Is the existence of different wages a problem for societies, and if so, how can it be remedied?

 

Adam Smith, and Karl Marx, both believed that labour value lies at the heart of all economic value. Commodities, goods, and services arise from the interaction of land, labour, and capital. Since Land is fixed until new land is cleared or built by workers, and since capital enhances labour and is invented by people, they both thought that the only people who added value in economic transactions were workers.

This theory of labour value was qualified in the second half of the twentieth century by the elevation of entrepreneurialism as a factor of production. The enterprising businesspeople who took on risks, brought factors together, and who were rewarded with profit having been prepared to make losses, were elevated to a ‘fourth factor.’ This idea makes some sense, but also serves to undermine the idea that labour value on its own creates economic value.

If labour has value, some argue that the value of time taken from a life to work should be viewed equally. This means that there should be a basic price for each unit of labour. Since some products of that labour are more valued than others, it follows that the returns for each unit of labour are different. This idea lies at the heart of the idea of economic rent (which can also apply to other factors.) The economic rent characterises an equilibrium price in the market as being the product of transfer earnings and the amount of perceived addition to value added by a specific worker or factor (the economic rent.)

The economic rent argument therefore explains wage in terms of two things; what the employer needs to pay to get the worker to transfer from another activity, plus the additional value that the employer perceives the worker as adding to employer operations.

Whilst quite simple, this argument is unsatisfactory as an explanation of wage differences. It is based on the normative whims and speculation of the employer; it acknowledges very little agency for the worker; and it does not explain why different employers might compete for a worker whilst paying the same wage.

There are other explanations for differing wages. The simplest is that all labour is in derived demand, and therefore the demand for labour is linked to another market. For instance, the demand for bricklayers is demand from the demand for buildings, whether for private or commercial use, and from the amount of money or credit available to maintain those buildings.  This is a persuasive argument, except in that it again denies agency to workers, and says little about their supply, productivity, or relationship with employers.

An economist could therefore elaborate on the derived demand theory to note that wages are also a matter of supply of workers, and that supply is affected by elasticity. One set of workers might be more available than others. They could take longer to develop their skills or have a shorter working life. There might be fewer substitutes in terms of technology, so the opportunity cost to an employer of using them might be lower than if the employer could employ a productive machine. The model does not explain employer demand, but it does suggest why different wage points might arise from the intersection of demand with different supply lines.

The theory of marginal revenue product helps clarify the relationship between employers and employees. This holds that a worker’s value lies in the product of the extra amount which they produce in a given time multiplied by the extra revenue that they bring in. In such circumstances, the employee’s MRP will rise, peak, and fall. The employer’s demand, however, will be set by the rate in the market, which will set their average cost line. The point where average cost and MRP intersect in a competitive market, (typically at a point beyond the peak of a worker’s output, but before they begin to cost the employer more than they produce) is where the wage for the firm will be set.

Many employers, and employees, do not exist in a fully competitive market. It follows that there may be circumstances where an employer or group of employers could dominate the labour market as single buyers of labour. In such circumstances, they would be monopsonies or oligopsonies, employing the majority of people in a sector or area.

Where monopsonies arise, the employer can effectively pay workers at average cost, but get the full marginal benefit of their product while not paying marginal cost. This means that they will employ a smaller number of workers than they would in a competitive market, pay them a lower wage than a market would require, and yet get more out of them. Any worker who revolted against this model would find themselves unemployed with few or no other options and replaced by the pool of local or sectoral unemployed.

In such circumstances, employees should create a countervailing monopoly of labour supply by joining a union. This is exactly what many do in government, or the service of large natural monopsonies such as railway companies, energy producers, or specialised production. This would not solve the problem of local unemployment, however, as the union, if successful, would drive up wages to near or equal marginal cost for employers. This would eliminate employers’ profits from labour, make technology which could replace workers more attractive by lowering the opportunity cost of capital, and could ‘lock out’ jobseekers who would do the work for a lower wage than union members.

Finally, employers might simply be discriminating when paying different wages. This means that they could be attributing a higher MRP to some workers than others based on characteristics which do not relate to the actual productivity of workers. Some differences could really exist, of course—some people might be more skilled than others, some tasks might be better suited to a particular sort of worker than others. Discrimination is possibly rational and, by moving the price of workers closer to its marginal cost in a market, could improve economic efficiency. In many circumstances, it makes sense for mathematicians in short supply but with high skills who are in derived demand and who are highly productive to be paid more than cleaners, even though cleaning is a vital job.

Discrimination on non-economic grounds is, however, of almost no use to any economy. There may be a vague association of local jobs with positive externalities arising from community prosperity or coherence, for instance, but they will come at the expense of less competitive local markets with higher prices, and therefore create a deadweight loss for consumers. The government should intervene in those circumstances to prevent discrimination because of non-economic or irrational choices by employers.

Similarly, a role exists for governments to intervene in markets to create a minimum wage, not for political reasons but because this prevents an employer by paying wages so low that they gain an unfair advantage over other businesses and drag all wages below the point at which workers can earn enough to save, and to consume something other than inferior goods. If wages did fall to such a level, the situation in the economy might improve temporarily in terms of productivity, but ultimately, investment, competition, prosperity, and living standards would fall. The only people who would benefit would be ‘malefactors of great wealth’ who extracted all labour value and profit and then disappeared.

Governments need to be vigilant to prevent an imbalance of power in which unions become a block on innovation, growth, or new entrants to the market because of restrictive practices, abuse of the strike power, or the addition of costs and barriers to the operations of employers. Such interventions, which involve the elimination of secondary picketing, the introduction of transparency and democracy in union operations, the restriction of ‘wildcat’ strikes, and the elimination of closed shops can benefit everyone so long as the fundamental right of workers to join unions, engage in collective bargaining, and strike is respected. It can add to general prosperity, and to the positive externalities in terms of community infrastructure, savings, and spending that flow from it.

Finally, governments and societies can benefit in multiple ways from the existence of different wages. For instance, progressive taxation can ease the burden of necessary taxes by transferring taxes from the poor to the rich, who in many developed societies provide most of the tax income without much loss to the quality of life of the rich. This can be because very high incomes might be subject to diminishing returns, so that the rich are not in any serious way hurt by a slight lowering of their disposable income. Secondly, different wages inspire personal development, the use of savings for education and investment, and innovation. People want to get on. They are part of the incentivisation scheme of capitalism and much better than central control and Stalinist medals for service. Thirdly, markets balance all of the approaches above—the elasticity of workers, their MRP, the derived demand of employers, and the informed discrimination and judgement of employers, and generally allow for higher living standards than a more controlled ‘equality’ of outcomes would.

It follows that the existence of different wages is only a problem for societies if it reflects or leads to great inequality, the rise of relative and absolute poverty, regressive tax policies, and an economy full of discouraged or low paid workers with no mobility dependent on inferior goods. Such monopsony costs would then lead to strikes, labour unrest, and ultimately, to the rise of incomes in ‘fits and starts’ with no coherence against a backdrop of long-term economic underperformance and misallocation. Progressive taxation, a minimum wage below equilibrium but set at a level which allows the purchase of normal goods and some saving, competition in labour markets, and balanced union legislation which allows for business-led growth at home and abroad is best.

 

 

 

 

 

 

 

 

 

 

Should big firms always face regulation, and if so, why, and how?