Swan pointed out that when we compare the productivity performance between Australia and New from 1991 – 1996 we find that after New Zealand’s “dramatic shift from collective bargaining to individual contracts with the passage of the Employment Contracts Act 1991” the country’s productivity fell significantly, lagging considerably behind Australia’s. Using labour economist David Peetz paper Is Individual Contracting More Productive? as a source, he tells us that

…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.

He then smugly revealed how the “Business Council of Australia has searched in vain for evidence to support the argument that individual contracts will boost productivity”, concluding:

None of these or any subsequent studies have evidence that stands up to scrutiny that higher productivity –– and hence jobs and wages growth –– will result from a shift from collective bargaining to individual contracts.

What the vast majority of labour market reform supporters have missed is that the impetus behind it should be the desperate need to slash unemployment and not to raise productivity. If these people had been properly informed they would have known that free labour markets cannot in themselves guarantee rising productivity.

Ignorance on this point is truly staggering. Stuart Wood, a director of the H. R. Nicholls Society, is an unfortunate example of what is seriously wrong with the current case for labour market reform. In his rather self-opinionated A wreath for Reith: we’ll miss you (Australian Financial Review, 26 March 2001) he wrote that labour market reforms raise productivity and real wages. Wood’s defence was so bad that I felt impelled to respond. In Unions, wages & the H R Nicholls Society I stressed the basic fact that

What an economist — at least a competent one — will tell you is that unhampered labour markets will always tend to clear. This obviously says nothing about the forces that raise real wages. Although this will evidently come as a surprise to Mr Wood, there is nothing incompatible about a free labour market accommodating a continuous fall in real wage rates.

I once pointed out the above fact to a member of the H R Nicholls Society who responded with the look of a stunned mullet. The possibility that falling real wage rates, meaning falling productivity, can occur in the presence of a free labour market had never occurred to him. Unfortunately Wood’s fallacy is accepted as an indisputable fact throughout the Liberal Party. Swan’s article demonstrates how Wood’s fallacy is hurting the cause of reform.

But try to bring the real economic facts to the attention of David Calvert-Jones, federal Liberal Party Treasurer and director of the Cormack Foundation, and he will dismiss them out of hand. Michael Kroger, a prominent member of the Victorian Liberal Party, is no better. His ridiculous response to being presented with the real nature of labour markets is to give the H R Nicholls Society a veto over such matters, which basically means the likes of Stuart Wood.

Once we take this bleak situation into account we can readily see why the Liberal Government’s labour market reform package has badly foundered. With the likes of Kroger and Calvert-Jones wielding such influence the party’s free market arguments are bound to be seriously deficient. This brings me right back to Swan’s basic argument, which amounts to the charge that free labour markets lower productivity and wage rates.

What need to be stressed is that capital accumulation is the fundamental force behind rising real wage rates, not free labour markets. Even in a seriously hampered labour market productivity can still rise so long as capital accumulation increases faster than the population. But if capital deaccumulation takes place or per capita accumulation falls behind the rise in population growth real wage rates must fall.

However, so long as the labour market remains free full employment will still be maintained despite the fall in wages. Any attempt to arrest the decline in real wage rates will result in rising unemployment. Regrettably, Calvert-Jones, Kroger, Wood, etc., are unable to grasp the importance of this argument.

We can now deduce that unions can only raise real wages by reducing the supply of competing labour, i.e., by causing unemployment. Friedrich von Hayek neatly summed up this situation when he wrote:

. . . workers can raise real wages above the level that would prevail on a free market only by 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, Gateway Edition LTD, 1972. Also see William H. Hutt’s The Theory of Idle Resources, a sadly neglected but very important work on this subject. In addition there is Frederic C. Benham’s The Prosperity of Australia, O. S. King & Son LTD, 1928).

When we apply economic analysis to the figures Swan uses to justify his anti-market stance we find that they support not the unions and ‘labour economists’ like David Peetz but free-market economists like Hayek and Hutt. This is certainly the case in Europe when compared with the US. The US Bureau of Labor Statistics revised data for 2003 shows that the increase in US manufacturing productivity was 9.7 per cent compared with 3.6 per cent for France, despite the fact that labour markets are far more flexible in the US than in France.

In addition, manufacturing productivity in France lags behind the US, which brings us to overall productivity. By having a larger participation rate and a far smaller pool of unemployed the US appears to have lowered overall productivity. I say appears because measuring productivity in the service sector is, to put it mildly, a vexatious task.

Therefore France has, unintentionally, raised its general productivity level by raising the level of unemployment. (The Black Death achieved a similar outcome in the fourteenth century by wiping out about one-third of Europe’s population. See Liberal Party labour market reform founders on ineptitude). I think it is now clear why France’s alleged superiority in productivity has been accompanied by rising unemployment.

That strong growth in employment and hours worked is frequently associated with weak increases in output per hour, i.e., productivity, is a common observation. It was noted that when Europe was shedding labour in the early 1990s productivity rose. What raises real wage rates for everyone, however, is rising productivity generated by capital accumulation, not an increase in the unemployment rate.

Let me make this so clear that even Mr. Swan can grasp it: as more people are employed, given a constant demand curve, average productivity will decline. This process is complicated by the fact that labour is heterogeneous and that movements in demand curves are ultimately determined by the level of investment. This is why the intensity of demand for labour in Australia and the US is far greater then in India or China, irrespective of the number firms that compete for labour services.

It is true that, as I have noted before, that a sudden increase in labour flexibility can raise wage rates and productivity. But this is because previous labour conditions had created a substantial number of sub-optimal factor combinations. This means that the productivity gains from eliminating these combinations will eventually work themselves out and productivity will once again decline (assuming no significant increases in per capita investment) even though real wages rates will now be at a higher level. (See William Harold Hutt’s The Keynesian Episode: A Reassessment, LibertyPress, 1979, first published in 1963).

Unfortunately the Liberal Party is apparently oblivious to all of the above facts and arguments.

Note: Irate Liberals have sent me emails saying that I would not be so mean to Liberal officials if I were a member of the party. I fail to see what is mean about pointing out the economic ignorance of some of the party’s nabobs and their cavalier approach to economic policy. That is why I honestly believe that when it comes to economics these luminaries are downright dangerous. Moreover, I am a Liberal Party member –– and I don’t see why that should prevent me from speaking my mind.

However, I have had very supportive emails from other Liberals congratulating Brookes for publishing “highly informed and comprehensive articles about labour markets and union myths”. What was sad about these emails is that the senders complained that without Brookes they would know next to nothing about the real nature of labour market reform.

Gerard Jackson is Brookes’ economics editor