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November 18, 2019

Do overtime hours and pay regulations promote wage and employment growth?

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A common form of labor market regulation sets statutory limits on the work week beyond which employers are required to pay their workers a wage premium for hours worked in excess of that limit. Standard workweeks and overtime wage premia are common in both developed and developing economies. Such interventions appeal to the likely benefits to workers of more employment opportunities and possibly higher earnings. In some contexts, the motivation for overtime regulation is to place limits on workweeks that the public deem to be excessively long.

The notion that raising the overtime premium enhances employment follows from the expectation that making overtime hours more costly curbs their use, so that the reduction in overtime hours is converted into new jobs (work-sharing). Empirical studies show that overtime regulations make overtime hours more costly and that employers consequently do use overtime more sparingly. That these circumstances will generate net job creation is a far more speculative proposition.

Whatever the merits of social policy directed at reducing excessively long workweeks, numerous studies over different time periods and across countries have found little credible evidence that overtime hours and pay regulation increase employment. There are plausible reasons why employment growth would not be a consequence of raising the overtime premium or reducing the standard workweek. 

First, these policies are expected to increase overall production costs, encouraging employers to substitute nonlabor inputs, such as capital and materials, for workers. The logic is that if it would have been more profitable to reduce the workweek and the extent of overtime, employers would already have done so in the absence of the regulatory changes. Hence, the regulations increase production costs, which in turn will reduce the level of employment or employment growth. 

Second, to the extent that in many cases overtime workers are at least medium-skilled, the difficulties of substituting less-skilled, or even unemployed workers to make up for the reduced hours of skilled overtime workers makes any large positive effect on their employment fairly unlikely.  

Third, reducing the standard workweek has been found to increase moonlighting among overtime workers, which results from their reduced hours and weekly earnings, giving these workers more time and monetary incentives to seek second jobs. Since they compete with unemployed workers for jobs, although the number of jobs held might increase, the number of individuals employed would not.

It is also important to distinguish between the short- and long-term effects of overtime hours and pay legislation. Whatever the short-term effects are, the long-term effects can be quite different. In the longer term, workers and their employers can be expected to adjust to policy-induced changes in overtime provisions via adjustments in the growth rates of straight-time hourly wage rates and hours of work. While the dire consequences of employment reductions might very well be avoided in the long term, the neutralizing market adjustment process that might mitigate the consequences of the policy-induced cost increases would yield negligible effects on employment. Hence, the prospects for expected job creation stemming from the policy changes are not positive.

© Ronald L. Oaxaca

Read Ronald L. Oaxaca’s IZA World of Labor article “The effect of overtime regulations on employment.

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