How to really fix wage stagnation

Many Australians see wages for the low-skilled as far too low already and believe wage stagnation is making things worse.  They find it inconceivable that the low-paid can survive on current wages, and so support government intervention to raise wages.

In this climate, the ACTU’s “Change the Rules” campaign to lift the wages of the low-paid does not come as a surprise. Nor perhaps does the business lobby’s widely reported response praising enterprise bargaining and condemning the ACTU’s plan to restore “1970s-style” industry bargaining.

The positions taken by peak union and employer bodies, while unsurprising, are disappointing.  Both sides seem content to offer the same old tired rhetoric, and neither seems remotely interested in genuinely exploring fresh ideas.  But what if the standard policy prescriptions are unlikely to reverse wage stagnation and there are practical alternative policies that could?

Any serious consideration of this issue needs first to examine the consequences, including unintended consequences, of current policies on a rigorous, broad basis.  The benefits should then be weighed against the costs to see whether on net current policies are effective, or whether a different policy mix might be more effective to raise the living standards of the low-paid.

Minimum wages

The starting point for such an exercise is to examine the benefits and costs of the main current policy, minimum wages.  Under this policy, the Fair Work Commission makes a modern award that sets a minimum wage for workers in each of 122 industries and sets a lower default national minimum wage for everyone else.  This policy places a series of legal floors under the price of labour that, in effect, bans employers from offering low-paid work.

This policy has the undeniable benefit of securing a decent income for some low-skilled workers.  But perversely, minimum wages harm the poor if – as economic theory predicts – employers substitute machines or higher skilled labour for now over-priced low-skilled labour.  Numerous studies both in Australia and overseas validate the existence of this dis-employment effect.

The income loss from being unemployed is not the only cost to the low-skilled of minimum wages.  By losing the opportunity to gain entry level job experience low-skilled workers do not build human capital, or at least that process is delayed.  In addition to the resulting loss of earning capacity for the low-skilled, minimum wages starve the economy of human capital and so causes an overall efficiency loss.

A further difficulty is that it is impossible to restrict minimum wage jobs to low-income families. Undeniably, many minimum wage jobs go to middle-class teenagers living at home, who do not need any income support.  In this way, perversely, minimum wages subsidise the well-off at the expense of the poor.

Minimum wages also have the drawback that they fuel the perception that employers cause low wages. The real reason for low wages is not employer greed, but low skill which in turn reflects low education and training.  Providing a higher wage when no training or education has occurred creates the wrong incentive for low-skilled workers.

Australia’s national minimum wage is one of the highest in the world.  Low-margin small businesses — particularly in rural and regional areas – have an incentive to evade the law if that is the only way to stay afloat.  The direct cost of policing such non-compliance is very high, not to mention the civil liberties cost of handing the Fair Work Ombudsman intrusive powers to root out offending.

Collective bargaining

Turning to the other main policy, compulsory collective bargaining, what are its benefits and costs?  Under this policy employers can be forced to bargain with unions at the enterprise level, and if agreement cannot be reached the Fair Work Commission imposes legally enforceable terms on the employer and employees.

It is tolerably clear that, as with minimum wages, mandated collective bargaining imposes an economic cost on the poor and low-skilled.  While these laws have the clear benefit of raising wages for those employed under union-negotiated collective agreements, this comes at the cost of lower or no wages for those not hired because the union has priced labour above its productive capacity.

Moreover, if the union wage premium is sufficiently large it can cause firms to utilise alternative production techniques (e.g. ones involving more automation and less labour) or even to start up or move their operations to countries with lower wages. Ironically, by enlisting the government’s help to extract higher wages from employers, unionists put their own members’ livelihoods in jeopardy, not to mention the associated harm to economic efficiency overall.

Because compulsory collective bargaining artificially increases wages, its only real justification is to redistribute income from richer to poorer.  But the distributional consequences of this policy are bizarre — employees at workplaces covered by union-negotiated agreements are better off, but those who either miss out on or lose jobs at those workplaces are worse off.  This is a very odd way to redistribute income.

A fresh approach

 All of this suggests, contrary to popular belief, that on net minimum wages and compulsory collective bargaining are unlikely to improve the living standards of the poor.  Moreover, strengthening these policies — as the ACTU would have it — is likely to just make matters worse.  So why not consider just putting an end to both policies?

Under such an approach the Australian labour market would unquestionably be more efficient, implying a larger economic pie overall, and with it a likely return to wages growth.  But there would be a downside — the low skilled would be paid lower wages, and possibly far lower wages, reflecting their low productivity.  This is of course exactly what economic efficiency dictates.

For most Australians, even those who accept the overall efficiency gains from deregulation, the resulting gap between the rich and poor would be intolerably large and would smack of exploitation.  This is a reasonable concern shared by almost everyone.  But it should not shut down the conversation.

Why?  Because there is a “third way” between the continuation of minimum wage and collective bargaining policies on the one hand, and the removal of those policies on the other.  If labour markets are given free rein to grow the economic pie overall, government could address the distributional fall-out through policies — such as a negative income tax, a basic income guarantee or earned income tax credits — that explicitly redistribute income from the rich to the poor.

Anti-poverty programs such as these can generate their own distortions, especially if too generous, but at least they target poverty directly by consistently transferring resources from richer to poorer.  Importantly, letting efficiency reign in labour markets maximises the economic pie that is available for such redistribution.

A mature conversation about living standards in this country must include the option of crafting a social safety net that is truly fit for purpose, and releasing labour markets to operate efficiently and generate prosperity for all Australians.  At present union, business and political leaders are not leading that conversation.  They should start doing so.

 

Mark Hemery

Mark Hemery

Mark Hemery is a partner in the Perth law firm of Hotchkin Hanly, specialising in employment law. He has over 30 years experience in legal practice, and holds a Bachelor of Laws with first class honours from the University of Western Australia and a Master of Laws from Melbourne University.
Mark Hemery

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