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Leave the Market-Failure Story Behind

David Henderson weighs in here on the paid-leave debate.

I was mistaken in my initial post to accuse AEI’s Aparna Mathur of offering no market-failure justification for government action to increase paid leave. She indeed did so, as Angela Rachidi pointed out in a comment here at Cafe Hayek and as David discusses in his post.

Alas, though, I’m unimpressed with Dr. Mathur’s explanation of why adverse selection allegedly causes markets to fail in a way that is correctable by government action. Below are my initial reasons for being unimpressed. (I originally offered these remarks as a comment on David’s post.)

I’m unimpressed with Dr. Mathur’s adverse-selection argument.

First, it assumes that for all workers at each firm – or at least for all workers at the same level (or job-classification) and seniority at each firm – the value of the monetary wages and the package of fringe benefits is the same. Yet I see no reason in reality, other than transaction costs, why such identical pay packages must exist.

An entrepreneurial – Dr. Mathur accurately says ‘innovative’ – firm could offer each employee pay-package A, which includes no paid leave and higher take-home pay, or pay-package B, which includes paid leave and lower take-home pay. In principle, of course, there could also be pay-packages C, D, … N.

I have no idea how common such differential pay-package offerings are in reality. If we do not see such offerings it might be because sufficient satisfaction of these different worker preferences is achieved across different firms rather than within each firm. Alternatively, it might be, as I suggested above, because of transaction costs: the value to employees of having multiple pay-packages among which to choose is too low to justify employers incurring the costs of offering such packages.

If transaction costs are the real-world explanatory variable here, will mandated or otherwise government-arranged paid leave make matters better? Certainly mandating paid leave won’t do so. But it’s unclear to me even how the policies pushed by some AEI scholars and other conservatives will make matters better.

Drs. Mathur and Rachidi would likely say that, by allowing workers to ‘purchase’ paid leave by borrowing against their Social Security funds, more workers of child-bearing age will be willing to work at firms that don’t offer paid leave among workers’ fringe benefits. And so (Drs. Mathur and Rachidi would continue) those firms will be able to keep their take-home wage offerings high enough to attract workers who have no interest in taking paid family leave.

So far so good. But if worker Jones is more likely than is worker Smith to take paid leave, Jones is a less-productive employee over time than is Smith. And so Jones will be employed only if he or she is paid a wage lower than that which is paid to Smith.

Now we encounter a problem with Dr. Mathur’s market-failure story. If the typical employer can overcome the transaction costs of paying otherwise identical workers (Jones and Smith) different wages to reflect Jones’s greater likelihood of taking leave, why can’t the typical employer overcome the transaction costs that attend the employer itself taking the initiative of offering to both the Joneses and the Smiths among their workers the choice of pay-package A or pay-package B?

I readily admit that assumptions can be made that ‘prove’ that the transaction costs in one case differ sufficiently from those in the other case to result in the AEI policy ‘working’ while markets on their own will ‘fail.’ But what are these assumptions? How realistic are they? Surely we – and especially scholars at organizations such as AEI – ought not go about pushing for new government programs simply because some of us are clever enough tell a tale of how markets might, just might, fail relative to how government might, just might, succeed.