The world is full of economists who, though they know little of the
specifics of labour economics, confidently propose policies for managing
the labour market based on their general knowledge of the neo-classical
model. All markets are much the same, aren't they?
I fear this is the
best we'll get from the Productivity Commission's inquiry into
regulation of the labour market. So a test of the commission's report
will be whether it displays knowledge of advanced thinking on how labour
markets actually work or is just another neo-liberal rant about free
markets.
In their efforts to bone up on the topic, the
commissioners could do worse than start with a quick read of Nobel
laureate Robert Solow's 90-page classic, The Labor Market as a Social
Institution.
Since the book was published in 1990, it should be
old hat to economists, but I doubt it is. If so, it shows how little
effort most economists - even academic economists - have put into
studying the labour market.
Solow starts by reminding economists
of a glaring problem they prefer not to think about: if the market for
labour is just a market like any other market, and so is capable of
being adequately analysed by the economists' standard tool kit of demand
and supply - prices adjust until demand and supply are equal and the
market "clears" - how come the labour market never clears?
How
come we always have high unemployment, which shoots up during downturns
and stays very high for years before falling only slowly?
To put
the puzzle another way, if the labour market works like any other
market, making wages just a price like any other price, why don't wages
fall and keep falling as long as the supply of labour exceeds the demand
for it?
Why do nominal wages almost never fall? Why is it the
closest we ever get is nominal wages not rising as fast as ordinary
prices, so wages fall a bit in "real terms"?
In a country with
Australia's history of many minimum wages, carefully specified in awards
and agreements, it's easy for economists to claim wages can't fall
because they're being held up by legal minimums. But this doesn't wash.
In reality, many if not most wages are well above the legal minimum,
meaning the minimum isn't "binding" and so isn't stopping actual nominal
wages from falling back to the minimum. But they don't - and nor do
they in the US, where the minimum wage is kept so low it's almost never
binding.
Overseas, some extreme neo-classical economists have
tried to escape this problem by arguing most unemployment is voluntary
rather than involuntary. It just so happens that, when economies turn
down, a lot of people decide now's the time to take unpaid holidays and
stay on them for many months. Yeah, right.
Solow says a more
credible line of explanation is to admit the obvious: there must be
something about labour markets that makes them different from other
markets (such as the market for cars, or the market for bank loans) and
so renders economists' usual analytical tools inadequate.
And it's
not hard to think of what that something could be. Other markets are
for the purchase and sale of inanimate objects, whereas every unit of
labour bought or sold comes with a real live human attached. Every human
is different - some are smart, some aren't; some work hard, some don't;
some are co-operative, some aren't - and bosses turn out to be humans,
too.
The thing about humans is they have egos and feelings and
moods. One apple doesn't care about the other apples in the barrel, but a
human cares about how they're being treated by their human boss, as
well about how they're being treated relative to all the other humans
working for the boss.
Hence the title of Solow's book. Unlike
other markets, the labour market is also a social institution. Only an
economist could imagine you could analyse the labour market successfully
without taking account of the human factor.
So maybe it's the
social dimension of labour that explains why wages are inflexible and
the labour market doesn't clear. Solow uses the work of some woman whose
name seems vaguely familiar, a Janet Yellen, and her
Noble-prize-winning husband, George Akerlof to outline one possible
explanation of the conundrum, "the fair-wage-effort hypothesis".
The
"efficiency-wage theory" says that in the modern economy workers often
have some control over their own productivity. They produce more when
they are strongly motivated to do so. "One way for an employer to
provide more motivation is by paying more than other employers do;
another is to threaten to fire the excessively unproductive if and when
they are detected," Solow says.
If that sounds obvious, note the
radical implication: a firm's physical productivity depends not just on
how much labour (and capital) it uses, but also on how well the labour
is paid. If so, wages won't fall just because unemployment rises.
Yellen
and Akerlof's version of efficient-wage theory says workers who believe
they're being paid "a fair day's wage" feel a social obligation to
deliver "a fair day's work" in return.
A different approach is
"insider-outsider theory". This says the people already working for a
firm (the insiders) are likely to be more productive than those who
aren't (the outsiders) because they understand how the firm works. If
so, the insiders are helping to generate "economic rent" for the firm
and thus are able to share this rent by negotiating higher wages.
An
outsider may be prepared to work for the firm for a smaller wage, but
the boss won't want to risk reducing his productivity by switching from
insiders to outsiders.
Whichever of those theories you find more
persuasive, the point is the workings of real-world labour markets are
far more complicated than most economists realise. Let's hope the
Productivity Commission does.
