Subscribe to BrookesNews’ Bulletin
How labour market reform sank the Howard Government
Gerard Jackson
Without a doubt labour market reform was the torpedo that finally sank the Howard Government. How could a policy based on sound economics have such damaging political consequences? First and foremost, the Liberal Party made the mistake of accepting advice from the H. R. Nicholls Society. This was bound to have a severe electoral consequences considering that the HRNS — as it is known as — proved itself time and time again to be completely incompetent in economic matters. By the time the Howard ministry discovered the irredeemably flawed nature of the advice given to it by the HRNS it was too late to act.
Despite the fact that the HRNS conned Liberal Party apparatchiks and MPs into believing that it was the only reliable source of information on free labour markets, it needs to be stressed that these people could have found sound advice elsewhere, even if it only amounted to looking up an economics textbook. That they chose to unquestionably take on board the economic nonsense that the HRNS was peddling — and still is — is sound evidence of their economic illiteracy and aversion to intellectual pursuits. The Honourable Chris Pearce MP, Federal Member for Aston is a prime example of this attitude.
Recently one of his constituent's asked him about the possibility of labour market reform. Mr Pearce's immediate response was to denounce the policy and declare that it was "now off the table". This is a man who once gave this policy unstinting support but who never made an effort of any kind to inform himself of its benefits and how it would work. Julian Sheezel, State Director of the party and one of Michael Kroger's stooges, had the job of helping to explain labour market policy to party members and the media. He was an utter disaster. Lazy, inept and thoroughly ignorant of economics, a basic knowledge of which was essential if the policy was to be successfully defended.
(To top it off, Sheezel and David Kemp — one of Sheezel's puppet masters — had the gall to fire two staffers for committing "acts of gross misconduct prejudicial to the interests of the Party". This is pretty rich coming from this arrogant pair of incompetents).
That the Liberal Government’s push for labour market reform faced ferocious resistance from the unions and their media mates made it all the more vital that the economics of the reform were fully understood. Not only did Sheezel fail dismally in this respect, he even ignored statistical data that would have seriously damaged the unions' anti-reform campaign. He has yet to explain his actions.
Moreover, the Liberal Party being the Liberal Party never thought to do the intelligent thing and try to expose as utter nonsense the myth that unions raise wages for everyone. It never thought to try and reach out to the public and explain why it has nothing to fear from free labour markets. Hell, this lot did not even have the sense to try and educate its own MPs on the subject.
It is impossible to describe how awful most Liberal MPs are when it comes to discussing labour markets in particular and economic policy in general. Some months before the election I received an email from one of these MPs in which he asserted that because "Australia has about 1.1 million businesses and with virtually no scope to exercise monopsony powers it is impossible for real wage rates to be driven down". What this MP was — and still is — unable to grasp is that the height of real wage rates are not determined by the number of businesses competing for labour.
Now someone with an elementary knowledge of economics could argue that competition among firms drives up real wages to the point where they equal the value of labour's marginal product. Although this is true it does not explain what it is that raises the value of the marginal product. Real wages rise when the intensity of demand for labour increases.
This phenomenon has nothing to do with the number of firms. As an example of what I mean let us assume that 12 millionaires are bidding for a Toorak property (Toorak is one of Australia’s most expensive suburbs) while at the same time 60 people are getting ready to bid for a similar sized property in the very modest suburb of Noble Park., which I am about to leave. The outcome will be that the Toorak property will sell for several million dollars while the Noble Park property will sell for several hundred thousand dollars even though it had five times as many potential bidders.
The man-in-the-street response is that the Toorak property sold for more money because the millionaires had more money to spend than ordinary wage earners. Guess what? The man-in-the-street response is absolutely right. Let us put it another way: demand for the Toorak property was more intensive than demand for the Noble Park property. This is just another way of saying that the millionaires’ purchasing power was greater.
We can now see that what matters for real wage rates is not the number of firms that bid for labour but the intensity of demand for labour services. In countries like India, Mexico and China the intensity of demand for labour is weak which makes real wages and consumption much lower than in Australia or America. The general demand curve for labour consists of an array of descending values of labour’s marginal product. From this we can deduce that when the demand curve moves to the right the intensity of demand has increased, i.e., the value of the marginal product has risen.
The real question therefore is what raises the demand for labour. Today an economist would turn to marginal productivity theory, which is called the modern theory. In fact this was worked out more than a 170 years ago. The brilliant Irish lawyer and economist Mountifort Longfield was the first to explain how capital accumulation raised real wages rates. As he put it:
...if a spade makes a man’s work 20 times as efficacious as it would be if unassisted by any instrument, 1/20 only of his work is performed by himself, and the remaining 19/20 must be attributed to capital. And this is the measure of the intensity of the demand for such an instrument. A labourer working for himself would find it for his interest to give up 19/20 of the produce of his labour to the person who would lend him one, if the alternative was that he should turn up the earth with his naked hands; or if he worked for another, his employer might pay a similar sum for the purpose of supplying him with an instrument. But this profit [rate of return] is not paid, because on account of the abundance of capital in the country… (Lectures on Political Economy, Richard Milliken and Son, 1834, p.195).
Despite what many think, Ricardo's theory of wage rate determination was not universally accepted, as Longfield's work clearly demonstrate. Nassau William Senior was another who openly repudiated the Ricardian theory that wages were determined by the price of corn, preferring, and correctly so, a productivity theory, stating that
...the extent of the fund for the maintenance of labour depends mainly on the productiveness of labour. (Nassau William Senior, Political Economy, Richard Griffin and Company, 3rd ed. 1851, p. 183).
Irrespective of the fact that John Stuart Mill badly damaged economic theory by rehabilitating Ricardianism to a considerable degree, he was still able to write that the "demand for commodities is not the demand for labour". He elaborated this observation with the statement:
I apprehend that if by demand for labour be meant the demand by which wages are raised, or the number of labourers in employment be increased, demand for commodities does not constitute demand for labour. I conceive that a person who buys commodities and consumes them himself, does no good to the labouring classes; and that it is only by what he abstains form consuming, and expends in direct payments to labourers in exchange for labour, that he benefits the harbouring classes, or adds anything to the amount of their employment. (John Stuart Mill, Principles of Political Economy, Vol, I, Routledge & Kegan Paul, 1981, p. 80).
The ramifications of Mill's observation are of profound importance. What is being said is that capital accumulation is what drives real wage rates upwards — not consumption. This fact completely destroys the view that it is the number of competing firms that puts a floor under real wages.
Note very carefully Mill's statement that "I conceive that a person who buys commodities and consumes them himself, does no good to the labouring classes". What he is saying that consumption spending does nothing to raise real wages. Hence, should the number of firms increase along with increased spending on consumption at the expense of maintaining the capital structure, real wage rates will fall.
He went on to further state:
… let us suppose capital advancing and population stationary; the facilities of production, both natural and acquired, being, as before, unaltered. The real wages of labour, instead of falling, will now rise. (Principles of Political Economy, Vol. III, Routledge & Kegan Paul, 1965, p. 722).
This is how Professor von Mises responded to union apologists who took issue with economic theory of wage rate determination:
The union doctrinaires are intent upon obscuring this primary issue. They never refer to the only point that matters, viz., the relation between the number of workers and the quantity of capital goods available. (Human Action, Henry Regnery Company, Chicago, 1963 edition).
In his Economics [chap. 37, pp 731, 10 edition, 1976] Paul Samuelson produced a simple output table relating the output of a growing labour force to a fixed quantity of land. Substitute the capital stock for labour and labour for land and we get a model explaining how real wages rise. A modern economist would merely say that if the ratio of capital to labour rises so will real wage rates. This analysis is carried out without once referring to the number of competing firms. It should be perfectly clear from Mill’s analysis why the number of firms should be considered irrelevant to the level of real wages. A constant reference to the ratio of firms to the labour force only serves to distort the debate – not that we really have one.
A union apologist could argue that this is all very well in theory but in reality there exists a zone of indeterminacy along the demand curve in which unions can raise real wage rates without causing unemployment. In the absence of union action wage rates would therefore tend to settle at the lower end of the zone, leaving labour at the mercy of capital and so allowing it to reap profits at the expense of labour.
What advocates of indeterminacy overlook is that if such a demand curve existed and wage rates were at the lower end of the curve a labour shortage would emerge and the demand for labour would rise as firms moved to compete away the profit. This process would continue until wage rate reached the limit of upper zone, at which point the demand for labour would become elastic. In any case, Mountifort Longfield demolished this argument in 1834.
The indeterminacy argument should be carefully noted because it is it and not the Marxist concept of exploitation that implicitly underpins the unions' myth that only they can be counted on to raise real wage rates for everyone. We now see that the argument that it is the number of firms that need to be taken into account when dealing with the level of real wage rates is completely false and should be immediately abandoned before it does further damage.
The response from our establishment rightwing on this vitally important issue was terrible to say the least. Peter Saunders of the Centre for Independent Studies defend "trickle-down" economics, despite the fact that it is nothing but a leftwing canard.
The Institute for Private Enterprise publishes articles on labour markets, the main theme of many appears to be the number of competing firms. Dr Mike Nahan, executive director of the Institute of Public Affairs, really did the free market cause a favour by arguing that many workers need unions to help them deal with their employers.
As evidence that our rightwing simply do not get it one need look no further than Ken Phillips' IPA article the Shift must come from within, the basic premise of which is that it is "management that must carry IR reform forward". It evidently never occurred to Mr Phillips that reform of this kind must have sufficient public support if it is to be widespread and permanent. (This is the same Mr Phillips who fatuously declared that Coase had persuaded him that "Firms are in effect islands of command and control socialism". So much for the HRNS's intellectual standards). Mises noted:
Everything that is thought, done and accomplished is a performance of individuals. New ideas and innovations are always an achievement of uncommon men. But these great men cannot succeed in adjusting social conditions to their plans if they do not convince public opinion.
The flowering of human society depends on two factors: the intellectual power of outstanding men to conceive sound social and economic theories, and the ability of these or other men to make these ideologies palatable to the majority. (Op. cit.)
The idea that these reforms must be imposed from the top was elitist, anti-democratic and doomed to fail.. It is typical of our right-wingers that they prefer to take what they think is the easy way out rather than try to "convince public opinion" of the rightness of the free market cause.
Our brilliant rightwing conceded to the unions' argument that monopsonies could exert a downward pressure on wage rates. See The labour-monopsony myth.
Gerard Jackson is Brookes’ economics editor
BrookesNews.Com
Monday 12 May 2008