Gerard Jackson
Regardless of the prattling of leftwing activists and union mouthpieces unions cannot raise real wages for everyone. That they can raise real wage rates for some, however, has never been disputed by free market economists.
As the late Professor Hayek put it: ". . . workers can raise real wages above the level that would prevail on a free market only limiting the supply, that is by withholding part of labour. The interest of those who will get employment at the higher wage will be opposed to the interest of those who, in consequence, will find employment only in the less highly paid jobs or who will not be employed at all" (The Constitution of Liberty).
What is being discussed here is a restrictive wage rate, one that raises labour costs above market clearing levels so causing unemployment. By restricting the supply of labour in certain occupations unions are able, therefore to raise real wage rates in those occupations — but only by forcing wage rates down elsewhere. Thus effective union rates are really restrictive wage rates. This is something that any competent economist should know and argue against, unless he thinks putting people out of work is a jolly good idea.
Economists know that the wage rates are determined by the marginal value of the labourers product and the supply of labour. They also know that it is only by increasing investment per worker, not by using restrictive rates, that real wages for all can continually rise. Ordinarily this should not have to be said, but Dr Mike Nahan wrote in the IPA Review (December 2000) that many workers need unions "to assist them when dealing with their employers."
What workers want are higher real wage rates and employment security, both of which unions cannot provide but free markets can. As executive director of the free market IPA (Institute of Public Affairs) Nahan is supposed to know this. Whether he is aware of the fact or not, he has given support to the unions’ wage rate myth. Moreover, he has done it in a way that has insinuated the idea of indeterminacy of wage rates into the debate about the bargaining power of firms versus that of employees. (It appears that Mr Nahan is more adept at playing factional politics than using economic analysis).
Indeterminacy was taken seriously by some nineteenth century economists (see Mill) until the marginalist revolution took hold. Once that happened indeterminacy fell into disuse, at least as far as wage rates are concerned.
The notion that wage rates are determined by bargaining power can only have any substance if wage rates are indeterminate, at least over a significant range of wage rates, meaning marginal productivities. The existence of such a zone would mean that wage rates could be increased without any detrimental effect on employment until they reach the zone’s maximum point beyond which the demand for labour becomes price sensitive.
This reasoning could be used to argue that in the absence of union pressure employers could use their 'superior bargaining power' to force wage rates down to the bottom of the zone, which might be very low indeed, unless unions were powerful enough to drive wage rates up to the zone's maximum point. Under these circumstances unemployment would not emerge. The reason is that any gap between the maximum point and any other another point in the zone represents a profit to the firm. Therefore union power could absorb this profit without reducing employment. And there lies the theory’s weakness.
The more workers that are hired within the zone the more revenue for the firm and the greater will be the output. With all firms being in the same situation they will therefore compete against each other for workers until the wage rate reaches the top of the zone, i.e., the market clearing rate. Under union conditions, however, the profits would be confiscated and employment and output suppressed. ( The situation of non-unionised subcontractors in the building industry, i.e., bricklayers, testifies to the fact employers will bid up wage rates when market rates exceed payments).
Whether indeterminacy or marginal productivity theory is used it is clear that below-market wage rates create labour shortages. Is there a shortage of low-paid workers? Quite the reverse. large numbers of unskilled workers have been priced out of the market place. Attempts to effectively raise minimum rates will only add to their numbers.
This brings us to a study by the British Low Pay Commission. There is only one thing to say — these studies are not only worthless they are destructive in the hands of unions. That the study found that the last rise in the minimum had no "measurable impact on overall employment" is what discredits it. There is no reason why every increase in the effective minimum should have a general effect on unemployment.
Minimum wage rates usually apply to a small section of the workforce. Even a marginal increase in this section’s unemployment rated can be concealed by rising employment elsewhere. But this kind of thing is bound to happen when dealing with aggregates. So the study would have to deal directly with this section.
Even then a number of factors would have to be taken into account. If demand for this type of labour is increasing then even an effective rise, if it is not too large, might not cause any unemployment if employers expect demand for their products to continue rising. This is because increasing demand would cut the real cost of labour and hence the increase in the minimum wage rate. If, however, employers’ expectations of demand are disappointed then people will be laid off. The time, if long enough, between the increase in the minimum and the rise in unemployment could lead some to conclude that the two are not connected.
Another factor is location. Demand for this particular type of labour could be rising in one region and literally be stagnant in another. The result of an effective increase in the minimum could apparently still see unemployment fall in the former region and rise in the latter, ironically giving the statistical impression that there had been no “measurable impact on overall employment”. Moreover, increases in labour costs can frequently be eliminated by inflationary policies designed for that very purpose. This is the key to Keynesian full-employment policies.
Nevertheless, it’s still necessary to call on economic history (the economist’s laboratory) to put some flesh and blood on our analysis. Fortunately America can provide us with abundant examples of the damaging consequences of effective minimum wage rates. In 1948 the minimum wage in the US had been rendered ineffective by war-time inflation, a fact was reflected in relatively low levels of unemployment for teenagers, with the black teenage unemployment rate being 9.4 per cent and 10 per cent for white teenagers. The minimum was raised in 1950 and again in 1956 causing youth unemployment to leap, with the greatest increase being among black teenagers.
Nevertheless, pro-union economists argued that raising the minimum had no effect on unemployment. Professor Orme W. Phelps (Introduction to Labor Economics, 1978 edition) cited The Monthly Labor Review, 1950, which based its findings on Southern sawmills. This actually showed that there was a general increase in investment and wage rates shortly after the minimum was introduced. Also cited was Studies of the Economic Effects of the $1.00 Minimum Wage, U.S. Dept of Labor, March 1997. This too was based on Southern sawmills and claimed that the increase in the minimum had little or no effect on output.
In language uncannily similar to the British report, the American study stated that "the minimum wage increase had not, by December 1956, resulted in any substantial changes in the economic situation of the nation as a whole, as measured in terms of employment, [or] unemployment . . . ." But as with the British case, free market economists did not say it would. What they did say is that marginal workers would be hit — and they were.
Youth unemployment leapt in the US after these rises. A fact that Phelps carelessly omitted. Returning to the first study will show just how defective this approach is. No sooner did Congress raise the minimum than the Korean War exploded. To finance the War the US government resorted to the printing press which in turn sparked off an inflationary boom that saw prices rise and unemployment dive from 5.9 per cent in 1949 to 2.9 per cent in 1953.
It was the boom and not the increase in the minimum wage that stimulated the Southern sawmills. The monetary breaks were rapidly applied pushing unemployment up to 5.9 per cent in 1954. Money supply was then relaxed and unemployment fell again, though not as low as previous levels.
These studies did not take account of monetary changes and their effect on the demand for labour, such was the Keynesian environment at the time, and that makes them worthless. At the end of the day, it is just not good enough for the executive director of the IPA to make a statement that suggests unions are needed to raise real wage rates, at least for some workers. Pandering to the unionocracy is no way to promote the cause of free markets.
Note: indeterminacy exists in certain circumstances, artists, for example, but not for general wage rates.
BrookesNews.Com
Tuesday 8 April 2003
Gerard Jackson is Brookes' Economics Editor ionocracy is no way to promote the cause of free markets.
Note: indeterminacy exists in certain circumstances, artists, for example, but not for general wage rates.
Gerard Jackson is Brookes' Economics Editor