Freeman

ARTICLE

Wages and Productivity

NOVEMBER 01, 1963 by W. M. CURTISS

Dr. Curtiss is executive secretary of The Foundation for Economic Education, Inc.

In discussions of wage rates, whether for individuals, firms, or for the entire economy, we hear a lot about the increasing produc­tivity of the worker, and that wages must rise to reflect such increases. A large steel company recently has negotiated a contract with its workers which says, in effect, "If your productivity in­creases, your wages will keep pace." Is this the way wages are or should be determined in an open society? Just what are the implications, if all wages were determined by this method?

How come that a boy today gets $3.00 or $4.00 for mowing the same lawn you did as a lad for 25 or 50 cents? Has the pro­ductivity of boys increased that much? True, a boy with a power mower can do the job faster; but when he’s finished, the total ac­complishment is no greater than when done a generation ago. In fact, the job may have been done better then, if you consider the trimming which boys with power mowers tend to neglect.

Or, take a haircut—$2.00 now compared to the quarter you paid for your first one! Electric clip­pers, to be sure; but again, you are interested in the finished job rather than the barber’s speed.

So it goes, for one service after another—a cleaning woman, win­dow washing and hanging screens, car waxing, house painting—what­ever the service, you find it costs a lot more to get the job done than when you were a boy.

When you think about it, you realize that inflation is a factor—a dollar doesn’t go as far as it once did. That might account for perhaps a doubling of the price, but what about the rest of the in­crease?

Supply and Demand

In a free market, wages are de­termined by competitive forces of supply and demand. A manufac­turer, after very careful plan­ning, concludes that he can make and sell so many of a particular item at a given price. He must assemble his resources, including his plant, his equipment, his man­agerial talent, and workers, and hope to recover the cost of these things from the price buyers will pay for the finished product.

So, the manufacturer goes into the labor market to hire men to work for him. If his offered wage isn’t high enough to get the workers he needs, then he must either give up the project or fig­ure how to recombine his resour­ces in such a way that he can pay higher wages and still come out ahead. He may do this by sim­plifying his manufacturing proc­esses, by introducing more or bet­ter machinery, or by innovations of some sort.

The worker, on the other hand, will look after his interest, too, and will consider moving to a new job if it seems more attractive to him for reasons of higher pay, better working conditions, shorter days, more vacation, or whatever.

But, suppose some manufac­turer comes along with an item he can make and sell very profit­ably. It may be because of pat­ents he holds, or special skills or processes that only he knows about. He may be able to afford to pay wages half again as high as the going wage in the area and still come out ahead. Shouldn’t he do this?

Various Alternatives

In a free market, he is at lib­erty to pay the higher wage if he wishes. But if he has had some experience in manufacturing, he knows that competition is behind every tree and someone will figure out a way to put a competing prod­uct on the market that will un­dersell his, with his high labor costs, in which case he may find himself without his expected buy­ers. So, he probably will decide he should pay the going wage for his workers, or just enough more to fill his needs, and use most of his technological advantages to reduce prices to the buyer and build his market. If, in the early stages, he is able to gain a hand­some profit for himself and his stockholders, he will have a cush­ion with which to meet the com­petition certain to come.

All this has nothing to do with a particular businessman offering his workers production incentives. He may believe that his workers will produce more for him if he gives them every Wednesday after­noon off, or he may give them a share in the profits of the firm, or he may pay them on a piece-work basis. That must be each employ­er’s decision; but most will offer a base wage rate not greatly dif­ferent from the going wage in the area.

Competition the Key

But, what has all this to do with the cost of getting my lawn mowed, or a haircut, or hiring a woman to clean my house? Why have wages in the services increased over the years about as much as those in highly automated indus­tries? In one instance, efficiency of doing the job may not have in­creased at all, while in the other, it may have increased tenfold.

Competition is the answer. If you want a man to cut your hair, you must pay enough to keep him from going to work in a factory or at some other occupation. As a result, we have what may be re­ferred to as a wage level for the entire economy. This is a some­what mythical figure, not too meaningful because of the vari­ability of individual skills. For ex­ample, consumers will pay a great deal more for the services of a skilled brain surgeon than for the services of a messenger.

The calculation of a wage level for a country is a tremendously complicated procedure and not too satisfactory at best. Nevertheless, it is a useful if not precise tool in comparing the economy of one country with another. We know, for example, that the general level of wages is much higher in the United States than in India, which leads to certain conclusions about how wages may be improved in any economy.

With a free market, in an ad­vanced economy, most of the re­turns from production go to the workers—roughly 85 to 90 per cent. Competition forces this. If workers are supplied with good tools and equipment, they are more productive and their wage level is higher than it would be otherwise. This is a generaliza­tion regarding all workers. The general wage level is higher in a country where there is a relative­ly high investment in tools and equipment per worker. It is just that simple! In the United States, the investment per worker in tools may be $20,000, and it is not un­heard of to find a particular busi­ness with an investment of $100,­000 in tools and equipment per worker.

The road, then, to a higher wage level is through savings and in­vestment in the tools of produc­tion. There is no other.

A high investment in tools and equipment benefits the barber, the cleaning woman, and all service employees, even though the invest­ment is not directly for their work. Competition sees to this.

A Negative Bonus

However enlightened it may ap­pear on the surface, the wages of an individual worker or for a group of workers cannot be tied to the productivity of their job or to the profitability of a particular firm. If this were the case, a highly skilled worker might find himself working for a negative "bonus" in a firm which, for some reason, happens to be operating at a loss.

The same may be said for tying wages to a cost-of-living index. A fair wage, both to the worker and the employer, can only be estab­lished by bargaining between the two interested parties—the work­er taking what appears to him to be the best he can get and the em­ployer, all things considered, get­ting the best deal for himself.

The lesson here is that while productivity of workers is highly important when considering a gen­eral wage level, productivity does not determine what the wage rate ought to be for any given firm or industry within the economy. The effect of general productivity on wages is automatic in a free mar­ket with competition. And all workers stand to gain when tools and capital are made available to some of them.

Footnotes                          

NOTE: The economics of wages, while rel­atively simple in general terms, is complex in detail. The above is an oversimplified state­ment of one phase of the wage problem. The student who wishes to go further into a study of wages is referred to Why Wages Rise, by F. A. Harper: The Foundation for Economic Education, 124 pages, indexed. $1.50 paper, $2.50 cloth.

This article by Dr. Curtiss will be number 44 in the Founda­tion’s series of suggested answers to Cliches of Socialism. Mr. Read’s article on page 46 is number 43. The first 32 of these answers are bound in a 124-page paperback, subsequent numbers available only as single sheets at 2 cents each. For the full set of 44, including the book, send $1.00 to The Foundation for Economic Education, Irvington-on-Hudson, New York.

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November 1963

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Unfortunately, educating people about phenomena that are counterintuitive, not-so-easy to remember, and suggest our individual lack of human control (for starters) can seem like an uphill battle in the war of ideas. So we sally forth into a kind of wilderness, an economic fairyland. We are myth busters in a world where people crave myths more than reality. Why do they so readily embrace untruth? Primarily because the immediate costs of doing so are so low and the psychic benefits are so high.
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