Passing thoughts on wages and the fallacy behind union bargaining

Gerard Jackson

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.

24 thoughts on “Passing thoughts on wages and the fallacy behind union bargaining”

  1. I had some questions indeterminacy but considering gerry is going to revisit the topic I thought it best to wait.

  2. Frodo actually raised an interesting point. How come nobody Catallaxy or the IPA seem to have raised the question of indeterminancy.

  3. good question, Jack, and I think the answer is obvious. They are just not very good. Just think of what Gerry wrote about the number of companies and the amount of capital. It makes you wonder if the right-wing know anything

  4. I’m sorry we have a pretty de-regulated labour market with wage rises the lowest they have been since Gerry went to school.Gerry’s thesis jst doesn’t hold water.

    If you wish to reduce minimum wages then I suggest you read what the 5 economists wrote about it a long time ago. I support it but it costs revenue.
    Howard proudly boasted in the 2007 election we had the hifghest mi,u, wage.
    The problem with the minimum wage is not due to unions. There is no problem with wages overall.

  5. There’s something wrong with nottrampis. “There is no problem with wages overall”!!! A quick check on the net revealed “Youth unemployment at 12-year high” of 13.1 percent for the 15 to 24 age group. Then there are the part timers who cannot get full time work.
    http://www.abc.net.au/news/2014-06-13/youth-unemployment-surges-even-as-jobless-rate-holds-steady/5521040

    Don’t tell me wages don’t matter. I have worked for firms that couldn’t take on an extra young worker because the minimum was too high. And it is just like Gerry said in another post, the actual wage is the wage rate plus all the extras that politicans and unions pile on top of it. People like you would prefer to see our youth unemployed rather than admit wages matter.

    Thank god we have someone like Gerry dealing with your nonsense.

  6. Thanks to Gerry I now know that it is the “effective” minimum wage that causes unemployment. I don’t know how any sensible person coulc deny this fact.

  7. Sarah,

    high minimum wages is not a recent phenomena, we have unfortunately had them for a long long time.
    They did not occur because of big bad unions.

    of course wages matter however real wages are declining at present which again shows the impotency of the unions!

  8. Notrampis always seems to miss the point. Gerry was clearly writing about the arguments used to justify unions trying to raise wages. Yoou say nothing about this. You also say that real wages are falling but ignore Gerry’s point that actual wages include all oncosts. you also ignore Gerry’s point made in other posts that what matters for jobs is the wage “relative to the value of the product”.

  9. Sarah,
    On-costs are in the Wage price index. They are part of unit labour costs. They both say the same things. Wages are not a problem.
    Unions now have to negotiate agreements with companies that take into account their financial position.
    If companies cannot negotiate propelry then that is THEIR problem but it is not occurring.

    the Labour market completely changed from 1993 onwards.

    few people here seem to understand that

  10. Gerry explained in his post on Australia and the great depression that employers are not interested in the real wage, he means purchasing power. What they want to know is whether it is profitable to hire someone at the wage demanded. I know this to be true from my own personal experience.

    That “Unions now have to negotiate agreements with companies that take into account their financial position” has nothing to do with it. A little logic tells me that this means unions could use so-called wage bargaining to rip away a company’s profits on the grounds that the company can afford it.

  11. two points.
    There is a lot of empirical evidence to suggest real wages is the most important basis for employing or the opposite.
    Since the advent of the EBAs this just hasn’t happened.Only profitable companies can pay good wages and larger wage rises and vica versa.

  12. complete rubbish. Name me a single firm that calculates the purchasing power of a wage before hiring anyone. While your at it tell us what it is that raises wages.

  13. Sarah is right. When I needed a lot of work done on my property I asked for lots of quotes. When considering the quotes it never occurred to wonder what the real wages of the workmen would be. Anyhow, what does raise real wages?

  14. Sarah,

    that isn’t how you do empirical evidence however if wages are rising at 2% and inflation is 3% you do not need to be Einstein to know what is going on and what it means for a firm!

  15. It seems to me that all Nottrampis ise doing is confirming gerry’s views. Gerrt proved his case in his post on Australia and the Great Depression. I know this is off topic a bit but I would like to point out that Davidson and Kates are still pretending that this article was never written. That’s just so typical of that mob.

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