We are Not Apples

The Restaurant Association of Ireland and Ibec won’t like it. Fine Gael certainly won’t like it. The army of commentators armed only with superficial and out-of-date analysis won’t like it. But the report on the Joint Labour Councils written by Kevin Duffy and Dr Frank Walsh does a good job of bringing a fact-based, well-researched piece of work – one that respects economic analysis – to our attention. And in so doing they burst some myth-bubbles along the way.

In short, the Report calls for the retention of the Joint Labour Committees and their wage setting mechanism. If anything, there is scope to extend their roles in the economy. While there are a number of recommendations and findings I want to focus on one: their conclusion that cutting wage rates or even abolishing JLCs will not increase employment.

Employers and Fine Gael have argued that cutting the wages of the lowest-paid, will set in train an employment-creation process. This is based on a labour market model that follows the rules of supply and demand; that is, the cheaper you make labour, the higher the demand for labour will rise. This model follows those neat little graphs in Economics 101 textbooks: if you cut the price of apples, people will buy more apples.

The problem with this ‘perfect competition’ model is that it falls apart when it meets the real world. People and their labour are not apples. The Report makes this clear:

‘In recent decades imperfectly competitive models of the labour market have become more prominent in the economics literature. In these models the impact of minimum wages on employment is often ambiguous.’

Why is the impact of minimum wages ‘ambiguous’? Because markets are not perfect. They are imperfect. Not all participants in the market have full knowledge, not all participants are rational or income-maximising (and only income-maximising) actors.

One reason why labour markets, especially among the low-paid, are ‘imperfect’ is because the employer is in stronger bargaining position than the worker (a ‘monopsonistic’ market). It seems so obvious but it took awhile to escape the nonsense of ‘perfect’ competitive models – where the owner of capital and the owner of labour are in equal bargaining position - to construct ones that are based on reality.

And here is the real killer: in monopsonistic markets, increasing wages can actually increase employment. The report made reference to one particular study: “Myth and Measurement: The new economics of the minimum wage”:

'David Card and Alan B. Krueger look at the impact of a substantial increase in the minimum wage on fast food employment in the U.S. State of New Jersey relative to a neighbouring state where the minimum wage remained unchanged and found small positive employment effects from the minimum wage [increase].'

This study caused a storm among economists, for the simple reason that – through a fact-based analysis – they showed that perfect competitive models are out of step with the real world. It provoked a counter-attack, in particular from economists who don’t want to give up their beloved models. But as they old saying goes, when the model doesn’t confirm real life, change the model.

Ultimately, there is no imperative for firms to create employment.  That is not their raison d'etre.  Labour is a production input which they purchase to generate greater output that responds to rising demand or in anticipation of higher demand. However, in times of falling or stagnant demand, why would a firm create jobs? 

If a restaurant serves 500 meals a day, why would they employ more labour just because wages are reduced, if demand remains at 500 meals (at the margins, a restaurant may add staff to improve service in the hopes that this will gain more customers - but this is only likely to occur on any scale if demand is rising; but consumer spending is falling this year and will probably continue to fall next year).  And if cutting wages reduces demand in the economy - and cutting already low-wages will certainly do that - the restaurant will struggle to serve even 500 meals.

Of course, the report doesn’t recommend an increase in JLC rates, any more than it recommends a cut. But that it went out of its way (and does so throughout the report) to highlight studies and situations which undermine the simplistic competitive model is worth noting.

So now that the report has dispensed with the simplistic arguments that cutting wages, like the price of apples, will create more employment, let’s start debating the benefits of actually increasing wage floors – both JLC and the minimum wage.

This, too, is not straight-forward. It would mean assessing current wage rates, the monopsonistic or exploitative wage level (is it the same as the current wage?), and the optimal level under current conditions to which wages can rise to the benefit of employment and economy.

Then we can discuss how we improve the ‘current conditions’ to facilitate even higher wage increases to improve workers’ living standards. This would lead us into a virtuous cycle.

And lead us into a real debate where economics and people matter more than apples.

Comments

[Pidge]

Interesting article.

Though, in your restaurant example, wouldn't lower labour costs decrease the restaurant's cost base, and allow them to lower their price and sell more meals at a comparable profit margin? Wouldn't consumers also be getting food at a lower cost? What you've described seems a bit simplistic, just after you've shown that the issue of wage reduction is anything but that.

[CMK]

What if the reduction in wages for restaurant workers results in them being less able to go to restaurants?

Like reducing wages for pub staff resulting in pub staff not going to pubs on their time off and drinking at home.

Keep sawing at the branch you're sitting on is not a good idea, in most cases. If you're a member of Fine Gael it might make sense, for rational human beings it doesn't.

[Michael Taft]

Pidge - apologies for getting back late on this. You put your finger on a real problem of analysis. The reduction in wages may lead to (a) lower prices, (b) repaired profit sheet, (c) repair cash-flow, or (d) higher employment. The reduction can't facilitate all four.

But take one example: reduction in prices induces more demand. This is what the textbook models tell us. However, a firm may have not reached labour capacity. In other words, The staff currently employed may be able to absorb the increased custom. If so, there is no employment gain, but there is the ability to do (b) and/or (c).

Further, firms may already be profitable. Supermacs reported a €6 million profit last year, Tesco and Supervalu are currenty expanding outlets, Dublin hotels are some of the most profitable among major European countries. The reduction in wages will feed their already healthy profit line. This represents a transfer from poorly paid/working poor to owners.

The problem with Minister Bruton's proposals is that he doesn't provide any model, any analysis, any emprical data to justify his claims that falling wages will produce higher employment.

Just a final note: if falling labour costs will save enterprises and induce higher employment, why hasn't it been done already? In the last two years, labour costs have fallen by 4-5% in the retail and hospitality sectors. Doesn't seem to have done the trick.