What is the labour market

My recent post on universal student allowances was relatively provocative (I thought it might be a little more provocative – maybe it would have been if I said all students and all unemployed people should borrow money instead 😛 ). As a result, it is a good time to briefly go through the way I see the labour market and a few of the things I think are important for analysing it.

The labour market is a difficult thing to analyse given that it is the only input to production where we also value the outcome for the input!  The best way to look at labour in this case is to separate out the person selling the labour and the “labour input” – so when you go to work you are “selling an input” and the price you receive is your compensation for that – the wage.

Fundamentally, the labour market starts with the core bit – actual working labour. There are people who are employed in firms working for those that own capital.

Now, just by looking at employees and capital owners we can’t say anything about the labour market without rabid conjecture an flying euphemisms. In order to get an idea about how the “trade” between the owners of labour and the owners of capital occurs we need to get an idea about the people who do own labour but aren’t selling it.

Note: Very long post – skip to conclusion if you want, I doubt you will lose anything 😉

First there are those who are “unemployable” – people that will not be hired at any wage. These people are not part of the labour market – and as a result there welfare considerations are completely separate from it.

Secondly there are those who do not want to work for the given wage – these people are not part of the labour market, but how we are willing to treat these people gives us some idea of what we would determine is “fair” for people in the labour market.

Third we have the “unemployed” – there are a lot of flavours. Fundamentally, unemployment is part of the normal functioning of the labour market, and as a result should be treated in the same way as those that are unemployable. This group matters as its existence influences the potential wage other people can sell their labour for – they are the competition.

Reservation levels

Now what we are willing to pay any of these groups helps determine a reservation level that people are willing to sell there labour at. If this did not exist then it is conceivable that, in some labour markets, people would have to sell there labour ouput for a very low leve – subsistence even. This is the sort of thing that many on the left complain about.

Of course, what they ignore is that in our current society this level is definitely set about subsistence – and government policy will keep a binding reservation level, no matter how high the unemployment rate gets. This is the factor that allows economists to call the labour market “voluntary”.

So beyond the fact that a benefit provides a security net it also increase the ability of labour to extract a higher surplus from the labour-capital production process, in areas where there is likely to be a strong asymmetry in terms of bargaining positions.

The second group

The second group (people that are not working) can be divided in two:

  1. Those that are consuming leisure,
  2. Those that are investing in human capital.

These groups do not directly impact on the other two (except when wages change people move between this group and the others). However, given that they are both outside the labour market, these are groups we should, in theory treat consistently.

Now, we give people that are consuming leisure money. People that do not want to work and people that are retired can both get money from the state. In this case, it seems unusual that those that are investing in human capital can not receive the same transfer – after all, if we are willing to give it to other people who are floating outside the labour market, why not students?

The short answer that was given by commentators in the previous blog post was – they will have higher future incomes. So as a result, since students will earn more in the future we should “tax” them more now – as removing a subsidy is exactly the same as a tax. This is interesting- however I can see where they come from if we move to look at the linkage between areas of this entire labour market thing.


I have said that being a student is effectively taxed – given that you get paid to do nothing, but you do not get paid to study. Now, if this is the case people that are employed are taxed twice – not only do they not get paid a transfer but the income they earn is taxed again! The unemployed and those consuming leisure both receive transfers.

Now, looking at these groups all together we have some idea of what we think is fair etc – however, I’m not going to say anything about that now as I have no hard and fast opinions 😉

The key fact to realise is that all these different groups are being taxed and subsidised in different ways – and furthermore, people can MOVE between these groups depending on the associated transfers.

Government involvement in education

If we subsidise the people investing in human capital then we reduce production now, insofar as employees leave the labour market – however we increase it in the future (as labour will be more productive).

We can get past this trade-off if the resources that are increasing skills are the unemployed or consuming leisure groups. However, then we have to ask why these people did not invest in education in the first place!

Allowing labour to establish skills based on their own underlying demand (and provided information) is the best way for this trade-off to be made optimally – unless there are externalities. As a result, the government may want to get involved in the eduction if there are definite externalities from certain labour types.

As a result, this seems to suggest that students should pay for the whole cost, and take on the whole risk of their education – but those who take on subjects with a “social benefit” maybe should get a subsidy from the government.

Equality of opportunity

However, there are other factors that drive government involvement – namely equality of opportunity. As long as all people have the ability to enter tertiary education (given their initial skill set) then this is fine – even if it implies that all the funds must be borrowed!

Often people say that the complication here is that students may not be able to borrow – because of asymmetric information between the lender and the (student) borrower regarding the students “quality”.

However, this misses the point. First, the lender can make it that the student has to provide grades, or even sit a test, in order to get the loan. Secondly, if the fees are set appropriately, then only students who expect to make a sufficient return on their education will apply for a loan in the first place.

Back to the labour market

Now before I stated that I had no problem with a universal student loan in the current environment. The reason for that was that there appears to be transfers to each and every other group in the labour market – except students. Such an allocation of transfers appeared unusual to me – and as a result I felt that a transfer to students, effectively in the shape of negative income tax, would satisfy whatever social preference New Zealanders seem to be suggesting they have.

However, people that commented said they did not feel that this was true – that there was a reason this policy did not exist.

To me, the removal of this policy would also suggest that we should remove working for families and other such tax credits – which are just transfers to employed people. Furthermore, we should remove unemployment benefits and get people to borrow money when they can’t find work – in this case the only people that will get transfers are the unemployable, as they can’t make an income to repay any debt in the future.

However, this isn’t what people want either. You can defeat my unemployment call by moving back to the “reservation level” argument. Even so, we still have working for families.

When talking about this stuff I then hear “people that are unemployed should not have to borrow, people on low incomes should get transfers, students should not get an allowance” and I realise what people are saying – people with a higher lifetime wealth should have to pay more!

Effectively, this is the “fairness principle” that I gathered from the comments – people with a higher lifetime wealth must pay more. However, students will pay more even if they get this universal allowance – they will pay higher tax and they will have to pay back very large student loans while facing market interest rates.


If we believe that everyone in society deserves a minimum income then a universal student allowance does make sense – even if we believe that the wealthy should pay more. If we don’t believe that everyone in society deserves a minimum income (by virtue of being a citizen) then it doesn’t make sense.

This is the principle it all boils down to. If we refuse to recognise this, we will treat groups in society differently and inconsistently – a sure way to upset people and disincentivise optimal choices.

Now I don’t have strong views about what we should do in individual parts of the labour market – however, I do have a strong view that the overall strategy for employment, benefits, and education must be aligned.  As a result, my previous post was an attempt to align these individual markets based on a social welfare function I felt had been “revealed” by the creation of working for families and a “working tax credit”.  This seemed to imply that some “minimum level of income” was a goal of government – and as a result I ran with it 😛

13 replies
  1. Will de Cleene
    Will de Cleene says:

    Yeah, whatever happened to the Guaranteed Minimum Family Income thing? A universal minimum income regardless of circumstance, be it student, single Mum, or the whanau-centric.

  2. Matt Nolan
    Matt Nolan says:

    “Yeah, whatever happened to the Guaranteed Minimum Family Income thing?”

    It is still floating around – it is popular among many economists still:


    The way I see it is that there is still a major debate surrounding the true social welfare function we have – do we believe that everyone should have a “minimum income” as part of modern society or not.

    If we do, then that is the best way to do it – as the efficiency cost is the lowest. However, given that such a scheme would lead to lower participation rates in the labour market there is still an efficiency cost. As an economist I want the cost to be transparent so that society can debate it – however, politicians do not want to do that 🙁

  3. Will de Cleene
    Will de Cleene says:

    Ta for the link. As for the major debate surrounding social welfare eligibility, that’s part of the larger argument regarding the natures of citizenship, permanent residency and visitors. It’s one that needs to happen but is stuck in the too-hard basket.

  4. Matt Nolan
    Matt Nolan says:

    “As for the major debate surrounding social welfare eligibility, that’s part of the larger argument regarding the natures of citizenship, permanent residency and visitors”

    The whole construct of a nation is an issue that is in flux. We will see I guess

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