Labour Market In The Real World

Orthodox economics treats labour as a good like any other subject to the laws of supply and demand. However this misses a crucial point that we are not dealing with commodities but rather people. With goods, demand is decided by consumers and supply by producers, whereas with labour, demand is decided by producers and supply by consumers. The entire system is turned on its head yet neo-classical economics claims the results will be the same.

Neo-classical economics views the decision to work as one of payoffs. People can work or enjoy free time and base their decision on the balance between the two. So some people will work 6 hours a day, some 8 and some 10, all dependent on how much they value leisure time. Needless to say this isn’t how the real world works. In most places if you get a job you are given a fixed amount of hours to work. In most jobs it’s a 40 hour week or nothing. A few places do part time, but for the majority of workers you only have three options: full time, half time or nothing.

Neo-Classical view of the labour market – it views labour as identical to any other commodity

This also assumes that the only thing stopping you from working is your personal choice. The idea that you could be unemployed despite wanting to work never enters the theory. For 15% of Irish workers this is reality. It is absurd to rely on policy advice derived from a theory that assumes our unemployment problem came from the fact that the number of lazy people spontaneously quadrupled in two years.

The leisure/work trade off is often used to explain that people will receive unemployment benefit if it pays better. Yet this completely ignores societal norms which govern the way we act. It ignores the fact that all humans have a drive to be independent, to provide for themselves, to work. It ignores the fact that there is huge stigma and shame attached to receiving “handouts”. We are not solely money seeking machines; we have concepts of respect and dignity that also explain our actions.

There is a second problem with the traditional description of the labour market and it is a word that never enters the textbooks. It is Power. No neo-classical viewpoint ever sees the simple fact that employers have power. Instead textbooks describe a lovely fantasy world where both employers and employees are equals and will strike a fair balance that benefits both of them equally. In reality the employer holds all the cards. No employee can strike a hard bargain by themselves (unless they possess a rare skill, which few do). If they dislike the wage offered the employer can simply find someone else. There are always more potential employees than potential employers, so the balance (even in good times) is always in their favour. In a recession the threat of unemployment so scares the employee that he/she will accept any deal (however one sided) that allows them to keep their job. Every employee knows this so this stops them from ever considering driving a hard bargain in the first place.

In the workplace the bosses’ word is law and the workers sole purpose is to do what they are told to do. It is absurd to expect the worker to be momentarily elevated to the bosses equal for wage negotiations only to return to subservient for the day to day running of the business. In this way wages are not simply set by the interaction of supply and demand but rather by the degree of power which the employer has. They can use this power to push the supply curve down safe in the knowledge that no individual worker is going to risk their job by complaining. The simple fact is that workers take the wage they are given and don’t fight it.

It is for this reason that unions play an important role. Although in the neo-classical world they are a source of harm by pushing wages too high, in reality they are a necessary counter balance to employers’ power. It is only through a strong union that workers can negotiate with bosses on an equal footing. (see here)

Even still, on average employers will still have the upper hand. This is because not every worker joins a union. At their height (decades ago) Irish unions represented only half of Irish workers whereas American unions only represented one third of the workforce. Even still, as union’s strength is dependent on its willingness to strike, employees may be in a weaker position if they are in a timid union. There are significant problems in organising and getting a large number of people to agree on a course of action which is a significant barrier to any strike. People will also be held back by fear. Fear of being fired or reprimanded for striking. It is necessary to have large savings to support yourself during a strike. There is also the simple but common fear of questioning authority that all of us have and holds back any attempt for workers to earn a decent wage.

A third major problem with the neo-classical view of labour is that the supply of labour can do something no commodity can do, it can bend backwards. It is not a simple straight line (nothing involving humans ever is). At a certain point most people will say enough is enough. At some point most people will say they have enough money and don’t need any more. After all what is the point of being rich if you do not have any time to enjoy your wealth. This point was recognised by Adam Smith himself who argued that labour supply is backward bending.

The backward bending supply curve

For example say your bills and expenses are 1,000 and your wage is 1,000. Then let’s say the boss gives you a pay rise of 10%. You could work the same hours and get the same pay or you could work 10% less and get the same pay. Traditional economics does not take this into account and instead argues that people care solely about money and will work as much as they can to maximise their income.

The situation could also work in reverse let’s say the same person as before, instead of getting a 10% pay rise gets a 10% pay cut. They could work the same hours for less pay but then they won’t be able to pay their bills. As people become accustomed to a certain standard of living they are unlikely to drastically reduce their expenses (even if they could, which if their bills are necessities like rent and electricity they can’t). This means a pay cut will increase the supply of labour, the direct opposite result to the one predicted by the textbooks.

As each person has their own personal supply curve it’s not possible to simply add up each individual to get the market supply curve. This means there is no such thing as the market conclusions supply curve for labour.

For all the above reason the labour market is not represented by the standard demand and supply curves. This means that the common policy measures suggested by neo-classical economists of wage cuts, less union power, smaller welfare state, cutting the minimum wage etc, will not bring the promised results. If anything they will probably make the situation worse. People are not commodities and we need a new economics that sees this.

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One response to “Labour Market In The Real World

  1. Pingback: A New Economic Theory | Robert Nielsen

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