All Commentary
Wednesday, March 1, 1978

The Market for Labor


Mr. Bechara recently earned a master’s degree in Labor Law at the University of Pennsylvania. He is an attorney and a member of the bars of the Commonwealth of Puerto Rico and the District of Columbia.

Throughout history there have been numerous schools of thought dealing with the determination of wages and the proper role of workers. Most of these economic philosophies have opposed the free market method of production and employment and have sought, by various means, to alter our allegedly unjust system. Therefore, in order to understand these proposed means and their inherent fallacies, it is necessary to analyze how wages are determined in the free market.

The concept of marginal productivity describes the economic forces at work in the labor market. When an entrepreneur needs employees, he must offer them enough incentive to entice them away from other possible employers. However, the salary that an employer may offer prospective employees is limited by the realities of the market. Consequently, the employer must weigh how much income he will receive from the production that each new employee will generate. If the employer pays a wage that is above the laborer’s marginal productivity, then he will incur losses, which will force him to lower the wages. If, on the other hand, he pays too low a wage, lower than the marginal productivity, then the prospect of gain will entice other entrepreneurs to take advantage of the difference between the marginal productivity and the wages prevailing in the market.

Interventionists, those people who argue in favor of numerous laws which create minimum conditions for employment, are inconsistent concerning wage determination. They argue that employers are miserly and refuse to give employees a fair wage. The interventionists are thus assuming that employers would not compete against one another for workers, because that would tend to bid wages up toward the point of marginal productivity. But if employers are so guided by avarice, why would they not seize the opportunity for profit when they observe a wide disparity between high marginal productivity and low prevailing wages?

Effect of Unemployment

It is often argued that in the real world we confront an ocean of unemployment and that an entrepreneur does not have to entice employees already employed, so that he is able to offer a salary lower than the marginal productivity. However, to the extent that there is involuntary unemployment, it is a result of the interventionist policies of the government. The consequence of imposing a minimum wage is that those people who cannot produce economic goods worth more than that minimum will not be hired. Furthermore, the imposition of inflexible laws that restrict the labor market create unnecessary and tragic human consequences. The argument that we must combat the result of one government intervention with more government intervention is simply a non sequitur.

Even assuming that the interventionists are correct about the effect of unemployment on wages, the theory of marginal productivity remains unassailable. Inasmuch as those who are unemployed are in such a position as a result of the interventionist policies, they cannot effectively compete on the labor market with the rest of the employees in the market. Hence, marginal productivity still applies to the employed.

If we assume, however, that the unemployed population does compete with the rest of the labor force, the net effect would be to bring about a readjustment in wages, taking the unemployed into consideration. Those who argue that the unemployed can compete with those employed are, in effect, admitting that prevailing wage rates are too high, above the equilibrium level. Otherwise, no involuntary long-term unemployment could result. Therefore, regardless of which point of view we adopt concerning unemployment, the marginal productivity theory cannot be denied.

Syndicalism

Contemporary interventionist philosophy frequently advances the idea of worker ownership-in‑common of the means of production. The origin of this notion can be found in syndicalism, an historical reaction to the market system. Syndicalism argued for the expropriation of the means of production from rightful owners, and the substitution of the workers themselves as the owners. This method of economic organization would allegedly bring about income equality.

The syndicalist society, however, denied the existence of change. As some workers sell their shares in production, or simply squander them, income inequalities again result, which was the evil that syndicalism was supposed to remedy. When workers die and leave an inheritance, we have the same problem: heirs own shares of enterprises in which they do not necessarily work. Therefore, we find that this system not only created income inequalities, but also allowed people to own shares of entities in which they did not work, both evils in the eyes of the syndicalists. In order to enforce the syndicalist method of production, a great bureaucracy with ever-widening powers needed to be created to redistribute wealth continually so as to eliminate these consequences.

Syndicalism faced difficulties with respect to growing and dying industries. Aside from the obvious problem of the raising of capital, the syndicalist state had no way to deal with the fact that some industries became prosperous, while others were headed toward bankruptcy. The employees of the bankrupt industries would have lost all the assets they earned, while those employed by the growing industries would oppose any new employee from entering their industry since it would imply having to further divide the shares of the enterprise among more people. Consequently, syndicalism induced tremendous rigidities on the labor market.

The syndicalist society failed to perceive the nature of our system, which involves not only production, but exchange. As John Chamberlain put it:

In the early 1920′s the Italian syndicalist trade unions seized the factories. But there followed a sit down strike of the salesmen, the commercial agents, the factors, the middlemen. Syndicalism had no way of entering the world of commerce, the world of connection, which must go either by the law of contract or by administrative fiat. When no provision is made for the world of commerce, a vacuum exists outside of the factories. A state is needed to enforce the freely accepted terms of contracts or to staff an administrative apparatus. If there is no state, gangsters step in to do the job.

Inequalities Persist

Syndicalism, therefore, brought about the same income inequalities which it attempted to eliminate. At the same time it denied the economy the benefits of market pricing under capitalist production and exchange. Although it may be easy to neutralize the appeal of syndicalism, the underlying ideas which engendered it remain with us to this very day. These ideas nourish the belief that employees are not receiving their fair share and that laws should therefore be enacted to alter such inequality. Hence we find a rising popularity for such methods as profit sharing and worker participation in managerial decisions (codetermination) as the ways to create a middle ground between pure syndicalism and pure capitalism.

It is possible that profit sharing and codetermination may have positive consequences in some industries, that productivity may rise and that labor-management relations may be improved. However, it does not necessarily follow that what may be good for one firm may be good for the economy as a whole.

With regard to profit sharing and codetermination, it must be remembered that these topics are considered here strictly from the point of view of what would take place in the event laws were enacted to compel every firm to establish its own method of profit sharing and codetermination.

Profit sharing is not a new idea, and has been tried before:

Albert Gallatin, Secretary of the Treasury under Presidents Jefferson and Madison, installed profit sharing in his glass works at New Geneva, Pennsylvania in 1794. Horace Greeley had a profit sharing plan for certain employees at the New York Tribune, and was a strong advocate. In 1886, Colonel Procter introduced a profit sharing and general employee relations program at Procter and Gamble. Eastman Kodak joined the ranks of the profit sharers in 1912, and Sears, Roebuck and Company in 1916. In 1920 the National Industrial Conference Board surveyed the field and found fifty-four companies with profit sharing plans; in 1940, its survey uncovered 158 plans.2

Profit Must Be Earned

A profit sharing plan may be described as one which is organized so as to make intermittent payments to the employees out of any possible profits. Consequently, the success of the plan is contingent on the success of the enterprise. If there is no profit in a given year, no contributions can be made.

However, the term “profit sharing” is misleading because it implies that profits exist only as the bottom line of an accountant’s ledger. Yet, true profits, from a strictly economic point of view, consist of “the reward willing customers accord an entrepreneur who efficiently uses scarce resources to satisfy their wants.”3

Profits that are shared with employees or taxed away by the state cannot effectively be a part of an economic process by which consumers reward the most productive and ingenious entrepreneurs. And what of that portion of profit which represents an interest payment to the investor? If investors are at liberty to place their savings elsewhere to obtain an appropriate yield, it is not feasible to consider sharing the interest portion of profits.

One could argue that if a law were passed imposing profit sharing plans on all enterprises, then there would be no threat of investors withdrawing their funds to other firms. However, this argument fails to realize that under such a law there would be no investment unless the investment yields an interest above the yield which would be confiscated by the profit sharers. Therefore, if a universal profit sharing plan existed, its first consequence would be to reduce and limit investment to those areas profitable enough to cover the profit sharing burden as well as the interest which investors would find acceptable. All other investments which would produce less than that sum would be discontinued, because no investor would find it worthwhile to invest his savings at a negative interest.

No Panacea

Profit sharing does not promise an extensive future. For the years 1969 through 1974, corporate profits after taxes averaged about $55 billion a year. If that entire amount had been divided equally among an average employed labor force of 81 million, each worker’s share would have been about $13 a week.4 But in that case, no profits would have been available as interest or a return to investors. Of course, when we speak in terms of figures and aggregates, we deal with imperfect concepts which tend to be misleading. Historically, an average of 45 per cent of the annual reports of companies show a loss for the year.5

Hence, it becomes obvious that the ideal of profit sharing, even if universally applied, cannot become a panacea for our industrial problems. The average employee will see his particular work as too far removed from the actual profits earned, so that the motivation to be more productive is very weak.

Problems dealing with equity will also arise every time the profit is divided, each sector of the labor force demanding a larger share than the one actually allocated to it. Similar difficulties will emerge regarding the “fair” division of the profit between shareholders and employees.

Profit sharing is also a deceiving term because its proponents use it to allude to a mechanism for raising wages. After dividing among the employees what the proponents call profit, there will still be some amount left over for investors, which will be considered as the net profit. The amount divided among the workers, rather than profit, is another wage, a bonus which is part and parcel of the costs of production.

Whatever the problems inherent in the profit sharing idea, some firms still may see it as the better way to pay their workers according to their marginal productivity. This is tolerable in a free market, and there should be no law against it. But neither should the law deny others their liberty by making profit sharing universal and compulsory.

Codetermination

Codetermination has become a reality in many West European countries. Although each country may have its own devices, the general tendency is to allow a certain number of employees on the board of directors, so that both labor and management may have an influence on decisions which may affect the employees.

As in the case of profit sharing, in the free market some firms may look upon the process of codetermination as their better way to compete for employees—and that should be their privilege. However, we are dealing in this essay not with the voluntary actions of employers and employees, but with the possibility that laws be enacted to force this concept on all corporations.

In a sense, codetermination is a thrust against the concept of private property, a limitation of property rights but short of outright expropriation. Others than the property owner would enter into the decisions about how to risk his investment. Instead of economic efficiency, the guide would become political expedience. And if business activity is thus politicized, where is the process to end?6

In the long run, an employer cannot impose his will on his employees because he is limited by the action of the market. If the employer insists on conducting his personnel affairs in an arbitrary manner, he will lose the most efficient of his employees, who will be hired by his competitors. If an employer insists on acting in an authoritarian way, he will find that in the long run the quality of his employees will deteriorate, the products he manufactures will reflect this and his business will generally be affected. Thus does open competition in the market effectively curb the abuses cited by proponents of codetermination.

In addition to those who advocate forced profit sharing and codetermination are others who believe that the only way to raise wages is through union pressure on employers. However, the price mechanism has its effect here as in any other area where commodities are bought and sold. It is possible that unions will be able to obtain wages higher than the market level, but adverse effects will follow. In the first place, the industry involved may have to raise its prices to pay for the higher production costs. This may reduce demand for that company’s products, so that some employees will be discharged. Conversely, if the demand for these products is not as responsive to their price, then the consumers will have that much money less to spend or invest on other products, so that other industries will suffer a decrease in their business. At the same time, the long-run effect of wages higher than the equilibrium level in any industry, as imposed by union pressure, is to trap capital. As a result of this, investors will no longer be willing to reinvest in such industries, and the apparent benefits of union pressure become short-lived.

Capital the Key

The only true way for raising wages is to allow for capital formation. Marginal productivity determines wages in the market, but that productivity is affected by the amount of capital invested per employee. American workers are more productive not because they are any more intelligent than other workers, but because they have at their disposal more efficient and more productive tools. These efficient tools alone cannot guarantee that profits will be made, since profits depend on the behavior of willing customers whose needs have been correctly anticipated. However, once consumer preferences are correctly foreseen, then the more productive the tools the more the marginal productivity of employees rises.

What we may wisely ask of government is that it not interfere with capital formation and that it respect and protect private property and the right of every individual to contract and trade freely with others who are willing.   

                        

—FOOTNOTES—

‘John Chamberlain, The Roots of Capitalism (Indianapolis: Liberty Press, 1976), p. 245. See also Ludwig von Mises, Human Action (Chicago: Henry Regnery Co., 3rd ed. 1966), pp. 812-820.

‘Claude Robinson, Understanding Profits (Princeton: D. Van Nostrand Co., 1961), p. 303. ³“³”Profit Sharing,” The Freeman, December 1973.

‘Statistical Abstract of the United States 1976, U.S. Department of Commerce, Bureau of the Census.

‘Robinson, op. cit., p. 79.

‘Implications of representation trend for U.S. corporations,” Harvard Business Review, January/February 1977. “The Realities of Co-Determination,” The AFL-CIO American Federationist, October 1977. “Participation by Agreement,” Lloyds Bank Review, July 1977.