My post on the minimum wage got me involved in a couple of exchanges regarding the determination of wages rates in the market place, hence this post. Now free market economists are perfectly correct in pointing out that unions justify their existence on the basis of the alleged “imbalance of bargaining power” that lies with employers. According to union apologists, particularly in the media and the Australian Industrial Relations Commission, employees must combine if they are to get a fair wage.
Unfortunately, these economists rarely attempt to explain why the “imbalance of power” concept is another dangerous fallacy. This is a particularly egregious failing on their part considering that union apologists have sometimes even drawn on the writing of Adam Smith in support of their actions. In fact, one could even argue that it was Adam Smith who fathered the “imbalance of power” idea. According to Smith:
It is not, however, difficult to foresee which of the two parties must, upon all ordinary occasions, have the advantage in the dispute, and force the other into compliance with their terms*.
So we have it from the very ‘Father of Economics’ that labour is always at a disadvantage that this situation can only be corrected by collective action. Furthermore, did not Smith admit that that the capitalists’ advantage was due to them being “fewer in number”? A closer reading of Smith, however, reveals that he contradicted himself on this subject. He further argued that in any dispute the “master must generally have the advantage”. In the next sentence, however, he declared 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”. (Ibid. p. page 85.)
In plain English, Smith admitted that you cannot permanently keep wage rates below their market clearing levels: no matter how hard you try they will always rise. This is something an uncomprehending crown discovered in England after the Black Death struck in 1348. This, of course, tells us nothing about the economic forces at work. However, Smith gave us the answer when he said:
It is not the actual greatness of national wealth, but its continual increase, which occasions a rise in the wages of labour. It is not, accordingly, in the richest countries, but in the most thriving, or in those which are growing rich the fastest, that the wages of labour are highest. (Ibid. p. 87).
Smith also tells the reader:
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”. (Ibid. p. 277).
It seems to me that Smith’s thoughts on why real wages and living standards rise explains why he did not pursue the “imbalance of power” argument. Unfortunately the proponents of ‘collective bargaining’ are still free to selectively quote Smith while their opponents remain wilfully oblivious to his ambivalence on the subject. Now a modern economist would simply say that it is capital accumulation raises wage rates and the standard of living.
At this point I think should be noted that the number of competing firms is irrelevant to this process. This needs to be stressed because it has been argued by our right that it is the number of firms in Australia that puts a floor under the height of real wage rates. This is pure nonsense. Labour is paid according to the value of its marginal product. This in turn is basically determined by the length of the capital structure. In other words, the fundamental flaw in what one could call the “numbers argument” is that it completely ignores the crucial role of capital accumulation in raising the standard of living.
That advocates of market reform have failed to stress that which really raises and maintains the standard of living is, I think, a remarkable failure on their part. Equally remarkable has been their failure to address the indeterminacy argument that is implied in union pleas for wage hikes. Indeterminacy assumes a bargaining zone in which unions can raise real wages at the expense of capital without causing unemployment. Even if all wage rates were indeterminate this would not justify so-called collective bargaining. The reason is the profit motive.
Firms will continue to hire people so long as the value of their services does not exceed their wages. Were indeterminacy to prevail throughout the economy then firms would still compete to drive up wage rate rates until they reached the upper limit of the zone, beyond which the demand for labour would be elastic, the sensitive to any further increases in wage rates. So long as labour is paid below the upper limit an economic profit can be made from hiring more labour. Moreover, in such a situation there would be a general labour shortage.
At the end of the day, the union argument rests on the assumption that wage rates are at the mercy of capital. Yet in 1834 Mountifort Longfield published his Lectures on Political Economy in which he was the first to describe how the accumulation of capital raised wage rates. We now call this productivity theory. Once again we can see that the actual number of firms is irrelevant.
I intend to elaborate on these comments in a later article, particularly with respect to indeterminacy.
*Wealth of Nations Vol. 1 LibertyClassics edition 1981 p. 83.