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Labour market reform versus unemployment
Gerard Jackson
Keith Hancock was one of nine former presidential members of the federal arbitration tribunal who signed a letter to The Australian Financial Review (8 April 2005) criticising the Government’s wages policy and declaring that the Australian Industrial Relations Commission is “well informed on the economic effects of wage fixation, and the debates surrounding them, as any of the commentators”.
If the commission was that well informed about the tragic consequences of its constant meddling with wage rates every single member of it, assuming they had any integrity, would resign. That they don’t suggests that they are either a bunch of economic illiterates or they are so consumed with their own self-importance and status that they don’t really give a damn about the people whose jobs they destroy.
To draw attention to the fundamental economic fact that if the cost of hiring labour is raised above its market clearing level unemployment will emerge is to risk immediate verbal assault consisting largely of vigorous denials or pro-union rationalisations, especially by anti-market journalists. Unfortunately, the issue of labour costs and unemployment has become so politicised that critics of free-market analysis are now defined by their ideology and political loyalties, including former members of the commission. Not for them the hard slog of economic reasoning
Keith Hancock, former research officer for the ACTU (Australian Council of Trade Unions), is another critic of market solutions who never allows economic reasoning to reveal the role unions played in creating our unemployment problem. Yet he has the nerve to condemn the Government.
Several years ago he wrote a sanctimonious letter to the Australian in which he asserted that “if the Government were attracted to the idea of reducing real wages to counter unemployment, it should see to ensure that all wage-earners, and not only those dependent on awards, participate in the sacrifice”.
This is an extraordinary statement for a so-called Professor of economics to make and is utterly ridiculous economically, morally and socially. But then, I keep forgetting Hancock’s union connections and his former role as senior deputy president of the job-destroying Industrial Relations Commission.
As an economistHancock should know that there are no sacrifices involved in market-induced labour cost adjustments. These adjustments operate to ensure that the market clears and that labour tends to get the full value of its services. Sacrifices are only made when Hancock’s union mates force labour costs above their market level thus imposing 100 per cent wage cuts on those unlucky enough to lose their jobs.
This is one involuntary sacrifice that the ever so compassionate Hancock always chooses to ignore. Moreover, it needs to be stressed that in a free labour market only those rates that cause unemployment would be adjusted accordingly. There is and never has been any need for en bloc uniform wage cuts. That was just a figment of Keynes’ imagination.
Like all union apologists Hancock likes to refer to the low-paid worker’s weak bargaining power vis-a-vis employers. This is pure man-in-the-street economics. The price of labour is set by supply and demand with demand being a descending array of marginal productivities. The market rate, i.e., the total cost of hiring labour which equals the gross wage, is therefore determined at the point where the supply of a particular type of labour intersects the demand curve for that labour.
Raising the cost of labour above this point raises unemployment. Trying to force labour costs below the market rate creates shortages. No matter how much they might want to, employers cannot pay below the market rate for long. To do so would cost them money because they would be forgoing increased net revenue. Hancock should understand this situation as well as I do.
Of course, he could always argue that there exists an indeterminate zone through which wage rates can be increased without causing unemployment. According to this view unions are necessary to force wage rates to the zone’s maximum point otherwise it will pay employers to use their superior bargaining power to force wage rates down to the bottom of the zone.
Therefore Hancock’s assertions about bargaining power only make economic sense in the context of indeterminate wage rates. But does indeterminacy exist and if so does it matter? A qualified yes is the first answer followed by an emphatic no.
Indeterminacy emerges where the market is highly specialised and narrow. A film star or a successful artist would be two examples of indeterminate earnings in a modern society. But as the market becomes very wide and the labour force more mobile the indeterminate zone tends to shrink and eventually disappear, even where a great deal of labour is highly specialised. The exception exists where there are great discontinuities in an individual’s marginal productivities, as in the case of a highly successful actor. Hence the argument that indeterminacy applies to the workforce in general does not hold.
However, even if indeterminacy was the general rule, Hancock’s argument still falls down. If, for instance, the price for a certain type of labour services was at the bottom of the indeterminate zone then the difference between that wage rate and the rate that would prevail at the top of the zone represents pure profit. In other words, the employee’s services are under priced in relation to the value of his product.
This means there is a maladjustment, with the labour supply lagging behind demand. It now pays employers to hire more labour, which means bidding up its price. This process continues until profits have been competed away. On other hand, if unions moved to raise labour costs ahead of market processes, output will be less and payrolls and employment lower than would otherwise have been the case.
There is, unfortunately, a case of so-called union bargaining that seems to support the indeterminacy argument. Where there are large amounts of fixed capital, e.g., steel mills or oil refineries, it appears to some that unions can force wages up to very high levels without affecting employment. But what we have here is a case of ‘trapped’ capital being exploited by unions. Since the capital is specific it now becomes costless because it has no alternative use. Thus investors are forced to meet union demands on the grounds that any return is better than no return.
What is usually overlooked is that savings, which fuels growth, is highly mobile and that makes capital very sensitive in the longer term. Though these workers are benefiting now, the effect of their actions is to curb investment in these types of capital intensive lines of production. After all, why should one invest in an industry if unions are going to confiscate the returns? It does not need any imagination to see where this would lead regarding future living standards and jobs.
All said and done, the critics of labour deregulation have no moral or economic case. If anything, the reverse is true.
Gerard Jackson is Brookes’ economics editor
BrookesNews.Com
Monday 22 August 2005