are provided for the years 1967 through 1989 in Table 2.18 The income data are expressed in 1992 dollars.19 By the year 1989, it is estimated that, on average, the loss of income amounts to $1,894 per low income quintile family.
Table 2 Estimated Mean Family Income in Absence of Wrongful Termination Doctrine, Actual Mean Family Income, and Income Loss Per Family Due to Wrongful Termination Doctrine, Bottom Quintile of Income Distribution United States, 1967-1989
Year Hypothetical Income($) Actual Income ($) Loss of Income ($) 1967 9,380 9,380 0 1968 10,135 10,134 1 1969 10,456 10,455 1 1970 10,264 10,263 1 1971 10,301 10,300 1 1972 10,770 10,769 1 1973 11,072 11,069 3 1974 10,909 10,902 7 1975 10,526 10513 13 1976 10,779 10,759 20 1977 10,658 10,591 67 1978 11,063 10,918 145 1979 11,259 11,089 170 1980 10,809 10,506 303 1981 10,874 10,497 377 1982 10,010 9,535 475 1983 10,322 9,514 802 1984 10,961 9,835 1,126 1985 11,446 9,966 1,480 1986 11,930 10,291 1,639 1987 11,853 10,157 1,696 1988 11,979 10,197 1,782 1989 12,253 10,359 1,894
IV. CONCLUSIONS
Individuals and groups are increasingly using the legal system in an attempt to redistribute income to themselves. Lawyers, labor unions, and other groups have successfully sought changes in the legal environment in which business operates to subvert the sanctity of private contracts, particularly the ancient doctrine of employment-at-will. In a sense, these developments are a form of stealth taxation. They have imposed very significant and real burdens on the American people. This paper has demonstrated that all told perhaps two million jobs have been lost from changes both in workers' compensation and in other aspects of employer liability since 1970. The annual income loss is even greater, reaching into the hundreds of billions of dollars, with the job loss compounded by reduced wages for workers.
This is stealth taxation because it is a burden that was not imposed in a manner that was clear and open to the taxpayers. Legislatures did not in a single historic vote decide to radically revise our system of contracts and property rights. Moreover, it is highly regressive taxation, falling heavily on the poor and disadvantaged. Take unemployment. In 1993, the unemployment rate for white males aged 45 to 64 was 4.4 percent, compared with 13.7 percent (more than three times as much) for black women maintaining families.20 The unemployment rate for relatively well off professional workers was 2.6 percent, compared with 9.7 percent for factory workers who were "machine operators, assemblers and inspectors." The unemployment rate for college graduates is less than one-third that of high school dropouts. Those with high income jobs are relatively secure from the ravages imposed by the litigation explosion: lower income, unskilled workers, and minorities are not. This is illustrated quite dramatically by the analysis of the impact of the emergence of the wrongful termination doctrine as a factor in explaining the rising levels of inequality in the distribution of income over the last quarter century. Clearly, this stealth taxation has played a major role in creating greater economic differences in the United States. Elimination of this regressive form of hidden taxation would promote both equity and economic efficiency in American society.
TECHNICAL APPENDIX
There are several technical aspects of the analysis described in the main body of this report which require further explanation. In the order in which they will be discussed, they are:
The extent to which additional labor costs associated with the emergence of the wrongful-termination doctrine will be reflected in wage adjustments and/or losses of employment. The choice of an appropriate estimate of the elasticity of demand for labor with respect to labor costs. The choice of an appropriate estimate of the elasticity of supply of labor with respect to labor costs. The nature of the data employed to allocate the economic impacts of the wrongful-termination doctrine among the individual states. The details of the regression analysis used to quantify the impact of wrongful termination on the real compensation of workers. The Cost-Shifting Problem
In this analysis, we treat any additional labor costs associated with the wrongful-termination doctrine as if they were a simple tax on the employment of labor. Figure 1-A shows the conventional demand for and supply of labor schedules, indicated by (DL)o and (SL)o. They generate an equilibrium labor cost, Wo, and level of employment, Lo.21 Now, adding a labor tax, T, shifts the demand schedule for labor to (DL)1. Employers may adjust to this wage tax in several ways. At the one extreme, all of the adjustment could be made in the level of employment of labor, reducing employment to L1', and none by lowering the cost of labor. In that case, the magnitude of the employment effect is determined by the elasticity of demand for labor (ED)L. The more elastic the demand for labor the greater will be the reduction in employment. Specifically, the percentage reduction in employment associated with the labor tax on employment implicit in the employer mandates of the Health Security Act is equal to the tax (expressed as a percentage of pre-tax labor costs) multiplied by (ED)L.
The other extreme possibility is an adjustment that reduces labor costs to W1 and employment to L1. In this instance, the elasticity of supply of labor with respect to the level of worker compensation (ES)L, also enters the picture. The percentage decrease in labor costs (i. e., wages) will be equal to the tax (in percentage form) multiplied by (ED)L/[(ED)L + (ES)L]. The term by which the tax is multiplied may be thought of as the wage adjustment factor. The employment effect (in percentage terms) is equal to the tax multiplied by both the wage adjustment factor and the (ES)L.
The Elasticity of Demand for Labor
The foregoing discussion indicates the importance of the numerical values of the labor demand and supply elasticities in quantifying the impact of the additional labor costs associated with the wrongful-termination doctrine. We turn first to the matter of the elasticity of labor demand. Our framework for estimating the numerical value of (ED)L employs a straightforward model of the labor market.22 Define the demand for labor as
1. D = D(R), D'(R) <0,
where D denotes the demand for labor per unit of population in the economy and R represents what we term the adjusted real wage (the real wage per unit of output). Similarly, define the supply of labor as
2. S = S(R), S'(R) > 0,
where S indicates the quantity of labor supplied per unit of population in the economy.
Expressions (1) and (2) can be combined to provide an unemployment rate (U) equation:
3. U = (S - D)/S = [S(R) - D(R)]/S(R).
Differentiating (3) and keeping in mind that S(R) and D(R) are always positive, it can be shown that
4. dU/dR > 0.
Thus, we may write a first approximation of (3):
5. U = U(R),
which may be further expanded by defining R in the current period as
6. Rt = Rt-1 (1 + Wt - Pt - PRt).
Wt is the rate of change in money wage rates, Pt is the rate of change in the price level, and PRt is the rate of change in labor productivity between time periods t and t-1. Thus,
7. Rt = R(Rt-1, Wt, Pt, PRt),
dRt/dRt-1 > 0, dRt/dWt > 0, dRt/dPt <0, and dRt/dPRt <0.
Combining (5) and (7) and expressing the result in linear form gives:
8. Ut = a + b Rt-1 + c Wt - d Pt - e PRt.
We use the standard data sources describing, on a quarterly basis, the unemployment rate, levels of employee compensation per hour, the GNP implicit price deflator, and average output per man-hour on a quarterly basis over the interval beginning with the first quarter of 1959 and running through the first quarter of 1992 to construct an adjusted real wage rate series and percentage changes in its components, the levels of money wage rates, prices, and productivity. Both the adjusted real wage rate and unemployment series are normalized so that their mean values are equal to 100. These data are then used to estimate an ordinary least squares regression equation embodying the relationships shown in expression (8) with multiple lagged terms. The results, lagging the adjusted real wage rate variable eight quarters, are shown in Table 1-A.
Due to the manner in which the unemployment and adjusted real wage rate variables are normalized, the regression coefficients shown in Table 1-A are direct estimates of the elasticity of demand for labor with respect to the adjusted real wage. The coefficient for the adjusted real wage lagged eight quarters is viewed as an estimate of the long-run elasticity of demand for labor. That value, -.83, is used in the calculation of the wage adjustment factor that should be used in quantifying the economic impact of the labor taxes implicit in the wrongful termination doctrine.
Table 1-A Ordinary Least Squares Regression Analysis of the Determinants of Unemployment in the United States, First Quarter 1959 through First Quarter 1992*
Independent Regression T Statistic Variable Coefficient Constant 16.94 0.77 Adjusted Real Wage (-8) 00.83 3.72 %Change Price Level - 0.16 2.25 %Change Productivity - 0.16 3.77 %Change Money Wage 00.14 2.43 %Change Price Level (-1) - 0.31 2.59 %Change Productivity (-1) - 0.25 3.44 %Change Money Wage (-1) 00.35 3.69 %Change Price Level (-2) - 0.54 3.63 %Change Productivity (-2) - 0.37 3.70 %Change Money Wage (-2) 00.51 4.00 %Change Price Level (-3) - 0.69 4.11 %Change Productivity (-3) - 0.59 4.74 %Change Money Wage (-3) 00.71 4.71 %Change Price Level (-4) - 0.73 4.02 %Change Productivity (-4) - 0.69 4.76 %Change Money Wage (-4) 00.77 4.50 %Change Price Level (-5) - 0.67 3.42 %Change Productivity (-5) - 0.70 4.26 %Change Money Wage (-5) 00.79 4.32 %Change Price Level (-6) - 0.67 3.26 %Change Productivity (-6) - 0.75 4.00 %Change Money Wage (-6) 00.77 3.98 %Change Price Level (-7) - 0.73 3.42 %Change Productivity (-7) - 0.81 3.90 %Change Money Wage (-7) 00.81 3.91
Source: Authors' Calculations. * The adjusted R2 for the regression equation is 0.972. This includes the effect of first- and second- order Cochrane-Orcutt autoregressive adjustments.
The Elasticity of Supply for Labor
There is substantial literature dealing with the responsiveness of the supply of labor to differences in rates of compensation. In general, these studies find an elasticity of supply that is in the range of .10 to .20.8 We postulate a supply elasticity at the midpoint of this range, i. e., .15. This suggests that, in the absence of any constraint on the labor market adjustment process, 85 percent of any tax on labor [.83/(.83 + .15)] would be shifted to workers in the form of reduced compensation.24
Allocation of Economic Impacts Among the Various States
In order to estimate the state-by-state economic impacts of the wrongful-termination doctrine, we relied on other data sources to determine the share of the aggregate impact that should be apportioned to each state. With respect to the job loss impacts, they were allocated on the basis of the relative numbers of workers employed in the various states using standard Department of Labor data for the year 1992.25 Allocation of the losses in wage income are based on weights derived from the standard data sources describing average annual pay of workers by state.26 Thus, they take into account differences in the level of compensation of workers.
Details of the Regression Analysis Explaining Real Compensation of Workers
In order to determine the impact of the wrongful-termination doctrine on the level of real compensation of workers through time, we regressed real compensation (COMP) against a time variable (TIME), designed to measure the time trend in real compensation, and a wrongful termination variable (WRONG) over the period 1970-1989. The wrongful termination variable is simply the number of states in any year adhering to some version of wrongful termination.27 The regression results are:
9. COMP = 85.49 + 1.5098 TIME - 0.1897 WRONG, (8.84) (3.20)
R2 = .9816, R2 = .9767, D-W = 1.8095,
where the numbers in parentheses beneath the regression coefficients are t-statistics. Two ARIMA adjustment terms are not reported.
Details of the Regression Results Explaining Variations in the Gini Coefficient
To explain movements in the Gini Coefficient over the period 1953-1989, we regressed the Gini coefficient (GINI) against measures of the availability of public aid (AID), the aid measure squared (AIDSQ), the unemployment rate (UNEMP), and the square of the time-series variable WRONG (denoted as WRONGSQ). The reason for the use of the square of the variable WRONG is that we expect this to be a non-linear relationship. As the number of states accepting some variant of the wrongful termination doctrine increases, the opportunities to escape its effect by shifting production operations to other states become fewer and fewer. Thus, we would expect the impact of additional states accepting the notion to be stronger as the number of states accepting some variant of the wrongful termination doctrine increases.
The regression results are as follows:
10. GINI = 359 = -0.00014 AID + 0.00000027 AIDSQ (4.15) (3.60)
+ .00224 UNEMP + .000019 WRONGSQ , (4.28) (13.90)
R2 = .9395, R2 = .9274, D-W = 1.96 ,
where the numbers in parentheses beneath the regression coefficients are t-statistics. Two ARIMA adjustment terms are not reported.
Details of the Regression Analysis Explaining Variations in the Percent of All Income Claimed by Families in the Bottom Quintile of the Income Distribution.
To explain variations in the percentage of all family income accruing to families in the bottom quintile of the income distribution (LOWINC), we regressed it against the same set of variables used in explaining movements in the Gini coefficient. Data are for the periods 1953-1989. The statistical results are as follows:
11. LOWINC = 4.6795 + 0.009859 AID (8.9521)
- 0.0001686 AIDSQ - 0.087131 UNEMP (6.9326) (5.2399)
- 0.0004153 WRONGSQ , R2 = .9176 , (9.5586)
R2 = .9011 , D-W = 2.0912 ,
where the numbers in parentheses beneath the regression coefficients are t-statistics. Two ARIMA adjustment terms are not reported.
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Endnotes
*RICHARD K. VEDDER is Distinguished Professor of Economics at Ohio University, where he has taught since 1965. Educated at Northwestern University and the University of Illinois, Vedder is the author of The American Economy in Historical Perspective, and (with Lowell Gallaway) Out of Work: Unemployment and Government in Twentieth-Century America. He has published more than 100 other articles, books, and monographs. He has served as an economist with the Joint Economic Committee of Congress and will serve this fall as John Olin Visiting Professor of Labor Economics and Public Policy at the Center for the Study of American Business at Washington University. His research on labor, tax and fiscal issues have received considerable attention both in scholarly circles as well as the popular press. He is a popular nationally known public speaker.
LOWELL E. GALLAWAY is Distinguished Professor of Economics at Ohio University, where he has taught since 1967. Educated at Northwestern University and Ohio State University, Prof. Gallaway has taught at the University of Minnesota and the University of Pennsylvania. Like Prof. Vedder, Prof. Gallaway has served as an economist with the Joint Economic Committee of Congress. He is a prolific author, and is listed in Who's Who in Economics. Gallaway's books include Poverty in America, Manpower Economics, as well as Out of Work (with Richard Vedder). He has published in the American Economic Review, the Journal of Political Economy, and other top economic journals, as well as the popular press. A labor economist, his research on poverty, welfare, migration, fiscal issues and other contemporary policy topics have attracted a wide audience.
1 This is a large change. One of the remarkable aspects of the available analyses of the economic impact of variations in the legal environment surrounding the labor market is the very large magnitude of the effects. For example, our estimates of job and wage losses reported earlier are quite conservative compared to estimates reported in Rand study, op. cit.
2 The estimate is calculated by using the regression results to estimate what the percentage share of all income would be in the absence of the wrongful termination doctrine, using that figure to calculate the percentage decline in the income share, and then applying that percentage decline to the Census Bureau's estimate of the real mean family income of those in the bottom quintile of the income distribution.
3 The Census Bureau data series detailing the mean income of families in the bottom quintile of the income distribution begins with 1967.
4 The Census Bureau's CPI-U-X1 price index series is used for purposes of converting money income to real income. The Census Bureau recommends the use of this series when making historical comparisons over time.
5 U.S. Bureau of the Census, 1994 Statistical Abstract of the United States, p. 416.
6 It is assumed in this analysis that the equilibrium wage-employment combination in Figure 1-A will have a certain amount of unemployment associated with it. This unemployment can be thought of as either the equilibrium level of unemployment or as the "natural" level of unemployment.
7 The model described here is taken from our "American Unemployment in Historical Perspective," Journal of Labor Research, Volume XV, Number 1, Winter 1994, pp. 1-17. A more extended version of the model may be found in our Out of Work: Unemployment and Government in Twentieth Century America (New York: Holmes and Meier, 1993). See, in particular, the Appendix, pp. 298-307.
8 The Congressional Budget Office accepts these estimates of the elasticity of labor supply. See their An Analysis of the Administration's Health Proposal (Washington, D. C.: Congressional Budget Office, 1994), p. 56. See, also, Mark Killingsworth, Labor Supply (Cambridge, England: Cambridge University Press, 1983) and James Heckman, "What Has Been Learned About Labor Supply in the Past Twenty Years?" American Economic Review, vol. 83, no. 2 (May 1993). In our own research, we found an elasticity of labor supply of 0.14 in Lowell Gallaway, Richard Vedder, and Robert Lawson, "Why People Work: An Examination of Interstate Variation in Labor Force Participation," Journal of Labor Research, vol. 12, no. 1 (Winter 1991).
9 This is quite consistent with other studies cited by the Congressional Budget Office in the course of its analysis of the Clinton Administration;s Health Security Act.
10 Statistical Abstract of the United States, 1993 (Washington, D. C.: U. S. Government Printing Office, 1993), Table 629, p. 396.
11 Statistical Abstract of the United States, 1993 (Washington, D. C.: U. S. Government Printing Office, 1993), Table 669, p. 425.
12 The data for this variable are taken from Dertouzos and Karoly, op. cit., Table 2.1, pp. 12-13.
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-- Ken Decker (kcdecker@att.net), January 10, 2001
Labor Market Responses to Employer Liability (1992)James N. Dertouzos, Lynn A. Karoly
Abstract: The labor market in the United States has always been more flexible than labor markets of other Western societies. American employers have been relatively unencumbered in dismissing poor performers or adjusting the labor force in response to exogenous changes in product demand, technological change, or the competitive environment. Recently, however, state judiciaries have adopted a number of wrongful-termination doctrines that challenge the "employment-at-will" rule. This report provides the first empirical estimates of the aggregate effects of wrongful termination. It outlines the major exceptions to employment at will that have been adopted by state court jurisdictions. It also examines the timing and pattern of state adoption of the new doctrines. In an econometric analysis, it identifies those political, legal, and economic factors that are correlated with, and possibly causes of, the changes in court views of employee job protection. The authors also consider the economic factors that may have induced changes in the legal environment to derive reliable causal inferences about the subsequent effect on labor markets. The authors also evaluate the likely consequences of the legal changes for the behavior of business decisionmakers and derive testable implications for labor-market outcomes. Finally, they present their empirical findings on state- level employment effects that can be linked to expanding liabilities. The findings suggest that the indirect effects of wrongful- termination doctrines are 100 times more costly than the direct legal costs of jury awards, settlements, and attorney fees.her or not these changes are desirable depends upon whether or not there are compensating benefits to employees, firms, or society at large.
According to the study, 83 percent of corporate executives report the fear of a lawsuit affects their decisions.
-- Ken Decker (kcdecker@att.net), January 10, 2001.
Article LinkJURY VERDICTS IN WRONGFUL TERMINATION CASES by David J. Jung
VII. Conclusion
One impetus for reforming wrongful termination law has been a belief that wrongful discharge verdicts are growing out of control. Although a study of jury verdicts cannot conclusively confirm nor refute claims about increased numbers of filings, the number of reported jury verdicts has indeed increased substantially -- almost 40% since 1992. The increase, however, is almost entirely accounted for by an increase in the number of discrimination lawsuits, (my emphasis) a trend that seems to be operating nationwide. Further, after reaching a peak in 1994, the number of reported verdicts now seems to be holding steady.
So far as unpredictability is concerned, there is undoubtedly a great deal of volatility in wrongful termination verdicts. Average and median verdicts can vary by 20% or more from year to year, sometimes in opposite directions! The explanation for this volatility, however, is probably mundane. Given the small number of verdicts in any one year, the averages and medians are being skewed by a handful of million dollar awards. By contrast, the rate at which plaintiffs win and the frequency of punitive damage awards have been quite consistent, at least over the last five years.
The movement to reform the law of wrongful termination has also grown from a perception that wrongful discharge claims impose a substantial economic burden on California employers. Compensatory damage awards in wrongful termination cases have clearly grown over the past decade. For example, one 1988 study of wrongful termination cases found that the average verdict in a wrongful termination case based on a violation of public policy was $269,792; the average from 1992 to 1996, by contrast, was more than $425,000.
The perception that wrongful termination verdicts put California employers at an economic disadvantage has been shaped in large part by a RAND study of wrongful termination verdicts done in 1988. The RAND study argued that while the cost of paying damages in wrongful termination cases was insignificant, the threat of unpredictable, million dollar punitive damage awards would cause employers to take costly precautions against liability.
The law of wrongful termination has changed significantly, however, since the RAND study. Arguably, the California employers now live a milder legal climate than they did in 1988. The California courts have made it harder for employees to recover damages in wrongful termination cases, particularly by completely eliminating punitive damages in cases based on a breach of contract.
Further, where punitive damages are still available, juries appear to be less inclined to award them than they were in 1988. That is, according to one 1988 study, 65% of the verdicts in public policy cases involved an award of punitive damages, and the average award was $372,800. From 1992 to 1996, only 22% of the public policy verdicts included punitive damages, and the average award was $406,619. Thus, the average punitive damage award grew at a slower rate than the average compensatory award, and the frequency of punitive damage awards decreased by two thirds. If the threat of liability did inspire California employers to take precautions to avoid punitive damages, the data suggest that those precautions have met with some success.
-- Ken Decker (kcdecker@att.net), January 10, 2001.
For educational use onlyThe Q-Word As Red Herring: Why Disparate Impact Liability Does Not Induce Hiring Quotas by Ian Ayres* and Peter Siegelman**
Excerpt:
"As Donohue and Siegelman and others have recognized, however, there is a tension between protecting applicants against discrimination in hiring and protecting workers from discriminatory firing after they have been hired. Antidiscrimination law forbids both kinds of conduct, but the two prohibitions are inherently at odds. By making it harder to fire certain workers, employment discrimination law tends to make these workers less attractive prospects at the hiring stage. An employer would prefer to hire someone who can be easily fired (should that prove necessary) than an otherwise identical applicant whose firing would be subject to legal scrutiny. Thus, protection against discriminatory firing acts as a kind of tax on hiring those to whom it is extended. My emphasis
While the tradeoff between "disparate treatment" hiring and firing protection has already been described, this article extends the analysis to the effects of "disparate impact" liability. McDonnel Douglas. Burdine, etc. Complications posed by mixed motives cases, Price-Waterhouse. 1991 Civil Rights Act partially overturns. Our major conclusion can be put succinctly: far from producing hiring quotas that induce employers to discriminate in favor of minorities, disparate impact liability may actually induce hiring discrimination against minorities (and other protected groups). Whether or not its net effect on minority employment is negative, disparate impact firing liability almost certainly blunts the positive incentives to hire minorities that Title VII was originally supposed to create.
Our thesis contradicts the common wisdom that disparate impact liability induces employers to hire "excessive" numbers of minorities. This quota theory of disparate impact liability has a long and distinguished pedigree. The Reagan administration sought to restrict disparate impact liability because of "its pressure toward quotas;" George Bush vetoed the 1990 Civil Rights Act because it was a "quota bill;" and a plurality of the Supreme Court in Watson v. Forth Worth Bank & Trust has enshrined the quota theory in its parsing of Title VII:
Respondent and the United States are thus correct when they argue that extending disparate impact analysis to subjective employment practices has the potential to create a Hobson's choice for employers and thus to lead in practice to perverse results. If quotas and preferential treatment become the only cost-effective means of avoiding expensive litigation and potentially catastrophic liability, such measures will be widely adopted.
Our thesis is that commentators have erred by only considering the effects of disparate impact hiring liability. There are strong theoretical and empirical reasons to believe that disparate impact firing liability is likely to have a much greater impact on employer behavior, and that this effect, far from inducing hiring quotas in favor of minorities, may induce hiring discrimination against these traditionally disadvantaged groups. As noted earlier, we argue that disparate impact liability should be modeled as a quota, but one that governs the racial composition of fired workers, not the composition of those hired.
-- Ken Decker (kcdecker@att.net), January 10, 2001.
Discussion with a liberal. A composite of discussions I've really had with various people.---------
Liberal: Your employer should not be permitted to fire you without some good cause.
Me: What if your employer claims the cause is good and you disagree. Should the courts decide who's right.
Liberal: Yes. Otherwise companies can screw you around.
Me: What if the courts tend to agree with the employee most of the time, even despite solid documentation to the contrary?
Liberal: Then the company's lawyers dropped the ball during jury selection. Too bad.
Me: Should you be able to quit your job without a cause that satisfies a jury?
Liberal: Yes
Me: Doesn't that sound a bit unfair -- you can break the relationship for no reason, but your employer must satisfy a jury at great expense and risk to do the same thing?
Liberal: The relationship isn't symmetrical. That's why we need unions.
Me: But won't companies be disinclined to hire, in the first place, someone it might prove impossible or prohibitively expensive to fire?
Liberal: Companies shouldn't hire unqualified people in the first place.
Me: What if they make a mistake?
Liberal: Then they can fire that person, because they'll have good cause.
Me: But what if that person claims their cause wasn't good. Back to the courts?
Liberal: Yes.
Me: What if companies are avoiding hiring any minority, for fear they won't be able to fire the losers?
Liberal: Then the government should make them hire minorities. Discrimination should be illegal.
Me: What if the company claims those they won't hire are unqualified? You said companies shouldn't hire unqualified people in the first place.
Liberal: Then they are breaking the law and should be found guilty.
Me: But in essence, you are giving the courts ultimate control over whom a company both hires and fires, instead of the company itself. Is this really what you want?
Liberal: No, only if the company is being unfair to people.
Me: But who decides if the company is being unfair or not? The courts?
Liberal: Yes, because the company will never admit it's being unfair.
Me: But in that case, the government is really deciding whether or not the government should determine who is hired and fired according to the government's judgment, all of which is incredibly slow and expensive. And these bureaucrats don't understand the necessary qualifications for the jobs, and enjoy no reward if they guess right nor penalty if they guess wrong! How can this possibly be an improvement?
Liberal: Because the alternative is the companies will be unfair, and that's worse.
Me: And what if the companies decide to leave the state or the country to avoid this?
Liberal: Then the government should force them to stay here and engage in fair employment.
......and off into the sunset. At least I know the superficial appeal of a planned economy. Mere experience stands no chance against the power of wishful thinking.
-- Flint (flintc@mindspring.com), January 10, 2001.
You are lucky, Flint, most of my conversations with radicals have been far less pleasant. It usually comes down to a moral conviction that businesses are evil and workers are good. The only way to mitigate the unbridled evil of corporations is to give government unlimited power to regulate and control the private sector. Of course, these good hearted liberals refuse to acknowledge that gov't has done some rather nasty things. We all know what road is paved with good intentions....
-- Ken Decker (kcdecker@att.net), January 10, 2001.
Ayn Rand had good foresight.
-- Cherri (jessam5@home.com), January 11, 2001.
Just wanted to comment on a misleading statistic in the essay that started this thread:"A 1991 survey by the Bureau of National Affairs found that terminated employees win 65 percent of wrongful termination suits that reach a jury."
The reason this is misleading is because it does not take into account the percentage of ALL actions filed for wrongful termination. How many of these actions are ended by summary judgement in favor of the defendant? WIthout that information, the above statistic really does not tell us much about the situtation as a whole.
-- FutureShock (gray@matter.think), January 11, 2001.
FS,For once I think we agree. The article said,
according to an American Bar Association study, between 1984 and 1985 the number of state and federal court decisions involving employment-at-will issues increased by 37.1 percent.6 More important than the sheer number of wrongful termination suits is the fact that plaintiffs win the majority of such suits, and that the average damage award is large. A 1991 survey by the Bureau of National Affairs found that terminated employees win 65 percent of wrongful termination suits that reach a jury.
The costs to society are probably far greater than would be determined from the statistic they used here, as even cases that are dismissed before trial still require legal expenditures on the part of the business (and passed on to the consumer) *regardless* of whether the emloyee wins or loses. Maybe the reason they used it was because it was an easily quantifiable measure that wouldn't be disputed *as much*.
Frank
-- Someone (ChimingIn@twocents.cam), January 11, 2001.
I agree Ken, "It usually comes down to a moral conviction that businesses are evil and workers are good." A conviction that is completely foreign to me. These workers obviously have never run a business. They've never seen the other side of things. I owned a business once and I never will again. To depend on workers can destroy one's sanity. They are lazy, tardy, and lack workmanship, and complain incessantly. I couldn't stand it any longer so I swallowed my debits and ran. Anyone starting up a business deserves all the profits they can get just for putting up with these "good" workers. I for one couldn't handle it.
-- Maria (anon@ymous.com), January 11, 2001.
Maria,I'm not quite ready to dismiss the entire U.S. workforce. I have been fortunate to have some superb employees. By the way, my comments were directed at the attitudes of serious leftists. The anti-capitalist dogma is an extension of Marxian philosophy.
Coming from a small business family, I can say that labor can be one of the biggest headaches. One problem employee can make day-to-day life miserable. Equally frustrating are employment laws and regulations. Most small businesses cannot hire an entire HR department, so the responsibility for compliance falls onto often overworked entrepreneur-owners.
For many, it's easier and less expensive to contract work out than to hire employees. Witness the explosion of "temp" firms. What liberals do not understand is that increasing to cost of hiring (or firing) results in job loss. Unfortunately, the study suggests this job loss most impacts the people liberals want to aid.
-- Ken Decker (kcdecker@att.net), January 11, 2001.
No Ken, I didn't mean to imply the entire workforce (especially since I am among them :)I was talking about the workers who resent big business and don't know the other side of employment. Absolutely, there are workers out there who are diligent, steady, reliable people. I wished I could have hired some of them. Unfortunately, I have seen the worst a worker can be. I was lucky if they showed up on Monday after a weekend of drunken mayhem. And the liberal attitude of "big business is bad and workers are at their mercy" is blatantly false.
-- Maria (anon@ymous.com), January 11, 2001.