Wages and risk: another leftwing fallacy

Gerard Jackson
BrookesNews.Com
Monday 5 May 2008

I've had numerous emails from leftists crowing that labour market reform is now "dead in the water". This is perfectly correct, thanks largely to the sheer incompetence of the grand-sounding H. R. Nicholls Society. Nevertheless, opponents of free labour markets still feel the need to make their views known, and in doing so they once again prove that bad ideas never die: they just hibernate until a more favourable political climate emerges. One of these ideas is that employers would use their "market power" to shift the risk of business decisions on to their employees.

Some years ago Stephen Long — a leftwing journalist and a dreadful economic illiterate — argued in the pages of The Australian Financial Review that labour flexibility and productivity schemes are attempts to shift the risks of doing business from the firm to its employees. His reasoning, for want of a better word, was that these arrangements enabled firms who suffer losses to pass them on to their employees in the form of lower wage rates, thereby forcing them and not the owners to incur capital losses.

Only someone utterly ignorant of economic theory, as Long clearly is, could mouth such rubbish. Unfortunately this garbage is now out of hibernation and apparently alive and well in the classroom. This argument completely overlooks the economic fact that market wage rates are determined in the market place and not the firm. In a free market individuals, as are all factors of production with the exception of specific factors, are faced with a downward sloping array of values, i.e., marginal productivities, otherwise known as the demand curve.

The wage rate is obviously determined at the point where the supply of labour intersects the demand curve for labour. Forcing gross wage rates (which includes all oncosts) above this point will raise unemployment. Conversely, trying to force rates below it will only create labour shortages. Therefore every firm has to offer wage rates that correspond to market clearing values — regardless of its state of profitability. The above clearly demolishes as utter nonsense the idea that capitalists can shift entrepreneurial risk on to their employees. It should have been obvious, even to someone like Long, that if a firm can no longer pay market rates it will lose its employees to other firms.

(It also escaped Long's attention that this kind of wage flexibility could allow time for a firm to recover or for its employees to find alternative employment rather than be simply dismissed).

But what if these productivity schemes, for example, were to dominate the market? Surely that would allow firms to force down wage rates? No. Attempts to keep wage rates below market rates would create profitable opportunities that companies could only exploit by bidding wage rates back up to their market clearing levels. What Long's argument (really his union mates' argument) ignored is that if flexible wage arrangements dominated an economy unemployment would not be so high during a depression and recovery would be accelerated. This is because firms' wage rates would be moving in tandem with the state of demand for their products.

It is painfully obvious that the likes of Long have no conception of the nature of entrepreneurial risk, nor do they have any understanding of markets. This is why they cannot grasp that employees cannot be made to share a firm's entrepreneurial risks, provided they have not invested in the firm. To argue otherwise is to argue that the entrepreneur can literally force his employees to bear his capital losses. This proposition should be too ludicrous for anyone to take seriously, including someone with Stephen Long's meagre intellect.

Unfortunately the anti-market views of Long (now with the ABC) and those of his union mates won the day. Their victory was made predictable by our phony free marketeers who put their own egos before the best interests of the country.

Gerard Jackson is Brookesnews' economics editor