Free market assumptions damaging

According to current economic theory, the concept of fair pay is unnatural, writes Peter Lyons.

I am a shareholder in several retirement village operators listed on our stock exchange. Their share prices have tumbled in recent days as the Government moved to ensure aged-care givers be paid a decent wage. I am also a shareholder in Restaurant Brands which operates KFC, Pizza Hut and Starbucks and Carl's Jrs. This share price has also tumbled as their workers strike for a decent wage.

This is appalling in a supposed free-market economy. What is this Government thinking? Doesn't it realise wages need to be determined by supply and demand in a free labour market. Union action and government intervention should not be part of a free market. Government intervention to address fairness in pay and strike action by unionised workers undermines the natural workings of the labour market. It is unnatural and will only lead to misery and pain for all, particularly me. It will lead to firms shedding staff and higher wages leading to higher prices. It will lead to more unemployment and higher inflation.

As a card-carrying capitalist I am dismayed by this upsurge in demands for fairer pay rates. It is affecting the profits of the companies I invest in. It is costing me money. It is unfair in the extreme.

Or is it?

I am currently teaching my students the standard theory of how wage rates are determined in a market economy. According to neoclassical theory, wage rates in various occupations are determined by demand and supply for, and of, workers. This theory has dominated economic policy in recent decades. Union power, unemployment benefits and minimum wages only serve to distort the labour market. They are ``unnatural'' in their effects. The explanation for the differences in wages rates between top executives, brain surgeons, builders, factory workers and checkout operators is purely because of the differences in the supply and demand for workers in each industry.

Whenever I teach this theory, I have a serious unease that I am teaching right-wing dogma. It all sounds plausible in theory but struggles under closer scrutiny. It is based on several unrealistic assumptions about the real world. It assumes there is no power imbalance between employees and employers. It assumes that in all occupations there are many workers competing for jobs and many employers competing for workers. It also assumes firms are operating in competitive markets for their output. They are not making excessive profits and therefore cannot afford to pay their workers more.

This theory seems plausible at first glance. According to the theory, the employer must pay the worker a pay rate that reflects his or her productivity, otherwise the worker can easily find other employment with competing firms.

Here is an alternative view of how wages are determined in a society. It is the view of early classical economists such as Adam Smith, David Ricardo and grotty old Karl Marx. It states that wages are determined by a power struggle between the owners of capital and employers and those who work for them. The economic pie is ultimately divided into profit and wages. This division is determined by the relative bargaining power of labour versus employers. This bargaining power has certainly skewed in favour of employers in New Zealand in recent years.

As a shareholder, I should be appalled at this recent trend of fair pay rates for workers and strike action by unions in some of the companies that I own. It is affecting my profits. According to theory, it should be left to supply and demand to determine wage rates. But strangely, it seems decent and fair to me that the power imbalances in some of these occupations are addressed. I would rather live in a fairer society where people who work hard are paid a decent liveable wage.

Peter Lyons teaches economics at Saint Peters College in Epsom and has written several economic texts.

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