'Fair Pay' Commission votes for higher a unemployment rate
Gerard Jackson
Australia's ridiculous Fair Pay Commission justified raising the minimum wage by 4.1 per cent by arguing that it would have little effect on jobs and inflation. (At least the Commission is half right). This should have got our economic commentariat thinking about wage rate determination and the real nature of inflation. No such luck. They largely contented themselves with parroting the Commission's anti-economic conclusions. So once again I shall endeavour to do that which seems beyond the capacity of our self-appointed guardians free market thinking, and that is apply some genuine economics to the issue at hand.
The unions and their media allies' defence of minimum wage rates neatly illustrate their intellectual bankruptcy. (Needless to say, this also goes for the Fair Pay Commission). Their arguments rest on the implicit assumption that unions, or governments, can raise and guarantee living standards. As Jeremy Bentham once said: "nonsense on stilts". It can never be sufficiently stressed that ultimately living standards can only be raised by increasing the amount of capital invested per head of the population.
In other words, a continual increase in real wage rates can only be achieved by making labour increasingly scarce relative to the quantity of capital. To suggest that unions could be the engine that drives this process of capital accumulation is too ludicrous for words — but not, unfortunately, for most journalists and leftist politicians.
A brief trip to fourteenth century England will provide us with a graphic lesson in the relationship between capital, land, labour and wage rates. The Black Death wiped out about 30 per cent of England’s population. So severe was the first wave in 1348 that the Crown passed the Statute of Labourers Act in 1349 in an effort to check rising wages caused by labour shortages. Proving ineffective another act was passed in 1351 setting maximum wages based on the average wage for the period 1325-31. This Act was equally ineffective. In fact, throughout history all attempts at price control have been utter failures.
By killing off so many in the work force the plague brought about a dramatic increase in the ratio of land and capital to labour causing average real wages to rocket by about 50 per cent*. The unskilled benefited so greatly from the labour shortage that of wage differentials were significantly narrowed. The lesson is crystal clear, or should be: If you want to raise wages for everyone then accumulate more capital. The following table should help explain the rise in fourteenth century wages rates.
If the supply of capital goods increases relative to the supply of labour then labour incomes rise. This process is illustrated by the following table that was taken from Paul Samuelson’s Economics (10th, edition, 1976, p. 731). Whereas Samuelson uses land as his fixed input I use capital. Production consists of a single stage at the point of consumption. Capital is homogeneous and consists of 1,000 units equalling 1,000 capitalists. Labour is also treated as homogeneous.
The table makes it clear that the height of real wage rates is determined by the capital-labour ratio. The higher the ratio of capital to labour the higher the real wage rate, and vice versa. As we can see, beyond a certain point the return to labour falls but starts increasing for capital. In other words, the increase in the supply of labour against a given capital structure lowers wage rates relative to the price of capital goods.
Because the height of real wage rates are basically determined are determined by the capital structure, the result of effective minimum wage rates is to generate a permanent pool of unemployment. The greater the minimum the larger the pool. Proponents of minimum wage laws sometimes refer to America's mass of "working poor" (less so now that more people have come to realise that it's just leftist propaganda) while ignoring Australia's "idle poor", courtesy of unions, ignorant politicians and journalists. America's "working poor" at least have hope and dignity: our unemployed have been stripped of both.
Now economists have never denied that some unions can raise wages for their members. The late Friedrich von Hayek succinctly explained how this is achieved and at what cost 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 therefore always be opposed to the interest of those who, in consequence, will find employment only in the less highly paid jobs [suboptimal employment] or who will not be employed at all. (The Constitution of Liberty, Gatway Editions LTD, 1972, p. 270).
It needs to be stressed that what matters is whether the minimum rate is an effective one. This means that effective rates are those that are set above market clearing rates. Therefore only the effective rate causes unemployment. It’s an important point because if wages rates are below free market rates then competition will drive them up.
Some proponents of the minimum wage argue that legislation would be simply doing the market’s work for it. Not so. If rates are lagging behind the value of the worker’s marginal product then market processes will raise them anyway.
However, if you want to give the impression that the state can successfully legislate for real wage increases without causing unemployment then a situation where productivity is leading wage rates can be used to confirm this dangerous fallacy. But it must not be forgotten that any minimum that is set at or below the market rate is not an effective rate, i.e., it is not a true minimum.
The hazards of this way of thinking are obvious and yet overlooked by our economic commentators. For some reason they adamantly refuse to use the term "effective minimum wage rate". The Department of Industrial Relations has expressed the view that wage flexibility would not reduce unemployment. This thinking is a product of gross economic incompetence, which some commentators still firmly cling to.
Furthermore, union complaints that wage flexibility leads to extensive wage differentiation rings hollow when one compares, for example, the wages of waterside workers with those of clerks, barmen, checkout tellers, etc. Wage differences in a free market are the result of differences between marginal productivities, not extortion.
The fact that some people can earn several times more than others in a free market is their good fortune, and no business of union apparatchiks, media hacks, political lackeys and leftwing academic loafers. They have no moral right to interfere with these people or price the less fortunate out of work in the phoney cause of social justice. The reality is that this mob is defied by history and no economic theory worthy of the name supports them.
As Ota Sik (economic adviser to Alexander Dubcek) put it: “You defy the market at your peril”. Australian unioncrats and their ideological allies, however, always ensure that the market is defied at someone else’s peril.
Unfortunately, trying to bring the above economic facts to the attention of Liberal politicians appears to be a complete waste of time. (For the benefit our American readers liberal in Australia means conservative). Over the years I have received numerous e-mails from readers who described how they were condescendingly dismissed by their local members when they tried to bring similar economic facts to their attention.
Given my own disappointing experiences with Liberal MPs' aloof attitude toward the opinions of the lesser folk I have absolutely no reason to discount these complaints. What is needed is less arrogance on our MPs part and more economic understanding, regardless of where it comes from.
Note: Ian Harper is the chairman of the Fair Pay Commission and a professor of economics who sidestepped the impact his generosity could have on the employment of marginal workers. The Commission argued that the demand for unskilled labour was still rising. If this be so then the real wage rates of this group of workers would be rising, making the Commission's decision superfluous and dangerous.
It seems that Professor Harper is a positivist with a strong distaste for the Austrian School, sometimes referred to as the Vienna School.. This is somewhat ironic given that he is clearly inclined to the thinking of the discredited Vienna Circle that preached logical positivism, an extreme form of empiricism. So much for intuition, a priory reasoning, introspection and inspiration.
*Jean Gimpel has some interesting stuff on medieval wages: The Medieval Machine, Pimlico, 1993, pp. 111-12, 213-17. James E. Thorold described the rise in real wages as "enormous" Six Centuries of Work and Wages: The History of English Labour, London: Swan Sonnenschein and Co., p. 233.
Gerard Jackson is Brookes's economics editor
BrookesNews.Com
Monday 18 April 2005
units of capital
man-days of labour
output of consumer goods
wage in consumer goods per day
labour's share of GNP (%)
rent in consumer goods per unit of capital
501
4008
1001
8008
3001
20,005
6001
33,604.2
8,001
39,000