Economics of Equal Pay
by Svetozar Pejovich
Issue 205 – June 6, 2012
After the World War II, the earning differences between men and women became one of America’s most heatedly debated issues. Two observations fueled this debate: the absence of credible evidence that men and women in the United States are not equally productive, and the fact that the market for labor is open and competitive. Given those two observations, profit-seeking employers were expected to bid for the services of women doing the same work as men and, in the process, drive their wages up? However, it didn’t happen. There are two major and conflicting explanations.
Political activists claimed that a major reason for the income differences is discrimination based on sex. The discrimination argument led to political pressure on legislators to enact the ‘equal pay for equal work’ legislation. Economically, equal pay for equal work legislation redistributes incomes. Institutionally, equal pay for equal work substitutes a top-down formal rule for the bottom-up voluntary contracts between employers and employees.
Professional economists argued that the real culprit for the wage differences between men and women was not discrimination but the behavioral incentives of the rules of the game. The wage differences reflected the market evaluation of the costs of hiring females based on the prevailing tradition. Hence, the market for labor treated women as a high-cost resource relative to men. Why?
Traditionally, American men specialized in earning incomes, while women specialized in homemaking and raising children. Single women were socially marginalized. Unwed mothers were not socially acceptable. Wives dropped in and out of the labor market in order to pay some specific expenses. The quit rate of women was relatively high. The costs of hiring women and their on-the-job training were then in general high relative to the costs of hiring men. The word general is important. The real cost of unequal pay for equal work was borne by career-oriented women. That was so because employers based their hiring choices on observed averages. The costs of identifying career women were high and employers had no incentives to incur those costs. Predictably, all women earned wages below those earned by men.
In the second half of the last century, the growing demand for labor and the increasing variety of durable consumer goods raised the opportunity costs of homemaking. Higher opportunity costs of homemaking led to a significant increase in women’s participation in the labor force from 33.9% in 1950 to 59.3% in 2005. However, the market for labor continued to respond to the incentives of the prevailing tradition, and women continued to earn less than men. The game had changed but the rules had not. In that institutional environment, by denying women an opportunity to compete for jobs at wages that compensate employers for the perceived difference in the costs of hiring them, equal pay for equal work legislation would increase unemployment of women.
The critical issue for women was to change the rules of the game. And career women, not political activists who emphasized the benefits and ignored the costs, did it by bearing the costs of institutional restructuring. They lived with men without marrying them. They accepted being single moms. And they accepted divorce as an unfortunate but not the career interrupting event. In general, they bore the costs of defying the prevailing rules. As competitive markets began to respond and drove the wages of career women up, other women followed in their footsteps. Eventually, the rules of the game changed to accept the Pill, single motherhood, live-in arrangements, and no-fault divorce.
By ignoring a number of job-related constraints that never bothered men, career women initiated changes in the rules of the game. And those changes, slowly but steadily reduced the income differences between men and women without interfering with the bottom-up voluntary contracts.
Svetozar (Steve) Pejovich, Professor Emeritus, Texas A&M University.