Job lock: Theory

Links to all posts in the series to which this post belongs are in the introductory post

On what basis does one have a reason to believe job lock exists? As Gruber and Madrian wrote,

The very notion that health insurance is responsible for imperfections in the functioning of the U.S. labor market is somewhat curious. After all, health insurance is a voluntarily provided form of employee compensation. There is little discussion of the distortions to the labor market from cash wages. Why is health insurance different?

As Gruber and Madrian show, in a perfectly competitive labor market in which employers can select which workers to whom they offer health insurance, employer-sponsored health insurance (ESI) does not impose any distortions on job mobility. Any firm wishing to hire a given worker either must offer that worker insurance or offer wages increased by precisely the cost of coverage for that specific worker. Since, in this simple model, employers can freely choose to whom they offer coverage, if an individual wishes to change jobs, she simply asks her new employer for health insurance—if she wants it—or the equivalent in wages of the cost of her coverage—if she prefers that. Since the cost is the same, it makes no difference to the employer.

Perhaps you can already identify some of the ways in which the real world deviates from this simplified model. Gruber and Madrian run through them. First, for all practical purposes employers are constrained in their ability to offer health insurance to some workers and not others. For one thing, according to Gruber and Madrian, the IRS will not grant favorable tax treatment of ESI unless “most workers are offered an equivalent benefits package.” (More about this and other legal constraints in a future post in the series.) For another, it would be prohibitively costly for firms to assess the precise cost of coverage for each worker.

Second, the labor market is not perfectly competitive. Firms face different prices for labor in part because they face different prices of coverage. In particular, large firms can obtain coverage more cheaply than small firms for several reasons (fixed administrative costs, lower risk due to the pooling of greater numbers of individuals). A consequence is that workers cannot obtain the same benefits across jobs, and they will attempt to match their preferences with employers that can accommodate them, a precondition for job lock.

Gruber and Madrian consider a situation in which a worker holding a job at firm A, which offers health insurance that the worker finds valuable. Assume that the worker would be more productively employed at firm B. However, insurance costs at firm B are much higher than at A, perhaps because it is a smaller business. As a result, firm B doesn’t offer coverage. Even if it would like to hire the worker, firm B can’t just offer coverage to him alone, for reasons discussed above. Unless firm B can offer a wage such that the worker can purchase insurance on his own and still be as well off as the combination of wages and insurance from firm A, the worker will not switch jobs.

Gruber and Madrian then raise an interesting possibility. Firm A, knowing that the worker values insurance and won’t switch to firm B on that basis, could reduce the worker’s wages. However, there has been no study to suggest that such worker-specific wage adjustment according to preference for insurance occurs. Moreover, it would probably be administratively difficult to administer such fine-tuned compensation packages. If we assume that firms rarely engaged in such fine-tuning of wages, then the forgoing provides a theoretical reason to expect job lock, at least with regard to job mobility.

But what about labor force participation?

Although we have framed the preceding discussion around the specific issue of job mobility, the same model developed above can be applied to labor supply decisions as well. In this case, the choice for the worker is not between one job and another, but between employment and nonemployment, where the health insurance availability across these two states may possibly differ. For example, consider an older worker thinking about whether to retire. Even if his value of leisure is greater than his marginal product of labor, a less healthy older worker may be unwilling to retire from a job that offers health insurance if health insurance when not employed is either not available or prohibitively expensive. This is a form of “lock.”

Gruber and Madrian go on to discuss theoretical considerations pertaining to “welfare lock” (that potential workers may not enter the labor force in order to maintain means-tested welfare benefits) and job lock within the context of a secondary worker (e.g., with a spouse who may be the source of health insurance coverage). These are not that different from what has been discussed above. So, for brevity, I will omit them.

So, the theory seems fairly clear that job lock can occur. The question is, is there evidence in support of that theory? That’s the subject of subsequent posts in this series, the next of which will be on Monday.


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