To support his spurious accusation he asserted that John Galbraith Jr had “showed convincingly that wages did not reflect the skills of the job”. As proof of this he stated that “Few jobs require as much skill and dedication as musical instrument making; and yet semi-skilled workers on motor assembly lines earn far higher wages”.

He then went on to unintentionally destroy his anti-market assertion with the observation that “Workers in knowledge-intensive and capital goods industries earn relatively high wages, reflecting both the market power of their employers and the high cost of mistakes on the job”.

To begin with, modern economic theory does not and never has claimed that a person’s pay is determined by “the skills of the job”. Legge’s assertion is nothing more than a vicious straw-man. Economics explains that wage rates are determined by the supply and demand for labour, with the demand curve consisting of an array of descending value marginal productivities. The point at which the supply of labour intersects the curve determines the wage rate.

From this any reasonable person can easily deduce that moving up the curve raises the wage rate while moving down the curve lowers it. Therefore it is not the skill of the workers that determines his earning but the value of his marginal product. For example, what would happen to the earning of plumbers if their number were miraculously quadrupled overnight? They would fall, of course.

Unions understand this fact, even if clever academics like Legge and Galbraith do not. That’s why craft unions and ancient guilds combined to restrict the supply of labour. Professor W. H. Hutt pointed out what every economist and union leader already knew: “The ‘standard rate’ is essentially an excluding rate” (The Theory of Collective Bargaining 1930-1975, IEA, 1975, The Theory of Idle Resources, LibertyPress, 1977, first published in 1939).

Regardless of what Legge would have his readers believe marginal productivity theory is not a “set of theories” but a theory. Moreover, the accusation that it has “no factual foundation”, meaning statistical support, is itself a lie. If he is correct there would be no correlation between wage rates and productivity. But a 1990s study by Bank Credit Analyst, a Canadian group, showed that real wages for American workers actually increased in line with value productivity, just as marginal productivity theory predicts.

The following chart shows that from 1960 to 2000 gross wages, what Americans call “real compensation costs”, moved in line with productivity, measured as output per hour of labour in the business sector. (This data came from the Council of Economic Advisors 2001).

Chart 1

Chart 2 reinforces further the close relationship that exists between real wages and productivity by illustrating the trends in the two from 1910 – 1955. We can therefore see that the trend in real wages in America over a 90-year period clearly show a statistical relationship with the upward trend in productivity, which is precisely what one would expect from marginal productivity theory. Yet the brilliant Mr Legge claims without a blush that the theory has “no factual foundation”.

Chart 2

It is rightly understood that a correlation between two or more variables does not necessarily mean there exists a causal relationship. However, when a theory makes a specific prediction about a functional relationship between two variables which is then continually confirmed by numerous statistical studies, I for one believe it fair to conclude that there is good reason to presume that the theory is correct. After all, a theory with no predictive powers is really no theory at all.

(Carefully note that chart 2 shows that from 1930 to 1940 real wages exceeded productivity. This was a period of mass unemployment. For an eye-opening account of this period see Vedder and Gallaway’s Out of Work, New York University Press, 1997. This book provides invaluable statistical support for marginal productivity theory).

The next chart comes from the World Bank, World Tables and shows the movement in South Korean real wages in manufacturing from 1971 to 1996. Note how closely it parallels the upward trend in productivity. Once again the theory without a “factual foundation” stands vindicated.

Chart 3

The above charts illustrate why Legge’s assertion that though average “incomes in America have risen in line with productivity growth, the whole increase has been divided between highly educated professionals and corporate senior executives”. Phillip Henry Wicksteed put this nonsense to rest more than 100 years ago when he wrote:

Everyone knows that units of a factor will be hired up to the point where the added product just covers the added cost. The sensible employer will take on more men as long as the last one earns at least as much as his wage, but no longer. (An Essay on the Co-ordination of the Laws of Distribution, 1894).

In English so plain that even an academic lefty can understand it: marginal productivity theory explains why Legge’s class-war accusation is utterly ridiculous. Now he also asserted:

In the US, the real value of the minimum wage has not even kept up with inflation over the past 25 years; with the result that the median wage, that earned by the typical worker, is no higher in real terms now than it was in 1980

This is a baldfaced lie. In fact, the statement contains two baldfaced lies. First, in addition to the Federal mandated minimum wage rate the states also have their own minimum rates. The rule is that the highest rate should always prevail. For example, though the Federal minimum is $US5.15 California’s is $6.75: Connecticut is $US7.10, Washington is $US7.35 and Oregon is $US7.25.

His second lie that the purchasing power of the median wage has stagnated since 1980 is patently ridiculous. We can easily see from charts 2 and 3 just how stupid this statement is. Now, if Legge were telling the truth then a stagnant real wage would be reflected in stagnant consumption. Michael Cox, senior vice president and chief economist at the Federal Reserve Bank of Dallas, put this lie to rest years ago. He did a statistical study in which he found that

In 1971 a color television went for more than $US600 and one would have had to work 174 hours to purchase it. Today, a better 19-inch color television costs about $199, which requires 14 or 15 hours of work. (Myths of Rich & Poor, Basic Books, 1999).

The same went for the whole range of household appliances. A 5000-BTU unit air conditioner dropped from 45 hours of work in 1970 to 23 hours in 1999; a portable radio dropped from 13 hours to 1 hour. Everything from washing machines, stoves, vacuum cleaners, microwave ovens, VCRs, telephones and telephone charges, holidays, cars, clothing, food, computing power, even McDonald’s hamburgers, have fallen in terms of work time. Moreover, these consumption figures conceal the enormous improvements that have occurred in established production and development of new products and services.

Now these figures not only refute Legge they also support the productivity trends that the above charts have plotted. In any case, how in heavens name could America nearly double factory output between 1979 & 2000 and significantly raise productivity while keeping wages stagnant for half the workforce?

What needs to be explained is what raises the value labour’s marginal product. The answer is capital accumulation. A progressing economy is one in which the capital structure is continually adding more complex stages of production to its structure. It is this process that raises real wages and hence living standards.

(Neoclassical economists would simply say that increasing the capital-labour ratio raises real wage rates. Unfortunately, this view, though fundamentally correct, overlooks the complex ramifications of capital accumulation as well as the true nature of capital. [See Ludwig M. Lachman’s Capital and Its Structure, Sheed Andrews and McMeel Inc, 1978 and Capital Expectations and the Market Process, Sheed Andrews and McMeel Inc, 1977. There is also Israel Kirzner’s An Essay on Capital, Augustus M. Kelley, Publishers, 1966]).

Figure 1 crudely illustrates this process. The downward-sloping demand curve in country A represents the capital structure. Therefore, where the population is high relative to size of the structure real wage rates will be much lower. This is why, Mr Legge, aircraft “assembly workers in China and Brazil get far less than aircraft assemblers in Toulouse or Seattle”. Now figure 2 illustrates the situation in which country B has the same capital structure but only 60 per cent of the labour force. Here wages rates are twice as high.

Crude as these illustrations are they do emphasise the singular importance of capital accumulation in raising real wages. It takes little imagination to see that if the increase in population exceeds the increase in capital accumulation real wages will fall.

Seventy-one million Americans were employed in 1965: today the figure is 142 million –– a 100 per cent increase. Since the 1970s alone, the US economy has created some 57 million new jobs as against only several million in Europe, a truly astonishing achievement. Despite this massive increase in the workforce the US economy still leads the EU.

Compare the US situation with France whose per capita GDP is even lower than Alabama’s, America’s poorest state; its unemployment rate is about twice as high as the US rate while its total private per capital consumption is about half the US level. (Funny thing though, one never reads anything from the likes of Legge and Galbraith about stagnant wages in France). The situation is not much different in Germany. In 2004 US average per capita income averaged $US38,324 as against $US26,937 for Germany while its jobless rate is also twice the US rate.

(According to Legge and Galbraith the $US38,324 income figure is misleading because everyone knows filthy corporate executives are confiscating US workers’ productivity gains).

However, there probably are employment black-spots in the US economy. To get a grip on this situation it is vitally important to understand that there is no such thing as the labour market –– there are only labour markets, the most vulnerable of which consists of the unskilled and uneducated. What makes this group vulnerable is not rapacious capitalists but the well documented inflow of millions of illegal immigrants whose entrance into this labour market has had a detrimental effect on its wage rate structure. But this is a fact that lefty critics like Legge and Galbraith choose to ignore.

Another thing they ignore is the extent to which the left has devastated US education standards. This is how Legge treats the matter. He claims that

The last crash of a jet passenger aircraft in the US before September 11 involved an aircraft whose pilot was paid half the normal rate and baggage loaded by contract workers on the minimum wage.

Presented with a crate marked in large yellow letters on a red background “Do not air freight”, the handlers loaded it anyway.

That these handlers might not have been able to understand what was written thanks to America’s progressive “education system” is a thought that Legge could not entertain. Furthermore, perhaps these handlers were illegal immigrants with a slippery grasp of English. Whatever the case, to blame the accident on a minimum wage rate is an incredibly stupid thing to do –– even for him.

In defending minimum wages Legge argued that “American academics Alan Card and David Kreuger found that rises in the minimum wage had very little impact on unemployment”. It’s a pity that he neglected to point out the Card-Kreuger study has been completely discredited. Furthermore, he also overlooked the fact that Card admitted that advocates of minimum wages had “overreacted to the New Jersey study.”

Nowhere did Card actually say that raising wages above the market level will not cause unemployment (BrookesNews.Com, 1 August 2005).

Nevertheless, Legge confidently pronounced that raising the minimum wage will lead to an “increase in aggregate demand” “because the low paid spend all that they earn. This brings us right back to the ridiculous consumption-drives-the-economy fallacy. Therefore, according to Legge’s primitive economics, rises in the minimum wage not only pay for themselves they also generate economic growth! If this is true, why doesn’t he propose a minimum wage of $1000 a week or even $10,000? John Stuart Mill thought he had put a stake through this fallacy when he wrote:

I apprehend that if by demand for labour be meant the demand by which wages are raised, or the number of labourers in employment be increased, demand for commodities does not constitute demand for labour. I conceive that a person who buys commodities and consumes them himself, does no good to the labouring classes; and that it is only by what he abstains form consuming, and expends in direct payments to labourers in exchange for labour, that he benefits the harbouring classes, or adds anything to the amount of their employment. (Principles of Political Economy, 1848).

In other words, demand springs from production and not consumption. (See Consumption and economic growth: the economic fallacy that won’t die and Getting the Australian economy wrong –– the consumer spending fallacy)

Note: What is truly infuriating is the Liberal Government’s inexcusable incompetence in defending its labour market reform package. It has allowed itself to be intellectually intimidated and confused by a bunch of leftwing flakes. How did this happen? If my informants are correct a great deal of the trouble stems from having the wealthy likes of John Calvert-Jones and Hugh Morgan influencing the Liberal Party on economic policy.

In the field of economics Calvert-Jones is a complete buffoon whose activities have helped restrict economic advice to a shallow few with the result that labour market reform is turning into a fiasco.

Like Calvert-Jones, Hugh Morgan (former CEO of Western Mining Inc) is a man who could not tell the difference between an isoquant and a demand curve. Nevertheless, he has the effrontery to strut about the public arena demanding attention for his economic views which largely consist of talking points of which he has little understanding.

For instance, on Lateline (ABC 10 August 2005) the only thing he could say about the minimum wage is that “It’s about 58 per cent of the median pay packet”. This is not an argument against effective minimum wages. Economic theory provides the argument against job-destroying minimum wages, not isolated statistics. Unless this genius thinks one does not need theory to explain statistics.

If this pair and their cronies were any good they would be wiping the floor with the likes of Legge, Galbraith, Belchamber, etc. That they cannot do it tells us a great deal about the Liberal Party’s very “important” people.

Free labour markets and a leftwing academic’s propaganda

Labour market reform and the costs argument

Gerard Jackson is Brookes’ economics editor

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