In Western countries the practice of regulating labour markets is one of considerable antiquity. In Australia and New Zealand departures from the traditional common law approach began as early as the 1890's. Their practice has by no means been unique, however. To some extent, almost all governments intervene in and regulate labour markets to some extent. In this paper I shall argue that most, if not all, of this regulation is misconceived. Far from protecting workers, it raises the wages of those who are already well off, reduces the wages of those are not, and throws many others out of work altogether. As we shall see, it also has other undesirable effects.
The essential premise of labour market regulation is that, left to itself, labour markets will produce lower wages than would otherwise be the case. In order to prevent this governments must fix the rates at which people are permitted to offer their labour. Moreover, they must intervene in other parts of the labour contract as well. Governments must stipulate the number of hours which may be worked, the rates which will apply if and when those hours are exceeded, the numbers of holidays which may be taken, as well as the way in which employment contracts may be terminated.
Liberal critics of this system proceed from the premise that labour markets operate like any other. For any given commodity, there is a supply curve and a demand curve. The supply curve, usually rising from left to right, indicates that as the price becomes higher, so will producers of that commodity place more of it on to the market. The demand curve, usually falling from left to right, indicates that as the price falls so will consumers of that commodity become willing to purchase more of it. The location at which the two curves intersect represents the point of equilibrium. At that price there will be as many producers willing to offer the commodity as there will be consumers willing to purchase it.
Critics of the liberal approach say that it is flawed, because in the case of labour we are dealing with human beings. Obviously, in this view, markets for their labour must necessarily behave differently to those for apples, bags of wheat, I-Pods or apartments on the Gold Coast. People are simply not commodities. Markets for their labour must be subject to different rules.
What this argument ignores, of course, is that commodities do not own and sell themselves. When I bought my house and car I first had to negotiate with their human owners. A man selling his TV set is in no different from seeking to sell his labour as a TV repairman. In both cases he will seek to maximise the return from what he has on offer. Emotional or sentimental attitudes will doubtless impact on the way in which he conducts his negotiations in both sets of situations.
The problem with all attempts to regulate, in other words, by law or government fiat to prescribe, the contents of labour contracts is that while one can certainly dictate the shape which those contracts will take, one cannot influence the willingness of one party or the other to enter them. Yes, you can stipulate that the wages of a widget packer will be $200 an hour and that he will enjoy 10 paid weeks of annual holidays. Yes, if an employer hires a widget packer he will have to do so upon those terms. But by no means, however, can you compel him to hire the widget packer in the first place.
This brings me to the central problem with labour market intervention: unemployment. Economists often say that they don't know much but that they certainly know how to create shortages and surpluses.
Want a shortage? Then fix the price of the commodity below that which would prevail in a free market. In that situation you will have more people seeking to buy a good than you will have people actually willing to put it on sale. This was what happened during the Second World War when price regulation was practiced across almost the entire economy.
On the other hand, want a surplus? Then fix the price of the commodity above that which would prevail in a free market. In that circumstance you will have more people willing to offer the commodity for sale than there are people willing to purchase it. This is precisely what we attempt to do in the case of labour markets.
The trouble is that attempts to regulate labour markets will often try to generate employment contracts which are more generous that those which would prevail in a free market. As a result, less labour is purchased than would otherwise be the case, and unemployment results. There seems to be a wealth of empirical evidence to support this conclusion. Countries, such as Britain, New Zealand and the United States, which have significantly deregulated labour markets fare much better in the unemployment stakes. Their unemployment rates typically hover around five percent or less. In countries like France or Germany, however, where rigid labour market regulation is the norm, unemployment rates rarely come below double digits.
Contrary to what many people believe, labour market regulation does not tend to make poor workers more affluent. In many cases it achieves precisely the opposite outcome. This is because those workers, or their unions, who can use the system of labour market regulation to obtain higher wages for themselves, are often those, who, because of a strong bargaining position were able to obtain high wages in any event.
Advocates of labour market regulation often ignore the effect of what might be called substitutability for different types of labour. To illustrate this concept, let us imagine a workshop where two kinds of tradesman are employed. These are, let us say, carpenters and joiners. We need not be very specific about what carpenters and joiners do, it could be anything. However, carpenters are the more highly skilled of the two. There is nothing which a joiner can do which a carpenter cannot. However, because carpenters are more highly skilled there are many things which carpenters can do which joiners cannot. Having higher and more specialised skills, carpenters have always been paid more than joiners.
Let us say carpenters, using their trade union muscle, persuade the arbitration court to issue them with a new award. This significantly raises their wages to a level which is even higher than what prevailed before. However, the laws of supply and demand then proceed to operate. Less carpenters are employed than hitherto. Moreover, those carpenters do not sit around and allow themselves to do nothing. As I said earlier, there is nothing which a joiner can do which a carpenter cannot. The carpenters therefore seek work as joiners. However, this raises the supply of joiners and as more of them compete on the market, their wages are depressed.
The result of regulation in this case has been to raise the incomes of those whose wages were already high, and to lower those of workers whose wages were already less generous. It is hardly what one might think of as an equitable outcome. It is even worse than that, of course. Some lucky carpenters do get higher wages. But others are condemned to work as joiners.
Of course, one might say, this simply advances a case for protection all round. Floors should also be placed under the wages of joiners too. However, what happens then? The unemployed carpenters simply go nowhere but the scrap heap.
When you allow for the existence of substitutability, the effect of labour market regulation is in fact to raise the wages of those who were already doing well, to lower those of workers who were faring more poorly and, if the regulation is extensive, to throw others out of work altogether.
In a recently settled country like Australia labour market regulation can often have some other, very perverse effects. Contrary to what many may think, markets for labour are not the same from region to region. In large cities, there will be more employers tending to bid up the price of labour. Moreover, the higher cost of living, particularly rents, will compel employees to seek a higher wage. However, in country towns there are not as many employers and cost of living is also not as great. This suggests that in a free labour market, wages in large cities will be higher than those prevailing in country towns.
Typically, however, labour market regulators adopt a ``one size fits all'' approach. Rates of pay are fixed across the whole economy, with scant heed paid to any need for regional variation. Moreover, wages are fixed on the basis of what employees should receive if they work in a large city. Small towns are not used as the model.
Economic theory suggests that the greater the disparity between the mandated rate and that which would prevail in a free market the greater will be the rate of unemployment. Thus the rates fixed by the labour market regulators may not produce much unemployment in the large cities. However, in country towns the effect on employment may be particularly severe. It comes as no great surprise, therefore, that unemployment in country towns is often very severe. In Australia this has led to a progressive drift from country towns into large cities as people move to places where they can find work. It is no surprise that Australia, which has regulated its labour markets for more than a century, is also one the most urbanised nation in the world.
In an unregulated labour market prices for labour would be free to vary from town to town. If wages were to be lower in country towns this would offer a considerable price incentive for businesses to relocate their operations to those towns. The result, in Australia, would be a steady move of populations from the larger to smaller cities. That the reverse is taking place at the moment represents a considerable tragedy.
One of the other great tragedies of regulated labour markets is the preferential unemployment of minority groups. Under this sort of regime members of ethnic or racial groups which are marginalised find it much harder to obtain work.
Economic theory suggests why this should be the case. Let us assume that there are two ethnic groups in a society. We will call one group the Calathumpians and the other the Rosicrucians. Most employers belong to the Calathumpians. Among the Calathumpians, Rosicrucians are seen as undesirable, shiftless, second rate sorts of employees. They are seen as people who will not turn up at work on time, will not work as hard, will lie and steal and so on and so forth. Now, this may or may not be true. However, it is the attitude which most Calathumpians share.
In an unregulated labour market, therefore, the demand for Rosicrucian labour will not be a strong, given that most employers are Calathumpians. The law of supply and demand therefore suggests that the wages of Calathumpians will be less.
Now, at this point a critic may suggest that all this does is to enshrine discrimination against Rosicrucians, by ensuring that their wages are at a discount by comparison with those of their Calathumpian colleagues. However, it is precisely because of this fact that the market begins to exact some very severe penalties.
Remember, Rosicrucians cost less to employ than Calathumpians. Let us imagine that there is, among all the Calathumpian employers one who either has enlightened attitudes or simply wishes to get a input edge on his competitors. If he were to adopt an affirmative action policy and hire only Rosicrucians he would gain a considerable advantage over his rivals. If the prevailing prejudice against Rosicrucians is purely irrational, he will obtain a workforce which is just as good but comes at a significantly reduced price. In other words, discriminatory employers come to pay a hefty penalty for the privilege of indulging their prejudices.
In short a free labour market offers powerful and very effective disincentives to discriminatory practices. However, if wage rates are fixed, then an employer must pay the same rate to both Rosicrucians and Calathumpians. In other words, a discriminatory employer can indulge this particular propensity at zero cost. In other words, a regulated labour market can, and almost invariably does, enshrine and promote discrimination.
A critic might interject here and state that this is all very well and good, but Rosicrucians are being paid less than Calathumpians. Surely this is unfair? Well, yes, but consider what must happen over the long term. Employers who discriminate against Calathumpians will do so at a considerable price differential. This will ultimately drive up their labour costs and ensure that their products are less than competitive. Over time, the market will very effectively put those employers out of business.
It is interesting to note that groups who purport to speak on behalf of disadvantaged groups, such as the Rosicrucians, in reality do nothing of the sort. An interesting case in point was that of the Aboriginal stockmen. Up until the 1960's they were not covered by an award and their wages were significantly less than those of their white counterparts. However, precisely because of that pastoralists preferred to employ them as they often possessed skills which white stockmen did not.
Predictably, however, the union representing white stockmen campaigned vigorously for an award which provided that white and aboriginal stockmen were to be paid at the same rates. The trade union depicted this exercise as one of enlightened compassion and humanity on its part. In reality, they were simply seeking to eliminate a source of competition by insisting that it be priced out of the market. Once the award came through, aboriginal stockmen ceased to be employed in any significant numbers. There are a number of adjectives which could be used to describe this outcome, but ``compassionate'' and ``humane'' are not among them.
To put it simply, regulation of labour markets is bad policy. The sooner we rid ourselves of the habit, the better.
Brad Row