Monday, January 21, 2013

Why Wages Remain Low for Unskilled Work

My spring semester Introduction to MacroEconomics course has started.  Income distribution is covered in the first assigned chapter and a number of students had questions concerning the low wages of unskilled workers.

Wages are the price of labor and, like other prices, wages are determined by supply and demand.  While there is still demand for unskilled labor in the United States, supply has been shrinking and this should cause wages to increase.

One reason why wages for unskilled labor do not  increase very much is the fact that output per worker is low.  Thus, when wages begin to increase due to declining supply, companies tend to either invest in and begin substituting capital for labor or move production overseas to a place where such labor is cheap and plentiful.

However, another reason is that the role of the price mechanism is to attract resources to areas of scarcity.  So whenever the supply of something decreases its price increases and this increase in price (and the potential profit from meeting this shortfall) results in efforts to increase the supply.

In the case of unskilled labor an increase in wages results in an immediate increase in supply.  

Unskilled workers, due to lack of training and education, have nothing to offer employers beyond time and muscle.  The fact is that any able bodied individual can provide muscle power.  As to time, if the wage rate is high enough, the opportunity cost of such jobs is generally greater than using their time working in their skilled job.

Because the supply of unskilled labor is so elastic, noticeable increases in unskilled worker wages results in the supply increasing and driving the wages back down.

Skilled jobs require training which takes an investment of time and money.  This tends to set skilled workers apart and limits the supply to only those with the necessary skills.  

So, while an unskilled worker can never compete with a skilled worker for a skilled job without first making the necessary investment of time and money to acquire the skills, a skilled worker can easily compete for unskilled positions.  Skilled workers generally don’t compete for unskilled jobs, but if the wage is high enough, they can quickly move into that market, thereby increasing the supply of available workers.

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