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Law of supply and demand sets terms of work

Employee benefits — health insurance, pensions, sick leave and vacation days — are in the news a lot these days. State governments want to cut the cost of providing benefits by shifting some of the cost to the employee. Meanwhile, the Catholic Church asserts a conscientious objection to paying for health insurance that includes coverage of contraceptives. These seemingly unrelated issues can be addressed using the law of supply and demand.

In economics, a job is an exchange of work for compensation. In this exchange, the compensation package is in no way a gift: The employee earns the entire amount, regardless of its mix of money and benefits. Moreover, this exchange is mutually beneficial: The employer will never knowingly pay more than the value of the work received; the employee will not accept less than the value of the best available alternative employment.

The simplest illustration is the case of compensation consisting solely of money wages — that is, no fringe benefits. The exchange between employer and employee is complete once the work is performed and the wages paid. What the employee does with the money earned is separate from and subsequent to the exchange of work for pay. If the money is spent on dinner at a restaurant, it is clear that the employee and not the employer bought the dinner. The same conclusion follows when compensation includes fringe benefits. The benefits are neither a gift nor some form of excessive compensation. They are part of the employee's earnings.

Two cases

Public Employee Compensation

When reducing public payrolls by cutting back on fringe-benefit contributions, state governments are not exempt from the law of supply and demand. Unless they were previously paying more in total compensation than the competition, such cuts can result in self-inflicted economic harm to the state as they may find it increasingly difficult to recruit and retain a talented workforce.

Governors often defend these cuts by noting that the fraction of total compensation in the form of fringe benefits is higher for public employees than for their private-sector counterparts. That is true, once again due to supply and demand. The state has advantages that private firms do not. Governments last longer than business firms, and they can make longer-term promises to their employees. In turn, public employees are more willing to accept nonwage compensation than are private-sector workers. In addition, states expect economic growth to result from public-sector productivity, and so it is efficient for future taxpayers, who will enjoy that stronger economy, to help pay for deferred compensation.

Finally, there are federal tax provisions that favor fringe benefits over money compensation. So, while it is understandable that the fraction of compensation paid in benefits will be higher in the public sector, it remains true that it is the total compensation that must be competitive, not the individual components of compensation.


The law of supply and demand also governs the financing of contraceptives. The federal government recently set off a firestorm by stipulating that health insurance policies must, without copayment, finance purchases of contraceptive devices and drugs. Many employers, mostly in religiously affiliated institutions, objected to buying insurance that contained the required provisions.

Economics shows that the employee buys the insurance, not the employer. Having contracted to exchange work for a compensation package that includes health insurance, employees are entitled to use their earnings as they see fit. The decision to buy contraceptives financed by health insurance is separate from and subsequent to the exchange of work for compensation. Economics also shows that President Barack Obama's "accommodation," requiring insurance companies to provide this coverage "rather than the employer," makes no economic difference. The employee, not the employer, would pay for the insurance with or without the accommodation.

Charles O. Kroncke, left, is associate dean in the University of South Florida College of Business. William L. Holahan chairs the department of economics at the University of Wisconsin at Milwaukee.

Law of supply and demand sets terms of work 02/26/12 [Last modified: Sunday, February 26, 2012 3:30am]
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