## Chapter Study Outline

• There is more to a worker’s career than his earnings. A firm’s production technology will also dictate the worker’s tasks and responsibilities.

• Firms possess an internal labor market (ILM) characterized by a hierarchy of job titles, each associated with its own set of tasks.
• Instead of treating the firm as a black box, this section studies the inner workings of task assignment within the box.
• Model 15.1: Tasks and Abilities
• (a) There are two tasks, 1 and 2, and two workers, A (a man) and B (a woman), who differ in their abilities to carry out the two tasks.
• (b)The level of output (y) is governed by the task-based production technology: y = f(τ1,τ2), where τ1 and τ2 represent the respective amounts of task 1 and task 2 that are carried out during the period.
• (c) Worker A’s ability is characterized by (aA1, aA2), where aAi represents the maximum amount of task I =1, 2 that he can perform if he devotes all of his time to it.
• Worker B’s ability is characterized by (aB1, aB2).
• (d) Each worker can perfectly substitute time between tasks.
• A worker’s task-possibility frontier is the set of all feasible output combinations for a given amount of time. The worker cannot accomplish any combination outside of the frontier in the same amount of time, but he can accomplish less with less effort. Suppose A’s ability is (8, 4) and B’s ability is (9, 9).
• Since worker B’s possibility creates a triangle (ΔB) that completely encompasses worker A’s triangle (ΔA), worker B has an absolute advantage in both of the tasks.
• The slope of worker A’s frontier is a straight line with slope ρA = aA2 / aA1 = 1/2, while worker B’s is ρB = aB2/aB1 = 1.
• ρA and ρB characterize the opportunity cost of performing task 1 in terms of task 2.
• Since ρA = 1/2, if worker A increases τ1 by a unit, she must reduce τ2 by half a unit. Worker A’s opportunity cost of a unit of τ1 is only half a unit of τ2.
• Since ρB = 1, worker B’s opportunity cost of a unit of τ1 is a full unit of τ2.
• Worker A has the comparative advantage in task 1 since she has a lower opportunity cost for producing another unit of τ1.
• The firm’s isoquants represent the particular combinations of tasks that generate the same quantity of output.
• The slope of a given isoquant is the marginal rate of technical substitution (MRTS) between task 2 and task 1.
• The MRTS declines from left to right because the isoquant is convex to the origin.
• The isoquant’s convexity stems from the relative scarcities of the two tasks.
• The firm’s combined task-possibility frontier represents all of the output-maximizing allocations of the time of worker A and B. These allocations are governed by comparative advantage.
• At the intersection of the combined frontier and the y-axis, both workers spend all of their time on task 2.
• The portion of the line between the y-axis and the kink has a slope equal to |ρA|.
• At the intersection of the combined frontier and the x-axis, both workers spend all their time on task 1.
• The portion of the line between the x-axis and the kink has a slope equal to |ρB|.
• At the kink, worker A spends all his time on task 1 and worker B spends all her time on task 2.
• y* represents the firm’s optimal choice, at which point its isoquant is tangent to the combined task-possibility frontier.
• Given different technology, y* may lie elsewhere on the combined frontier.
• Thus far the analysis has assumed that workers can freely split their time between tasks. In practice, some jobs are characterized by indivisibilities and must be filled exclusively by a single worker.
• Indivisibilities may cause task assignments to be driven by absolute rather than comparative advantage considerations.
• The O-ring theory states that the more complex the production technology, the more that ability is valued at the margin.
• Kremer (1993) demonstrated that the labor market is characterized by assortative matching, which places high-skill workers in tasks with little room for error.
• Earnings and the level of output increase rapidly with skill.
• High- and low-quality producers co-exist in equilibrium, employing workers of correspondingly high or low skill and earnings levels at every level.
• Pekkarinen (2002) finds support that, ceteris paribus, the earnings of equally talented workers increase with the complexity of their employer’s technology.
• Assumption 15.1: Absolute Advantage
• (b') The task-based production technology is y = (τ1 - aA1) ∙ F(τ2), where F(τ2) is increasing in τ2.
• (d') Each task must be filled by only one worker.

15.2 Organizational Design

• In 1799 Eli Whitney’s musket assembly line precipitated a manufacturing revolution.
• The key features were dedicated machinery with interchangeable parts and standardized components, which led to reduced costs, improved quality, and increased quantity of production.
• In the nineteenth century Ford’s moving assembly line continued the evolution of production technology.
• In the late twentieth century, specialized equipment was replaced with flexible or lean production systems that could be quickly retooled to produce different components.
• These ideas were first implemented in the Japanese auto industry in the 1950s and 1960s.
• The ongoing restructuring of American industry resulted in large productivity gains and profound changes in the labor market.
• New production techniques favored high-skilled workers, which exacerbated wage inequality.
• New production techniques have moved from traditional mass-production (assembly-line) methods to lean manufacturing systems, which are characterized by:
• Total quality management (TQM): a set of systematic activities to efficiently achieve company objectives and produce the highest quality product for an appropriate price.
• Kaizen: the Japanese management philosophy of continuous improvement
• Just-in-time (kanban) production: a feature of the modern manufacturing system that uses small inventory holdings and seamless integration of the production process.
• This system reduces operational costs by tying up fewer productive inputs in inventories.
• Kanban also enhances product quality by quickly identifying and fixing defects in the system.
• Systemwide complementarities among business activities are extremely important in the production function, requiring a coherent overall fit among various business practices.
• Changing any one activity may either leave the total level of output unchanged or even reduce it.
• General Motors’ experience implementing new production equipment represents a failed attempt to increase productivity with a one-dimensional change.
• A firm can only increase output by making adjustments along multiple dimensions.
• However, determining the correct adjustments is an experimental stab in the dark.
• There are many valid reasons why firms may hesitate to adopt new production methods with huge potential gains.
• Reorganization is a costly experiment that may lead to failure of the firm.
• There are direct transitional costs to organizational change.
• There are opportunity costs associated with early adoption, namely, free-riding on information provided by others’ mistakes.

15.3 Human-Resource Management

• Given the importance of production complementarities, it would be foolish for a firm to invest billions of dollars in flexible production without harmonizing its human resource management (HRM) policies.
• High-performance work practices (HPWPs): methods that design jobs in a manner that takes full advantage of the productivity gains of combining bundles of complementary tasks. The category of HRM practices corresponds to lean manufacturing production methods, including:
• Problem-solving teams
• Job rotation
• Screening
• Information sharing
• Training
• Incentive pay
• Job security
• Traditional work practices (TWPs): the category of HRM practices corresponding to traditional mass-production methods.
• TWPs are characterized by the absence of many or all of the activities involved in HPWPs.
• There are also complementarities among HPWPs.
• The firm will have to implement a minimum of four HPWP components by first securing greater worker involvement, then introducing job security provisions, then adding greater job flexibility and training, and perhaps also implementing incentive pay.
• In the past, economists have studied firms using case studies of a single firm and cross-sectional and longitudinal industrywide data to examine a collection of firms.
• Insider econometrics evaluates the success of HPWP using detailed data collected from deep within the firm.
• A focus on a narrowly defined production process permits an apples-to-apples comparison of firms.
• Researchers visit production sites.
• Field research permits thorough understanding of the production process.
• Interviews with employees at multiple levels allow researchers to understand the firm’s HRM policies.
• Econometric methods estimate the model using panel data collected from the universe of firms that use the particular production process.

15.4 Hierarchies

• One explanation for workplace hierarchies is that the firm assigns the highest-ability workers to the top of the organization since their abilities enhance the productivities of all workers employed below them.
• At least part of the rightward skew of the earnings distribution in developed countries may be a result of hierarchical firm organization.
• Hierarchies may also exist to control worker shirking, with each superior level of workers in a pyramid-shaped hierarchy monitoring its subordinates.
• Scale of operations effect: the closer a worker is placed to the top of the hierarchy, the greater the impact of his individual performance on the firm.
• High-ability workers are better at catching shirkers.
• The pyramid-shaped hierarchy is also the optimal arrangement for dealing with the huge amounts of information that firms must process.