Unit 6 The firm and its employees

6.7 Employment rents: The cost of job loss

There are various reasons why people put in a good day’s work. For some, doing a good job is its own reward, and anything else would contradict their work ethic. Even for those not intrinsically motivated to work hard, feelings of responsibility towards other employees or the employer may provide strong work motivation. For some employees, hard work is a way to reciprocate a feeling of gratitude to the employer for providing a job with good working conditions.

But because workers are typically paid not for a job well done, but by the hour, their effort contributes to profits rather than their own incomes. So there is a conflict about getting the work done.

There is another reason to do a good job: the fear of being fired, or missing the opportunity to be promoted into a position with higher pay and more job security.

Laws and practices concerning the termination of employment for cause (that is, because of inadequate or low-quality work, rather than insufficient demand for the firm’s product) differ among countries. In some countries, firms have the right to fire a worker whenever they choose, while in others, dismissal is difficult and costly. But even in these cases, an employee has to consider the consequences of not reaching the employer’s expected standards. For example, they would be unlikely to achieve a position in the firm where they could count on promotion, or remain employed when lower demand for the firm’s products results in some workers being dismissed.

economic rent

Economic rent is the difference between the net benefit (monetary or otherwise) that an individual receives from a chosen action, and the net benefit from the next best alternative (or reservation option). See also: reservation option.

employment rent

The economic rent a worker receives when the net value of their job exceeds the net value of their next best alternative (that is, being unemployed). See also: economic rent.

Workers care about keeping their jobs because the value of the job (taking into account all the benefits and costs it entails) is greater than the value of the next best option—which is being unemployed and searching for a new job. In other words, there is a form of economic rent, called employment rent—the difference between the net benefit from the job, and the net benefit of being unemployed.

Employment rents can benefit owners and managers in two ways:

• The employee is more likely to stay with the firm: If they were to quit the job, the firm would need to pay to recruit and train someone else.
• They can threaten to fire the worker: Owners and managers exert power over employees because the employee has something to lose. The threat can be implicit or explicit, but it will make the worker perform in ways that they would likely not choose unless this was the case.

The same reasoning applies to the employment of managers. Owners wield power over managers because they can fire them, eliminating their employment rents. The economist, Karl Marx, recognized that this relationship between employers and workers made the employment relationship fundamentally different from that of buyers and sellers in goods markets.

Great economists Karl Marx

Adam Smith, writing at the birth of capitalism, became its most famous advocate. Karl Marx (1818–1883), who watched capitalism mature in the industrial towns of England, became its most famous critic.

Born in Prussia (now part of Germany), he attended the local classical high school, which was celebrated for its ethos of enlightened liberalism. In 1842, he became a writer and editor for the Rheinische Zeitung, a liberal newspaper. After the newspaper was closed by the government, he moved to Paris and met Friedrich Engels, with whom he collaborated in writing The Communist Manifesto (1848). He moved to London in 1849. At first, Marx and his wife Jenny lived in poverty. He earned money by writing about political events in Europe for the New York Daily Tribune.

Marx saw capitalism as just the latest in a succession of economic arrangements in which people have lived since prehistory. Inequality was not unique to capitalism, he observed—slavery, feudalism, and most other economic systems had shared this feature—but capitalism also generated perpetual change and growth in output.¹

He was the first economist to understand why the capitalist economy was the most dynamic in human history. Perpetual change arose, Marx observed, because capitalists could survive only by introducing new technologies and products, finding ways of lowering costs, and by reinvesting their profits into businesses that would perpetually grow.

This, he claimed, inevitably caused conflict between employers and workers. Buying and selling goods in an open market is a transaction between equals: nobody is in a position to order anyone else to buy or sell. In the labour market, where owners of capital and workers seem similar to buyers and sellers, the appearance of freedom and equality was, to Marx, an illusion.

Capital is long and covers many subjects, but you can use a searchable archive to find the passages you need.

Employers did not actually buy the employee’s work; instead, the wage allowed the employer to rent the worker and to command workers inside the firm. Workers were not inclined to disobey, because they might lose their jobs and join the ‘reserve army’ of the unemployed (the phrase that Marx used in his 1867 work, Capital). Marx thought that the power wielded by employers over workers was a core defect of capitalism.²

Marx also had influential views on history, politics, and sociology. He thought that history was decisively shaped by the interactions between scarcity, technological progress, and economic institutions, and that political conflicts arose from conflicts about the distribution of income and the organization of these institutions. Capitalism, by organizing production and allocation in anonymous markets, created atomized individuals instead of integrated communities.

In recent years, economists have returned to themes in Marx’s work to help explain economic crises. These themes include the firm as an arena of conflict and of the exercise of power (this unit), the role of technological progress (Units 1 and 2), and the problems created by inequality.

The costs of losing your job

To calculate employment rent—the net cost of job loss—we need to weigh up all the benefits and costs of working compared with unemployment.

There are some costs of working, such as:

• The disutility of work: Employees must spend time doing things they would prefer not to do
• The cost of travelling to work every day
• Childcare costs.

But there are many benefits, which would be lost if you lost your job:

• Wage income: This may be partially offset by unemployment benefit, or informal earnings or work on the family farm while searching for a new job.
• Firm-specific assets: Including workplace friends, and perhaps the proximity of the workplace to your present home.
• Medical insurance: Employers pay for the employee’s healthcare in some countries.
• Social status: The stigma of being unemployed is equivalent to a substantial financial cost for most people.

The overall cost of losing your job depends on how long these losses will continue:

• The expected duration of unemployment: That is, how long you expect to remain unemployed before finding another job.
• Whether you are likely to find a job of similar value: If your standard of living in unemployment is low, you may have to accept a less desirable job than the one you have lost.

How long people remain unemployed varies with the type of work they do, and the state of the labour market: how many vacancies there are and how many workers are competing for jobs. Figure 6.7 compares the results of surveys of unemployed people in a sample of countries in 2021, showing the average time they had been unemployed. In Canada and the United States it was 5 or 6 months, but in some countries it was more than a year.

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https://www.core-econ.org/microeconomics/06-firm-and-employees-07-job-loss-cost.html#figure-6-7

Figure 6.7 Average unemployment duration in a sample of countries, 2021.

OECD. Average duration of unemployment. Accessed December 2022.

This evidence gives only a rough indication of what an individual can expect when they become unemployed. But it illustrates that, for many people, losing a job matters a lot—because the loss of income and other benefits may be sustained over a long period. And in countries where unemployment benefits are less generous, average duration may be lower, not because there are more jobs available, but because people accept jobs that are a less good match, offering lower wages.