The shaded area represents the indeterminate zone. Union spokesmen like Grant Belchamber, the ACTU’s chief research officer, argues that this is the true labour market situation and that without the union movement wage rates would be pushed down to the lowest point of the zone, if not lower and hence to the right of E.

Let us for a moment accept as fact the union argument. Does this then justify union or state imposed wage rates in order to prevent workers from being exploited? No. If wage rates were at point E then the shaded area would represent pure profit to the capitalist. And just as “nature abhors a vacuum” the market abhors a profit. Whenever a profit emerges the market moves to eliminate it. The unwitting instrument of its retribution is the entrepreneur.

Profits not only reveal that consumer wants are being unsatisfied but that the factors employed in the production of that particular good are being underpaid relative to the value of their marginal product. On detecting this situation entrepreneurs begin to shift resources into the same line of production. In doing so they expand output, raise factor incomes, especially wages, and lower prices. We therefore see that part of the market’s function is not to create profits but to eliminate them. In other words, the entrepreneur is at the heart of the market’s equilibrating process.

It follows from this line of reasoning that in a state of indeterminacy firms would move to compete away profits by driving up wage rates until they reached the maximum point on the curve.

In Impact of Safety Net Adjustments on Wages and Jobs, (ACTU paper, December 2004) Belchamber drew on Adam Smith’s confused approach to wage rate determination, saying that “fairness is hardly a concept belonging to the Trade Union movement: Adam Smith in his Inquiry into the Nature and Causes of the Wealth of Nations said in 1776: …”

Smith did state that the “master must generally have the advantage”, strongly suggesting that indeterminacy was the order of day. He then stated that there is

a certain wage rate below which it seems impossible to reduce, for any considerable time, the ordinary wages even of the lowest species of labour.

In other words, there is a market rate for wages. Modern economics explains that it is the capital-labour ratio and not union officials or the number of employers that a floor under wage rates. In Book II page 277 Smith showed that he had a dim understanding inkling of this fact when he said:

As the accumulation of stock [capital] is previously necessary for carrying on this great improvement in the productive powers of labour [emphasis added], so that accumulation naturally leads to improvement.

Mill’s ambiguous rejection in 1869 of the wage-fund theory of wages combined with William Thomas Thornton’s attack on competition led a number of economists, including F. Y. Edgeworth, to accept the idea of indeterminacy. Thornton (1813-1880) had written the book On Labour in which he attacked the wage fund theory. Although Thornton had apparently been influenced by Francis D. Longe’s 1866 pamphlet defending union bargaining it is also possible that he encountered Jacob Waley who in 1867 read a paper to the Royal Statistical Society in which he defended indeterminacy.

What makes this so depressing is that in 1834 Mountifort Longfield published his book Lectures on Political Economy in which he used marginal productivity theory to explain why capital accumulation raised wage rates. Deeply impressed with Longfield’s groundbreaking work on pricing capital goods Isaac Butt, a contemporary, brilliantly extended his analysis to other factors of production.

By the 1860s the work of these men had been all but forgotten. Fortunately the sudden emergence of marginalism in 1871 gradually saw a return to determinacy as being the norm. Now I said the norm because indeterminacy can exist to a certain degree where the market is especially narrow or specialised. In this respect film stars and artists spring to mind. But with respect to unions indeterminacy is genuinely unimportant.

In his book Principles of Economics (Libertarian Press Inc, 1996, first published in 1871) Carl Menger laid out in considerable detail the pricing process, using marginal pairs to demonstrate how the market process narrows the price range to arrive at a determinate point. Eugen von Böhm-Bawerk did the same thing in his Capital and Interest: the Positive Theory of Interest, Vol. II, (Libertarian Press, Illinois, 1959. All three volumes were first published from 1884 to 1912).

Now Liberal Party supporters are thoughtlessly parroting the line that minimum wages are causing unemployment because they are 58 per cent of the median wage. Party blue-blood Hugh Morgan made this claim on Lateline (ABC 10 August 2005); Christopher Pearson did the same thing in No job? No cash? Sod off (The Australian, 29 October) –– and there are others. Unfortunately for them this ratio is utterly meaningless. There is no economic law that says there is a ratio of the minimum wage to a particular average at which point unemployment will emerge.

There is, however, an economic law that that says that when the services of labour are priced in excess of the value of their marginal product unemployment will emerge. Fortunately this can be expressed as a real ratio. In his book The Prosperity of Australia (P. S. King & Son, LTD, Orchard House, Westminster, 1928) Professor C. Benham provided tables showing the relationship between wages, production and unemployment. One table of these tables was based on the years 1916 to 1924 in Queensland. (Two of the tables can be found here).

What I did was to find the ratio of the value of production to the average wage for those years, which were ones of high unemployment. According to marginal productivity theory there should be a negative correlation between the ratio and the unemployment rate, meaning the higher the ratio the lower the rate of unemployment. The chart below show with stunning clarity just how close the relationship is. (The left hand side measures unemployment while the right hand side shows the ratio).

Chart 2

It can be easily seen that as the ratio falls unemployment rises and vice versa. As Benham said: “It would be hard to find a clearer proof of our thesis [that excessive wage rates cause unemployment]”. But according to Belchamber this relationship does not exist because

Award wages have increased by over $100 per week in nominal terms and by over $40 in real terms since 1996. According to Neo-Classical economics, these increases in award wages should have resulted in a fall in employment especially for award reliant workers. However, Australia has experienced strong employment growth since 1996. (Impact of Safety Net Adjustments on Wages and Jobs, December 2004)

Belchamber either misunderstands marginal productivity theory or he is deliberately misrepresenting it. As I have already stressed, the theory states that the wage rate must exceed the value of the product before unemployment emerges. In the case of widespread unemployment, bringing the wage rate in to line with the value of the product will therefore reduce unemployment. This is exactly what the chart shows.

There are other ramifications. If Belchamber were right on indeterminacy then there would be no correlation between productivity and wage rates. The following two charts completely blow that conclusion out of the water.

The first chart is from 1960 to 2000 and clearly shows how wages move in tandem with productivity, the dotted line. (The data came from the Council of Economic Advisors 2001 while chart 4 comes from a paper by John W. Kendrick, National Productivity and Its Long-Term Projection, National Bureau of Economic Research, May 1951). The second chart shows the same correlation from 1910 to 1960. A correlation that according to Mr Belchamber cannot possibly exist.

Chart 3

Chart 4

One should take note of two things when studying these charts. First, there is no correlation between union membership and the general trend in wages rates. From 1900 to 1936 union membership varied from 6 per cent to 9 per cent until 1936. Therefore any attempt to explain the correlation in terms of the union pushing wages rates up to the maximum point of the indeterminate zone do not hold water.

The second point is the period 1930 to 1941. It was then that wage rates, the dotted line, greatly exceeded the hourly product. It was also a period of massive and prolonged unemployment. (See Richard K. Vedder and Lowell E. Gallaway’s Out of Work for a devastating statistical critique of this period).

The bad news gets even worse for Mr Belchamber and his colleagues. If he were right about unions raising real wages how come that highly unionised Australia suffered an average of 8 per cent unemployment during the 1920s against an average of about 3.6 for the US. Moreover, as Professor Benham pointed out:

Women and juniors are within the ambit of wage-regulation to a smaller extent than adult males, yet during recent years their wages have risen more than those of adult males. In the United States and Canada where there is relatively little wage-fixing, average real wages have risen more than in Australia (op. cit.)

At the time of publication union membership “per 100 non-agricultural workers” in Canada was 11.6 per cent; it was 46.2 per cent in Australia.

I tried to raise these matters with Mr Julian Sheezel, State Director of the Victorian Liberal Party. In his first response he parroted the line that labour market reforms “are essential in ensuring future economic growth for Australia and the expansion of our jobs market”. (Who in heavens name is responsible for these horrible talking points?)

Of course, the response of unions and their supporters to this unthinking line is a loud guffaw. Any union activist worth his salt, and, unlike many on the Liberal Party payroll, most are, would immediately point to the 1960s as an outstanding refutation –– and they would be right.

The average unemployment rate for the decade 1962 – 1972 was about 1.6 per cent, less than half of the US rate. Today the Government cracks open champagne bottles if the official figure falls to 5.1 per cent. The average growth rate in the ‘60s was 5.5 per cent while it stands at 3.5 per cent for the 1990s. Average per capita growth for the ‘60s was 3.5 per cent but only 2.2 per cent for the 1990s. The current account deficit averaged 3.1 per cent as against 4.3 per cent in the 1990s. Since 2000 the CAD has deteriorated further. Productivity growth averaged 2.7 per cent for the ‘60s and 2.8 per cent for the 1990s.

A proper understanding of economic principles allows one to easily counter the argument behind these statistics. Unfortunately a proper understanding of economic principles is precisely what is missing in the Liberal Party. Isn’t it, Mr Sheezel?

It is interesting to note that the productivity figures suggest that if full employment had been established in the ‘90s productivity would have fallen. As Professor Benham observed:

For a rise in the basic wage, for example, may cause manufacturers to dismiss some of their least efficient hands. As a result the efficiency of the average worker in employment is raised, although not quite as much.

This is just another way of saying that as labour moves up the demand curve real wage rates rise. In the case of an enforced movement by unions unemployment emerges and there takes place a form of income distribution from those who had jobs to those who are lucky enough to keep theirs.

We conclude that a sudden resurgence of employment could very well reduce the average rate of productivity. However, it is possible that productivity could continue to increase even as employment fell if a more flexible labour market created optimum factor combinations. Nevertheless, this process would eventually work its way out through the economy unless offset by an increase in per capita investment.

That productivity can rise even in badly hampered labour markets is nothing strange to economists or economic historians. Ludwig M. Lachman remarked on this phenomenon in his book Capital, Expectations, and the Market Process (Sheed Andrews and McMeel Inc. 1977). Sydney Pollard’s The Development of the British Economy, Third Edition 1914-1918 (Edward Arnold 1988) discusses how productivity rose in the 1920s and 1930s in the face of high levels of unemployment. William Ashworth noted that despite heavy unemployment real national income in England increased from 1920 to 1939 by 40 per cent and that in 1936 productivity was about 20 per cent higher than in 1929 (An Economic History of England 1970-1939, Methuen and Co. LTD, 1982).

I was prepared to discuss, in my own time, some of these facts with Julian Sheezel, State Director of the Liberal Party of Victoria, but he made it clear in his letter that he and Michael Kroger are only interested, and I kid you not, in people who are “important and influential”. According to this crew, unless you are “important”, as defined by them, you have absolutely nothing of value to offer the party.

I asked Sheezel if he thought ordinary party members were important. He avoided answering the question. No doubt about it, Sheezel really is one of the guys.

The scornful attitude of this bunch of snobbish economic illiterates helps explain why the Liberal Government has utterly failed to persuade the public of the benefits of labour market reforms. No wonder Belchamber goes to bed every night laughing.

See Liberal Party treats members with contempt and Labour Market Wars

Gerard Jackson is Brookes’ economics editor