Can Pay Regulation Kill? Panel Data Evidence on the Effect of Labor Markets and Skills on Hospital Quality and Productivity

Centralized public sector wage setting for public sector workers is widespread. We would expect such regulation to have effects on labor supply and on the productivity of public services in areas with strong local labor markets. In this paper we test this, using the British National Health Service as our test bed. We predict that areas with higher outside wages should suffer from problems of recruiting, retaining and motivating workers and this should harm hospital performance. We construct hospital-level panel data on both quality as measured by death rates (within hospital deaths within thirty days of emergency admission for acute myocardial infarction, AMI) and productivity. We present evidence that stronger local labor markets significantly worsen hospital outcomes in terms of quality and productivity. A 10% increase in the outside wage is associated with a 4% to 8% increase in AMI death rates. We find that an important part of this effect operates through hospitals in high outside wage areas having to rely more on temporary "agency staff" as they are unable to increase (regulated) wages in order to attract permanent employees. We quantify the magnitudes of these "hidden costs" of labour market regulation, which appear to be substantial