Why is it that American Democrats like Krugman and Samuelson correctly understand that investment is the real source of productivity while our self-appointed conservative pundits think it comes from free labour markets? Moreover, why have they adamantly refused to use statistical data and a historical perspective to defend the case for labour market deregulation? The answer, I fear, is sheer incompetence married to intellectual grandstanding. Any Liberals who take advice from this lot deserve everything they get — and then some.

The economic illiteracy regarding labour markets is not all one-sided. We have, for example, the case of 151 leftwing academics who published Research Evidence About the Effects of the ‘Work Choices’ Bill: A Submission to the Inquiry into the Workplace Relations Amendment. This lot are so bad they are in danger of making the incompetent H. R. Nicholls Society look good. Wages are prices that are determined by economic laws. Not according to this lot. The following quote sums up the staggering degree of their economic ignorance:

Those on low wages have a high propensity to consume, as a high proportion of their incomes must be spent on essentials. The reduction in this spending power will have economic effects. P. 14. (Italics added).

What we have here is our old friend the purchasing-power-of-wages fallacy, which is a first cousin to the consumption-drives-economy fallacy. Accordingly, real wages must be maintained if the economy is to be prevented from going into recession. But real wage rates are determined by the supply and demand for labour, with demand consisting of an array of descending marginal values of labour’s output. The result is that market forces always operate to bring the worker’s wage rate into line with the marginal (additional) value of his output, i.e., the market clearing rate. (US economy: the Great Depression and interest rates).

If wage rates are forced above this rate then unemployment will emerge. Any attempt to force wages below the market rate will cause labour shortages. As for real wages, I have already stressed that they are the result of capital accumulation. Furthermore, economics explains why the benefits of raising the capital-labour ratio accrue to labour. This is not a new theory. More than 170 years ago Mountifort Longfield explained in some detail how this process operates. (Ibid.) In fact the standard textbook approach is fully in the Longfield tradition.

But let us take a closer look at this idiocy. If a man doubles his son’s pocket money no one would be silly enough to claim that this action raises aggregate demand. One does not need an economics degree to understand that the man’s spending power falls by the amount he now gives his son. Yet these academics argue to the contrary. If we carry their ’reasoning’ to its logical conclusion, all we need do to raise aggregate demand is to put the unemployed on the public payroll and fund their wages through increased taxation. Daft as this undoubtedly sounds it is exactly what these 151 academics are basically proposing. John Stuart Mill was only echoing the economic wisdom of his time when he wrote of this fallacy:

It is not necessary, in the present state of the science, to contest this doctrine in the most flagrantly absurd of its forms or of its applications. The utility of a large government expenditure, for the purpose of encouraging industry, is no longer maintained. Taxes are not now esteemed to be “like the dews of heaven, which return again in prolific showers.” It is no longer supposed that you benefit the producer by taking his money, provided you give it to him again in exchange for his goods. There is nothing which impresses a person of reflection with a stronger sense of the shallowness of the political reasonings of the last two centuries, than the general reception so long given to a doctrine which, if it proves anything, proves that the more you take from the pockets of the people to spend on your own pleasures, the richer they grow; that the man who steals money out of a shop, provided he expends it all again at the same shop, is a benefactor to the tradesman whom he robs, and that the same operation, repeated sufficiently often, would make the tradesman's fortune. (John Stuart Mill Essays on Economics and Society, University of Toronto Press 1967, pp.262-3)

Linked to this is the vitally important insight rooted in Say’s Law that the “demand for commodities [consumer goods] is not demand for labour”. (John Stuart Mill Principles of Political Economy, University of Toronto Press 1965, p. 78. Also William H. Hutt’s A Rehabilitation of Say’s Law, Ohio University Press, 1974). To put it simply, these academics have hopelessly confused a transfer of purchasing power with an increase in aggregate purchasing power. This incompetence is every bit as unforgivable as the H. R. Nicholls Society fallacy that it is the number of firms — and not the amount of capital — that puts a floor under wages rates. (At this juncture I think I should point out the obvious fact that two idiocies can never amount to a profound statement).

David Peetz, a Professor Industrial Relations at Griffith University, was one of the signatories and a leading opponent of free labour markets. This brilliant economic analysis appeared on television to give us the Ricardian substitution fallacy, according to which if labour costs fall then more labour will be substituted for capital and so lower real wages. (ABC’s PM, 13 June 2006). This is known as begging the question: It assumes what it is supposed to prove.

When confronted with this kind of nonsense I sometimes wonder where to start. It ought to be obvious — even to a lefty intellectual — that taken seriously this ‘theory’ would purport to show that economic growth is impossible. Growth is the accumulation of capital, and it is capital that raises productivity and real wages. Now if Peetz is serious he would have to argue that because Chinese labour is ‘cheap’ China cannot be accumulating capital. So how come she makes bulldozers for the home market as well as for export? His error should be obvious to any economist: he is making the mistake of treating labour and capital as substitute goods where as their services are complementary. (See Ludwig M. Lachman’s Capital and Its Structure, Sheed Andrews and McMeel Inc, 1978. There is also Hayek’s treatment of the subject in his Pure Theory of Capital, The University of Chicago Press, 1975).

This nonsense about labour being substituted for capital has been used to try and discredit New Zealand’s economic reforms. (The funny thing is that none of these people ever tell us where all this ‘surplus’ capital goes). Readers can see how I dealt with this in Liberal Government and labour market reform: more fallacious attacks. It would be superfluous to continue the argument here. However, in his ABC interview Peetz claimed that in “the long run, it’s the rate of technical progress that determines the rate of productivity growth and the rate of skilful motion in the economy”. This is more nonsense. There cannot be such a thing as a rate of “technical progress”. Technology can be no more measured than capital. (On measuring capital see Joan Robinson’s The Accumulation of Capital, Macmillan and Company Limited, 2nd edition 1966, p.117).

All that Peetz succeeded in doing with this statement is making it even more clear that he is hopelessly at sea when it comes to capital theory. Any economist worth his salt should know that capital embodies technology. (The apparent exception is where technical progress brings about an improved use of current equipment). It really does not matter a damn how much technical knowledge there is if it cannot be incorporated into capital goods. As von Mises emphasised so many years ago:

Let us look at the condition of a country suffering from scarcity of capital. Take, for instance, the state of affairs in Rumania about I 860. What was lacking was certainly not technological knowledge. There was no secrecy concerning the technological methods practiced by the advanced nations of the West. they were described in innumerable books and taught at many schools. The elite of Rumanian youth had received full information about them at the technological universities of Austria, Switzerland, and France. Hundreds of foreign experts were ready to apply their knowledge and skill in Rumania. What was wanting was the capital goods needed for a transformation of the backward Rumanian apparatus of production, transportation, and communication according to Western patterns. (Human Action, 3rd revised edition, Henry Regnery Company, 1966, p. 496).

To finish, Peetz and the rest of the opponents of free labour markets struck gold when they found that productivity fell instead of rising as promised by supporters of labour market reform. For years the H. R. Nicholls Society had been promising the Liberal Party that labour reform would stimulate economic growth and promote productivity. And for years I contradicted them, pointing out that growth and productivity are not a function of labour markets*. I stressed that at best there would be a temporary lift in productivity as firms formed more productive factor combinations. (I based this on the assumption that their would be no offsetting increase in capital accumulation. There wasn’t).

Once this effect had rippled through the economy productivity would decline as unemployment fell. I was absolutely right and the those from whom the Government got its advice were proved utterly wrong with the result that the likes of Peetz are now gloating over the productivity failure of labour market reform. This happened because the likes of the H. R. Nicholls Society are completely ignorant of capital theory, the history of economic thought and economic history. This ignorance is the principle reason why it could not comprehend that because free markets allocate resources to their most valued uses this does not guarantee a rise in the productivity of labour and hence wage rates.

Australian economy: Government confusion about productivity, growth and jobs

Joseph Stiglitz and Phillip Adams slime the US economy

Minimum wages and capital accumulation: lefty economists fail again

Labour market reform, the US experience and the productivity myth

Gerard Jackson is Brookes’ economics editor

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