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Professor Richard Epstein

Professor Richard Epstein

Back to Basics for New Zealand Labour Markets

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Pay Equity versus Open Markets

When I first visited New Zealand in July of 1990 at the invitation of the New Zealand Business Roundtable, one mission stood out above all. My job was to find some sensible way to stem the ever increasing tide of regulation in Kiwi employment markets. Ironically, the immediate target of that visit was the then Labour Party’s recently enacted, but short lived, system of “pay equity,” which would put the government in the happy position of deciding the relative wages for men and woman in all the different kinds of jobs thrown up by a modern economy.

In retrospect, it is hard to imagine a plan with less economic sense and more bureaucratic red tape than this one. The key feature of any market system is that jobs are defined by the contracts of the parties that create them, not by a central bureau. A single “category” of jobs—be it nurses or electricians—could contain within it a thousand critical variations known to the parties who create them, but utterly inaccessible to remote regulators armed only with their deep indignation of “unfair” wage differentials that governments should be sworn to undo.

That lumbering scheme of pay equity undercuts the key virtue of any market, which uses wage and price terms as a signal to indicate where services are in short supply and where they are not. In a world that has seen the price of oil first triple, only to fall by two-thirds, no fixed set of inherent values sets the salaries for workers in that industry relative to those in any other sector. To get the wages “right” between oil workers and secretaries could upset the balance between secretaries and janitors. Our hyperlinked economy throws off too many plausible comparisons for any one individual comparison to deserve pride of place.

It is therefore not encouraging that in the United States, President-Elect Barack Obama — whose strong suit is not labour markets — might try to resuscitate this moribund idea. So let us hope that his natural sense of caution pulls him back from this particular brink. Fortunately, the new government of John Key in New Zealand, should not have to expend much political capital in rebutting such a mindless proposal. Yet clouds still remain on the horizon, for in both the United States and in New Zealand, other proposals for the reform of labour markets are gaining traction. Each of these promises a further contraction of productivity, and each of these should deserves stout resistance.

Toward a Stable Legal Framework

The key principle for understanding labour markets is that the sound principles of their government depend on enduring features of the labour market, and not on the overall state of the economy. The legal regime that helps to institute prosperity in good times is the same one that works in hard times as well. Any temptation to claim market failures in labour markets is an open invitation to engage in counterproductive regulation.

What then is the preferred scheme against which all alternatives should be measured? Answer: freedom of contract, which allows workers and employers to devise whatever agreement they see fit. Labour markets are not characterized by tricky externalities. They do not pollute streams or require the creation of public goods. They are not characterized by genuine breakdowns in information, as workers are in a position to observe the conditions of their employment on a day-to-day basis. Left to their own devices, without explicit support from union activities, they will be highly competitive, and thus work hard to allocate scarce human capital to its most productive use. Workers have the option to quit for higher wages, and employers can always seek out low cost techniques to reduce their labour costs. Any short-term dislocation for firms or individuals is more than offset by the overall increase in the system productivity, spurred in part by clear signals that should increase investments in human capital.

The last thing we need, anywhere in the world, is a repetition of the recent spectacle where CEOs of the (not-so) Big Three Detroit automobile manufacturers to come hat-in-hand to Congress, backed by the United Auto Workers, for a huge public bailout that would do nothing to alter the ruinous terms of their long-term labour contracts. Trade unions are right, after a fashion, to trumpet the higher wages of union contracts. But they forget that these coerced gains cannot endure forever. The nonunion workers of Toyota and Nissan will not be left stranded by any bankruptcy of their employers. The workers of GM, Ford and Chrysler will sink with the firms that capitulated to union demands.

Trade Unions Business Productivity, and the Middle Class

This lesson, however, has not been learned by union leaders who always think that their services are essential to the success of business and the preservation of the middle class.

On the first point, they constantly stress the need for a “partnership” between management and labour to raise productivity to new levels. Sorry, it does not work that way. The only partnerships that work are those which are voluntarily formed. And those last only when each party can bring to the table something that the other partners both lack and need. But labour unions bring nothing to the table, if the goal is enhanced productivity. They know nothing about marketing, product design, finance, or for that matter effective labour relations.

No matter what the legal environment, trade unions can only succeed by bringing some form of monopoly power to bear on the firms that they organize. Once they plant the union flag in any firm, of course, they are right to care about the productivity of the firm that they have organized. Trade unions are bad at improving productivity, given that their first priorities are to increase wages and prevent layoffs, not to maximize profits. For example, it often makes sense for business to contract out some portion of its work. Few unions will tolerate that prospect. Businesses can always do far better with only one hand on the tiller than with two. The supposed management/labour partnership only leads to divided control that stifles flexibility and innovation. No ship needs two hands on the tiller, pulling in opposite directions.

But what about helping the middle class? This theme has been a dominant trope in the efforts of the American labour movement, strongly backed by a united Democratic party to introduce a set of far-reaching reforms under the so-called Employee Free Choice Act, which in essence allows unions to gain recognition through a card check system, after which they can force a firm to mandatory arbitration to a “first contract” of two years, if the two sides do not reach an agreement within 130 days—a short time to negotiate so complex an agreement.

This system of state coercion is of course antithetical to any improved cooperation between the two sides. And of course it does nothing whatsoever to improve the lot of the “middle class” no matter how it is defined.

First, no one profits from reduced productivity, whether they are located at the top, bottom, or middle of the income distribution. A smaller pie is presumptively bad because there is less to go around.

Second, the middle class does not consist solely of union members, or workers who would like to become union members. The middle class also includes of many hardworking owners of small businesses whose every step has been made more difficult by a set of government regulations with little net benefit. The unionization of those firms could knock people out of the middle class. But by the same token, the restrictive practices of unions can take their toll on nonunion workers who cannot join the guild. The monopoly wages and restrictive conditions for some necessarily impinge the opportunities for others. Trade unions do not provide us with a rising tide that raises all ships.

Third, union members themselves have to worry about being the victims of their success. Set wages too high, and they will fall to prey to the same grisly fate that decimated the ranks of autoworkers of Michigan and Ohio. Global competition does not offer a special dispensation for trade union workers. Indeed the great achievements of Sir Roger Douglas started with his recognition in the mid 1980s that New Zealand could only survive by cutting out tariffs and subsidies simultaneously, in order to put greater pressure toward competition on all domestic industries. Fortunately, New Zealand has not retreated into a protectionist cocoon , which reduces the power of trade unions to regain their economic clout.

These two common rationales for state intervention do not work. Nor are any other quick fixes likely to do the job. One common union line is that increased minimum wage laws will turn things around for workers down on their luck. No way. These laws are at best innocuous in those cases where they are set below the market wage for all categories of labour. But otherwise, they are just asking for trouble. Set the bar high above prevailing market wages, and the market will shut down. No jobs at high wages is not a way to jump start the economy. Raise them just a bit, and they will not shut down the market, but beneath the radar they will still reduce the gains from trade. In the new regime workers will have to accept less advantageous terms—less training, less flexible hours, fewer perks—in order to keep their jobs. As ever both sides lose from restriction on the ability to move wages

New Zealand Labour Legislation

The downside of labour regulations should not be forgotten in these hard times. The Employment Contract Act of 1990 was not passed in the best of times either. But it sought within limits to introduce a free system of contracts, which it did not quite introduce given the political opposition. But imperfect as it was, its achievements were impressive nonetheless. Between 1991 and 1997 overall, New Zealand generated 220,000 new jobs in a country of 3,600,000 people. Unemployment rates dropped from 11 percent in early 1992, shortly after passage of the ECA, to 6 percent in 2000. During first two years after the passage of the ECA, about 10 percent of workers received lower pay than before, as bloated union contracts were thrown aside. But thereafter overall wage levels increased on a sustainable basis, driven by higher productivity.

All of these gains were achieved by a system of market liberalisation that was cut short by the passage in 2000 of Labour’s Employment Relations Act, after which union membership rose only modestly, but productivity once again flatlined. There is no great mystery in these numbers. Clever social schemes to provided minimum standards against various forms of exploitation are wholly misguided because they mock the central truth of all labour relationships. The only source of mutual gain is through voluntary trade.

The desire of New Zealand’s trade unions to treat the current financial crisis as the jumping off point for reinstituting additional controls in labour markets mistakes the cure for the disease. When times are hard, it is absolutely critical to put as few public obstacles in the path of sensible labour relations. It bears stating that you cannot redistribute what you do not create.

All the fancy arguments against free labour markets have to face one central truth. The parties are better judges of the terms of their agreement than any remote and impersonal government agency. The key function of the state is to enforce agreements as made, and to make sure that no third person can disrupt them by either force or fraud. Sounds easy. But in times of stress it is amazing how many people gravitate toward systems of government intervention that can only complicate the situation on the ground. Let us hope that John Key and his new coalition government resists the siren call.