Why Might the Premium on Labour Experience Have Increased?

Labour economics was one of my areas at Rochester, but I have not studied it since I left.  As such, to say I have not kept up with the literature would be to put it mildly.   What follows is an experiment in using "the economic way of thinking" and not based on any research.

Has the labour market increased the premium on past experience? Without putting my nose into the current research, I do not know, but for the sake of argument let's suppose it's true.  Why could this occur?

We need an explanation that is not "why are employers willing to pay more for experience" but rather "why has this gap increased since, say, 1971"?  Here are some possible explanations - I would love to hear yours:

1. Changes in the types of jobs being performed.  Consider a position involving a greal deal of physical labour.  While the more experienced employee knows a number of short-cuts and methods to make the work easier, the less experienced employee is likely younger and physically fit, which levels the playing field.  As the amount of physical labour in North America has decreased, there is less advantage to being young and physically fit.


2. Jobs are more complicated now and require more on-the-job training. If training a new employee is a long and expensive process, then employers will pay a premium for employees who have already completed this training.  Thus, ceteris paribus, the wages for trained employees should rise and untrained employees should fall.


3. Decreased job switching costs for employees.  If it is difficult for employees to switch firms, then employers will look to hire people who are not currently employed, which will include a lot of new graduates.  This is not a free lunch for employees, however, as it means that employers can keep the salaries of experienced people low knowing that they would not leave.  
   
   There is a good life example of this: Baseball bonus babies of the 1950s.  In the 1950s there was no baseball draft, so high school graduates could sign with any team they wanted.  However, baseball had a reserve clause, meaning that a player was bound to a team for life. In the 1950s this mixture caused very high signing bonuses to young players but very low salaries after signing.  If it is hard to switch employers, this should cause a low premium on experience.  Removing that cost would increase that premium.  But has this happened outside of baseball?


4. The quality of employees has declined. It could have nothing to do with experience at all.  Maybe people born in 1968 are just more productive than those born in 1988, even controlling for experience.  But what would cause such a decline?  Culture?  A decline in the quality of higher education (meaning a degree from 1990 is more valuable than one from 2010)?  I don't see it.


5. Increasing number of women in the workforce / Discrimination against women under 35.  Unfortunately, I know a number of small and medium sized business people who actively discriminate against hiring women in their early-to-mid 20s. Why?  Because of the perceived costs on training those women, having them go on maternity leave, finding a replacement for them, and wondering if they will come back at all.
   
   I have not seen any hard data on this, but personally I believe this discrimination exists and it has driven down the wages for women in this age category.  I am in charge of hiring at our company, and I am continually amazed at how much higher quality the female applicants are for our jobs than the male applicants; I suspect the high quality male applicants are driven away by our low starting salary.  If I were to rank the 100 best applications we have received at our company in the last 2 years, I suspect at least 85 of them were from females.  Our company only has one male employee.
   
   When we get new applications that look good, I give them to all the employees to assign a grade between 1 and 10 to the employee.  At first I thought maybe our female employees were, for whatever reason, assigning higher grades to female applicants.  For one round of hiring I removed names and any indication of gender from applications before giving them to my staff.  It made no difference - the top 20 was dominated by females.
   
   But what does this have to do with experience?  Suppose you are a medium sized firm that is hesitant to hire women in their 20s.  What do you do?  You could hire mostly men in their 20s, but after awhile that is going to get noticed and you will be sued.  Plus there is the occasional fellow who wants to go on extended paternity leave.  So instead what do you is avoid hiring anyone under the age of 35 or 40 at all, as this will all but eliminate the maternity leave problem.
   
   Does this happen? I know it does.  Does it happen enough to have a noticable effect on the wages of people under 35?  I'm not sure, but it's at least possible.

Those are my potential reasons.  What are yours?

Comments

[Jon]

I wasn't aware this was happening significantly; however, I'd like to discuss number four.

The education of new graduates has changed: Knowledge has advanced. Topics that were once obscure research ideas have become commercialized and integrated in modern practice. People attend school for about the same duration but there is simply more to learn. Thus, new graduates either have a poorer general background or are more specialized within their field than before.

Neither one of these is advantageous. One advantage new graduates have is that the company will training them into the localized practices at that firm. Being narrowly educated is a disadvantage and being a weaker generalist is a disadvantage.

[Frances Woolley]

"Has the labour market increased the premium on past experience? Without putting my nose into the current research, I do not know, but for the sake of argument let's suppose it's true."

Mike, don't assume it's true. Yes, in Canada there's been a widening gap between the earnings of older workers and the earnings of younger workers. But that's because of the way that changes in the labour market play out. When Canada Post faces increased competition from FedEx and electronic delivery, it doesn't change everything all at once.

The people who are already in good union jobs at Canada Post stay on. The unionized workforce gradually ages and shrinks. New jobs are often temporary, contracted out, "flexible" work.

So in Canada the unionized protected sector of the economy has somewhat more older workers; the flexible, non-union, low wage sector of the economy has somewhat more immigrant and younger workers.

So, yes, in cross sectional data you'll see older people earning more.

But young people cannot assume that they, too, will earn more as they get older. It's as likely that the unionized protected jobs will simply disappear.

You also have to be very careful in reading the research. Most studies use 'potential experience' i.e. age-schooling-6 as a measure of experience. So the returns to experience become indistinguishable from the returns to age.

The returns to actual experience may vary.

Oh, and foreign experience counts for zero.

[Mike Moffatt]

I think I kind of muddled a few things above. The question isn't so much "why are existing workers earning more than younger ones", it's more "why is the wage gap between a newly hired 40 year old higher than a 22 year old". I'm not entirely sure that there is an increasing gap here (I need to spend more time in the literature). It's more an exercise of "what could cause this to happen".

[CBBB]

There's been a general decline in the power of labor - workers in the range of 3-8 years of experience have experienced this decline less because they have some skilled experience but yet not too many years of working so they are not too expensive yet.

[Frances Woolley]

Mike: "why is the wage gap between a newly hired 40 year old higher than a 22 year old".

Why is the wage gap between a newly hired 40 year old **and what** higher? Do you mean that the gap between a newly hired 40 year old and a newly hired 22 year old is higher than it used to be? If so, I think you need to be careful about even asking that question.

The market for 40 year olds has always been a thin labour market - buying a used employee is a bit like buying a used car - there's always a risk of being stuck with a lemon. (This doesn't matter for minimum wage jobs where you can easily fire someone who doesn't work out, it does for professional jobs). Resume studies have documented a lot of age discrimination in the labour market - e.g. submit comparable resumes, one from a 25 year old and one from a 45 year old - the 25 year old will generally get the job.

Any newly hired 40 year old in a professional job might well be "star" - buying a used car in general might be a risky proposition, but buying a MX6 in immaculate condition is sound investment.

If there's a lot of turnover in the labour market, and you know that a 40 year old in the labour market might just be unlucky, hiring a 40 year old is a better bet.

[Mike Moffatt]

"Why is the wage gap between a newly hired 40 year old **and what** higher? Do you mean that the gap between a newly hired 40 year old and a newly hired 22 year old is higher than it used to be?"

Yes, exactly. In yesterday's thread Determinant thought that it is. I'm not sure if it's the case, but if it were the case, what would cause that?

[Mike Moffatt]

I'll re-write this post to make it clearer what I'm asking. Unfortunately I have a deadline flying at me.

[Patrick]

"This doesn't matter for minimum wage jobs where you can easily fire someone who doesn't work out, it does for professional jobs"

Strictly speaking, this isn't true. At least not in AB. The employer can dump a new employee within the probation period (which, I believe, defaults to 3 months unless everyone agrees otherwise) for any reason, or no reason. No prudent firm would ever agree to hire anyone - professional or otherwise - unless they had a probation period.

[Frances Woolley]

Mike -

and I'm guessing that the presumption is that the newly hired 40 year old earns more than the newly 20 year old?

What could potentially cause that is a decrease in the amount of adverse selection in the labour market, which would be caused by an increase in turnover or a decrease in the importance of internal labour markets.

In a world where Bell Northern Research and John Deere and General Motors hire 20 year olds and keep and promote their most talented individuals, no one ways to hire a 40 year old - "Tell me again why you left your last job?".

In a world where Nortel and RIM lay off thousands of workers, there's potentially talented 40 year olds out there who are unemployed through no fault of their own so it's not so risky hiring a 40 year old.

Patrick, perhaps I wasn't clear. People will take a risk on hiring when they can fire people without too much expense, and hiring the wrong person isn't hugely costly. I agree that is not necessarily the case for all minimum wage jobs.

I don't know if the Labour Force Survey would allow you to test this. I don't think anyone has looked at that exact comparison in Canada, and you'd have to use Canadian data, as Canada and the US have such different age/earnings wage structures. I don't know if you'd find all that much.

[Patrick]

Frances, I was saying it the other way around. The firm can make it costless in terms of severance/notice to fire someone so long as they do it within the probation period. But I think you're probably saying that it's inherently more costly to hire and fire workers with high skills levels than those with low skill levels?

[Frances Woolley]

Patrick - o.k., and, yes, that's true i.e. it's costless to fire within a probationary period. Is it inherently more costly to hire and fire high skill workers? Not always, it depends upon on how costly it is to measure skills. But I'd say that firms usually spend more on searching for CEOs, controllers, engineers, accountants etc than on searching for cashiers, wouldn't you?

[Determinant]

For clarity, there is nothing called a "probationary period" in the Employment Standards Act in Ontario. There is a clause which says that you do not have to give notice or reason for dismissal, nor payment in lieu of notice if the employee has been employed for less than three months. Probation as a contract term doesn't enter into it. If you are employed for four months, you are entitled to one week's notice or pay in lieu of notice. You can't contract out of the law.

Though this is a little litigated area because short-service employees have little reason to sue.

In the previous thread I said that many employers who post five-year experience requirements for otherwise entry-level jobs are engaged in sheep-stealing, they want to hire away from a competitor and possibly save on training. Plus get a leg up on a competitor. But in total over any given sector this is a sub-optimal behaviour from an employment creation point of view. It means that employers are not bringing new people into the industry and are not expanding the workforce.

That says something important about the private sector in my view. Are their expected returns so poor that they have resort to grabbing a bigger piece of the pie instead of making the pie bigger? Is the price structure of employment and production deformed so that cannibalizing the industry is more attractive than expanding it?

An excellent example of this trend is the life insurance sales force. Only two organizations, Freedom 55 and Sun Life actively train and engage industry rookies. Manulife has stated that it doesn't train new agents itself, nor do any of the myriad of independent MGA outfits. The bulk of the life insurance sales industry is based hiring away agents from other companies.

In general if this trends persists long enough you would see both a large amount of open positions with large experience requirements and lots of unemployed workers to "lack experience". You can call this structural unemployment but I believe the fault lies with the employers. It is a result of employers choosing not to work with the broad pool of applicants that exist but instead holding out for perfection.

More pointedly, if this persists long enough a large pool of people are going to feel excluded from the labour market. The question then follows that why should they support and engage with private industry if private industry will not engage with them? It's a question that Keynes faced in the 1930's but largely dropped off the radar after 1945. But I believe in the next five to ten years we are going to have to face it.

[Frances Woolley]

Determinant: "many employers who post five-year experience requirements for otherwise entry-level jobs are engaged in sheep-stealing, they want to hire away from a competitor and possibly save on training."

That might be part of it, but I'm not convinced it's a huge part of the story.

An employer would, in an ideal world, like to post an advertisement, have maybe five or ten absolutely superb and hireable people apply, and then hire the best person for the job.

The real world doesn't work like that. Equity in employment laws require that job advertisements be widely circulated - and a widely circulated job advertisement is more likely to attract the attention of good candidates.

But it will also attract hundreds or thousands of applications from less qualified candidates.

So employers add in additional criteria - any criterion that will reduce the size of the applicant pool and eliminate less qualified candidates is fine. Must have a university degree. Must have relevant experience. Employers might throw out any c.v. that contains a typo or a spelling mistake. Any reasonable criteria that will get a pile of 200 c.v.s down to a pile of 20.

If ever there's a labour shortage, firms will soon change their tune.

And, yes, if this goes on people are going to feel excluded from the labour market.

Why should they support and engage with private industry? What's the alternative? Even going and living in the BC interior and subsisting on the produce of a small organic farm (complete with cannabis cash crop) plus what you can earn by writing involves private industry.

[Determinant]

Mob violence? Reactionary government? Think Spain can live with it's catastrophic level of unemployment for long? How about the On to Ottawa Trek by way of a Canadian example?

Private industry lives under the rule of law and of the government. If they systematically exclude enough people to create an "underclass", though one which has the vote in Canada, why should private enterprise be surprised if the resulting government is unpleasant for them?

Further, there is no duty to advertise in Ontario. The Harris government repealed the Employment Equity Act in 1995. Furthermore no employer I have ever worked for has ever been bound to follow a particular form of job recruitment and I have encountered all methods used. So no blaming the government for this one.

Second Frances, your reasoning is inconsistent. If an employer posts five-year job requirements and tosses out 180 of 200 resumes, then odds are they are getting workers with industry experience. We come back to the same result, sheep stealing. Net private employment is not being expanded and new entrants are not entering private industry.

So my question is why is private industry's record of job creation relative to demand for jobs so atrocious? You can't invoke pay either, I will tell you in the present environment most people are happy to get work and pay negotiations just don't happen. It's been that way for quite a while actually.

[Frances Woolley]

Determinant - any federally regulated industry has to comply with federal employment equity, at least for now. That's your insurance companies.

[Determinant]

Insurance companies aren't federally regulated for the most part. Insurance is a provincial matter. Insurance companies are not in the federal employment jurisdiction. Actually most insurance companies will call their agents "self-employed" though that can be argued with. Though you certainly work for the company, life insurance agents are generally not given the status of "employee".

[Determinant]

Additionally, federal employment regulation is largely irrelevant to most businesses in Canada. It applies to chartered banks, telecommunications companies, railways and airlines. Almost every private business you can think of is provincially regulated. Provincial employment regulations are the ones that really matter.

[Patrick]

In tech, IT, project management, and probably some others, the scam works like this: a firm will go to a staffing company and say "we need someone to do X". The staffing company looks after all the unpleasantness of finding a candidate. They also keep a stable of people ready to go. They present a number of resumes to their client. Usually, only one is expected to get the job. The others are filler. The client firm interviews the candidates and hires one, or rather appears to hire one. On the first day, the new employee finds out that - surprise surprise - they are actually employed by the staffing firm. You take direction from oone of the client firms managers, you sit in a cube like one of the client firms employees, but you are just on loan to the client, on contract. The terms of the employment are never more than what is required by law, and there are never any benefits. What the staffing companies really like is for their "employees" to have a numbered company. They usually have someone on staff who will assist you to create one. Then they completely eliminate the employer/employee relationship, and all the nasty regulations, taxes and administration. Of course, it also means they can dump you anytime, and you don't get to collect EI.

I worked briefly under a dodge like this as an employee of the staffing firm. Interestingly, around the same time CRA decided to crack down on this, and they said that if everyone involved was behaving as if an employer/employee relationship existed, then in fact it did and the firm had to take deductions at source. A few people suddenly become full time regulars, with benefits. Many more were told they were fired - some of whom had been there many years.

It was also standard practice at this firm to can a ton of people at year end because (apparently) the mangers had figured out they could rig their performance metric by doing so, and thus increase the size of their bonus. They would then bring everyone back.

Needless to say, one day I picked-up and walked out and never went back.

22 year olds have no idea what is waiting for them in the labour market.

[reason]

But has this happened outside of baseball?

Yes. It also means that firms won't invest so readily in on-the-job training, because the training can walk out the door.

[reason]

Re point 4 - it seems to me that there is an argument that says this is so. I'm aware of the drift in IQ raw scores that argues against this - but lets put that controversial issue to the side for the moment. The proportion of people going into higher education has increased substantially. So, assuming that the best academic are selected for the available university places, the average quality of candidates with degrees must have fallen - unless the average quality of all candidates has improved.

[rprus]

I haven't had an opportunity to review all of the comments yet, so forgive me if this has already been covered. I'm actually working as a labour market economist and as part of my position I conduct a fair bit of research with hiring managers/ workforce planners.

While a lot of the information they provide is qualitative, of the options you've outlined, #3 is the one that comes up by far the most in my work. As workers acquire experience or human capital, they become much more mobile within a sector (or between sectors). Companies spend a lot of time investing in these workers, so for them to have negligible return on this investment if the workers leave once they have a given number of years or certification doesn't make sense. According to the people I've talked with, the experience premium is still a good value because of the time, cost and effort it takes for a company to develop an experienced worker. They level of productivity of an experiences worker also tends to be much higher than a green one, so this premium allows the worker to recoup some of the added value they provide.

Based on conversations I've had as well, this premium could get even larger as demographics push older workers out of the labour force and into retirement. Already there are a number of employers I know who are "paying" (either with money, or more flexible/non-standard work arrangements) experienced workers to remain working longer, or to act as mentors for green workers to hopefully allow them to accrue experience faster.

[Determinant]

@Patrick:

I sat in an interview and was told that was what exactly what was being offered. They even mentioned something about people setting up companies. I'm a diabetic. That makes me more attuned than most to benefits and regularity. A regular schedule really helps diabetes control, which means I have to be a bit picky but that's life.

I didn't get the job and wouldn't have taken it if it was offered. I would have a paid a personal price in terms of degraded health that was just too high.