The minimum wage and defending the free market

Gerard Jackson

I am frequently asked why free-market thinking in Australia doesn’t seem to be making any headway against the statist thinking. Needless to say, these people also expressed considerable disappointment in Tony Abbott’s economic record, which brings me to the right-wing’s sorry record. No serious scientist ever disconnects from first principles, and the same should go for economists. Unfortunately, first principles are something that our self-appointed advocates of the free market seem incapable of applying, particularly when it comes to the pricing of labour. And this is why, after more than 30 years of intellectual grandstanding, they have failed dismally to persuade the great majority of Australians that the effective minimum wage destroys jobs.

The left, unlike our right-wing, understands the power and influence of symbols and myths. Minimum wages, state awards, the Australian Industrial Relations Commission, etc., are powerful symbols for the left and in its mind represent the necessity for the state, and also unions, to meddle in labour market processes. This is one area in which the left has public opinion behind it.

Now these symbols arise from a single myth, the myth that in the absence of these interventions labour would be ruthlessly exploited by capital. It follows, at least to those of us who have given the issue serious thought, that if the idea of free labour markets is to become overwhelmingly accepted by the population then the public must be persuaded that the idea of capitalist exploitation is just a myth.

Let us now get down to some fundamentals of economic theory. We know that most people are afraid that free labour markets would lower real wages for those who lack ‘bargaining power’. Des Moore, a prominent member of the H. R. Nicholls Society, essentially argues that there is nothing to fear because the number of firms competing for labour puts a floor under wages. This is nonsense: the number of firms has nothing to do with the height of real wages. In fact, real wages can fall even as the number of firms expand, and vice versa.

Taken to its logical conclusion, this quantitative-firm approach, as I call it, could lead to the absurd conclusion that mergers depress real wages because they reduce the number of firms and hence competition for labour: therefore all mergers should be forbidden by law. I can even imagine someone arguing that large firms should be broken up into smaller firms so as to increase the demand for labour. However, as every competent economist knows, real wage rates are determined by the amount of capital invested per worker and not by the number of firms in existence¹.

Our right is at one with neo-classical economics in that they treat capital as homogeneous. However, the Austrian school of economics tirelessly points out the reality that capital forms a highly complex heterogeneous structure consisting of complex stages of production. The longer and more complex these stages the higher will be the value of labour’s output and hence real wage rates². This nails as fallacious the idea that the quantity of firms is relevant to the height of real wages.

Regardless of what some people might think, demand curves always slope downwards. The demand curve for labour is really a schedule of its descending marginal value productivities. The point at which the supply curve intersects the demand curve determines the wage rate at which the market for particular types of labour clears. (We should never lose sight of the fact that labour is also heterogeneous).

Raising wages above the market rate always produces unemployment. In fact, it’s a process by which incomes that would have gone to the unemployed workers are in part transferred to those who are fortunate enough to keep their jobs. Logic and decency clearly dictate that this is indeed an unjust and exploitative situation that should be remedied by allowing the market to clear. Professor Stilwell, however, views the matter differently, arguing that this would be at the expense of higher paid workers and would be “contractionary” because it would reduce consumption³.

Allowing the market to clear would ensure that those who were priced out of work would now be priced into work, thus remedying the previous unjust situation. Secondly, this process would probably raise total payrolls, an important observation that our rightwing commentators always overlook, as do the market’s leftwing critics. Then there is this vital fact that is never referred to by our free market advocates, the process would also release withheld capacity which in turn would expand demand. The idea that allowing labour markets to clear would be “contractionary” is thus absurd to the point of utter stupidity and is just as bad as Des Moore’s opinion on competition and wages⁴.

When the debate over labour market reform was in full swing the rightwing argued that because Australia’s minimum wage was 58 per cent of the median wage and the highest ratio in the OECD this was proof positive that the minimum was too high. Unfortunately this statistic proved nothing and was totally ineffective against those who argued that minimum wages do not cause unemployment. What our rightwing overlooked is that statistics do not stand by themselves, they need to be explained. Let me quote Jean-Baptist Say’s thoughts on this subject:

Hence, there is not an absurd theory, or an extravagant opinion that has not been supported by an appeal to facts; and it is by facts also that public authorities have been so often misled. But a knowledge of facts without a knowledge of their mutual relations, without being able to show why the one is a cause, and the other a consequence, is really no better than the crude information of the office clerk…. What is theory, if it be not knowledge of the laws that connect events with their causes, or facts with facts?⁵

John Stuart Mill expressed similar sentiments:

Man is capable of rectifying his mistakes by discussion and experience. Not by experience alone. There must be discussion, to show how experience is to be interpreted. Wrong opinions and practices gradually yield to fact and argument; but facts and arguments, to produce any effect on the mind must be brought before it. Very few facts are able to tell their own story, without comments to bring out their meaning⁶.

Ludwig von Mises had this to say of economic statistics devoid of theory:

Experience of economic history is always experience of complex phenomena. It can never convey knowledge of the kind the experimenter abstracts from a laboratory experiment. Statistics is a method for the presentation of historical facts concerning prices and other relevant data of human action. It is not economics and cannot produce economic theorems and theories. The statistics of prices [including wages] is economic history⁷.

This has been a singular problem in Australia. Advocates of labour market reform have been supplying facts virtually without theory: hence the meaningless 58 per cent ratio that was so thoughtlessly bandied about. Moreover, the idea of an average wage or wage level is itself a statistical fiction. Robert A. Gordon said of this approach:

…the concentration of attention upon aggregates and upon distressingly broad vaguely defined index-number concepts — with insufficient attention being paid to those interrelations among components which may throw light on the behaviour of these aggregates. . .⁹

The danger of drawing economic conclusions from statistics without the use of economic theory was amply illustrated in Sinclair Davidson and Julie Novak’s Five and a half big things Kevin Rudd doesn’t understand about the Australian economy⁹. Their first error was to state that the “current economic crisis is due to regulatory, and not market failure”. This is nonsense: regulatory failure did not cause the crisis. The least they could have done was to try and apply some economics to the problem instead of just quoting from studies.

Their second error was their dreadful treatment of Australia in the great depression. It was horribly superficial and grossly misleading. In short, it was completely devoid of economic analysis. Needless to say, they, along with the rest of the rightwing, are in full agreement with P. D. Jonson’s pernicious view that “boom and bust are part of the natural order of capitalism”¹⁰.

Unfortunately the right’s frightful errors on the Great Depression, the nature of the trade cycle and the cause of the current crisis have become the established orthodoxy that has to be accepted without question. Given these facts it is no wonder that statist thinking remains largely undented in Australia.

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¹This means the capital-labour ratio. People are surprised when I tell them that this fact was well known to classical economists. As John Stuart Mill put it: “Wages, then, depend mainly upon the demand and supply of labour; or as it is often expressed, on the proportion between population and capital”, meaning the ratio of capital to labour. (Principles of Political Economy, University of Toronto Press, Routledge & Kegan Paul, 1965, p. 337.) Des Moore’s explanation of what puts a floor under real wages is not to be found in any textbook nor would it be acceptable to ANY classical economist.

²Strictly speaking, a lengthening of investment periods do not always require more stages of production. In some cases a lengthening requires the replacement of existing stages with more advanced but more time consuming stages. I stress the addition of more stages to emphasise the importance of the stages of production analysis.

³Frank Stillwell, Changing Track, Pluto Press, 2000, P. 74. I cannot fathom why the right allowed the likes of Stillwell to get away with their claptrap.

⁴For a comprehensive view of payrolls, withheld capacity and wage rates see William H. Hutt’s The Keynesian Episode: A Reassessment, LibertyPress, 1979.

⁵Jean-Baptist Say, A Treatise on Political Economy, Transaction Publishers, 2001, originally published in 1836 by Grigg & Elliot, p.p. 20-21.

⁶Collected Works of John Stuart Mill, Vol. XVII, University of Toronto Press, Routledge & Kegan Paul, 1977, p. 231.

⁷Ludwig von Mises, Human Action, Henry Regnery Company, Chicago, 1963 edition.

⁸Cited in The Keynesian Episode: A Reassessment, LibertyPress 1979, p. 351.

⁹Five and half big things Kevin Rudd doesn’t understand about the Australian economy  . Australia and the Great Depression: What you don’t know shows where Sinclair Davidson and Julie Novak went astray.

¹⁰Jonson, P. D., Capitalism, Connor Court Publishing, Pty, LTD, 2011, p. 282.