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Labour market reform and productivity: Liberal Party stuffs it up again
Gerard Jackson
When it comes to productivity and labour market reform the Liberal Government and its advisers just cannot get it right. As if to underline the mess the Liberals have created for themselves the Business Council of Australia made a public statement, Sunday 9 October, in which Hugh Morgan, the BCA’s chairman, revealed his economic illiteracy.
It’s important to focus on Morgan at this point because he, and I kid you not, is considered to be one of the Liberal Party’s “important and influential figure[s]”. This, in my opinion, surely helps to explain why labour market reform is turning into a debacle.
According to this “important and influential figure” the Government’s “proposed reforms continue the move toward greater workplace flexibility and productivity…” Morgan is clearly unaware that economics does not unequivocally support his claim. In fact, one would expect a loosening of our labour market restrictions to eventually result in falling productivity, which is precisely what has been happening during the 12 months*. Nevertheless, despite the fall in productivity the likes of Morgan mindlessly parrot the line that more labour reform will reverse the situation.
As expected, opponents of labour market reform have pounced on the productivity decline. Wayne Swan, Federal Shadow Treasurer, stated that productivity in New Zealand had declined since labour market reforms were instituted in 1991 (The Age, Heightened insecurity = lower productivity, 9 August 2005). He made a similar case for Australia:
In his 2005 paper, Is Individual Contracting More Productive?, labour economist David Peetz analyses labour productivity growth in Australia. He concludes that in the present productivity cycle –– following the introduction of the Workplace Relations Act 1998 –– annual productivity growth fell to just 2.3 per cent per annum and has since worsened. This was well below the productivity performance stemming from the shift to enterprise bargaining, under which productivity growth peaked at 3.2 per cent. It is even below productivity growth during the period of traditional awards in the three decades to 1983.
Yet Morgan appears completely oblivious, as do Liberal Party officials, to this criticism, which seems to be turning into an avalanche. I pointed out more than 2 years ago that making the labour market more flexible would probably boost productivity initially. However, the productivity effect would work its way through the economy, after which it would decline. The following figure will help explain why.
BrookesNews.Com
Monday 17 October 2005
Wu is the union rate while We-E is the market clearing rate. The shaded represents the unemployment caused by the union rate. The demand curve consists of a descending array of the value of labour’s marginal product. It is clear that if labour was allowed to clear the market the wage rate would move down D1 until it reached We, at which point full employment is restored. During this process of wage rate adjustments payrolls will rise as more labour is employed, and output will expand as falling unemployment releases withheld capacity.
It is important to note, however, that in order for the market to clear productivity must fall, even as total output expands. This is an elementary point that Morgan and his advisers have completely missed. Now it is true that if labour flexibility at the level of the firm has been significantly retarded, then more freedom for firms to optimise their factor combinations will raise productivity.
This will have the effect of shifting the demand curve to the right. But this will be a one-off movement that will eventually ripple its way through the economy until the point is reached where the continuing fall in unemployment will result in falling productivity. We can now see why Hugh Morgan’s claim that freer labour markets in themselves will bring about a sustained increased in productivity is nonsense. In fact, if labour is now about as flexible as it can get at the level of the firm then there will not even be a one-off increase in productivity –– there will, instead, be an accelerated decline.
The likes of Morgan talk as if it is free labour markets that continuously raise productivity. But the real driving force behind productivity is investment. Even a badly hampered labour market will still be much more productive than a free labour market so long as it has abundant capital to work with.
A man with a shovel moves more earth than a man using his bare hands; a man with a shovel and a wheelbarrow moves more earth than man using only a shovel; and a man driving a bulldozer moves vastly more earth than a hundred men with shovels and wheelbarrows. Obviously it is the accumulation of capital goods that causes a sustained rise in productivity.
Hugh Morgan and John Calvert-Jones, another “important and influential figure” in the Liberal Party, have a lot to answer for. Both of them are responsible for supporting and spreading the fallacy that it is the number of firms that put a floor under wages rates. The number of firms has nothing to do with it. It’s the capital-labour ratio that determines the height of real wages. The numbers argument confuses the number of firms with the intensity of demand. They are two different things
I have yet to discover where Mr Morgan’s talents lie. They clearly do not lie in the field of economics. As for Mr John Calvert-Jones, he apparently has only two talents: fundraising and yachting. It’s a pity he does not confine himself to these two activities.
*In a situation where regulations have seriously hampered production, one should expect deregulation to lead to a rise in productivity. This too should be followed by a productivity decline unless increased per capita investment takes place.
Labour Market Wars, a free book explaining the benefits of free labour markets.
Gerard Jackson is Brookes’ economics editor