Response by Keith Hancock
21st October 2000

WHY EMPLOYMENT IS REGULATED*

This paper is, in part, a reply to Des Moore, but I hope that it will also advance the debate by setting out some of the bases for labour market regulation.

Des has been campaigning for fundamental change in the nature of Australian labour law. In 1998, he prepared a report, The Case for Further Deregulation of the Labour Market, for the Labour Ministers’ Council. A condensed and more popular version of this was his Bert Kelly Lecture, ‘Better Than the Australian Industrial Relations Commission’, which he delivered in April 1999 and later published in the journal Policy. He also wrote a paper, ‘An Alternative to the Australian Industrial Relations Commission’, which appeared in the June number of the Australian Bulletin of Labour. I have taken these (and an earlier debate between Des and me) into account in trying to anticipate what he might say today. With many of the details of Des’s analysis, I am in substantial agreement. On major issues, however, we are far apart. What I say today will focus on these areas of difference.

The relations between the hirers and the suppliers of labour will inevitably take place in a legal framework. In a literal sense, deregulation is not on the agenda. The issue, rather, is the form of regulation. Des favours the regulation of employment relations by the common law. He qualifies that to the extent that he fears that the judges cannot be trusted; hence he favours a statutory codification of the common law as it stood about a century ago so as to shield it against judicial activism. ‘The key principle under common law’, he says, ‘is that the worker and the employer should basically be free to decide on the content of their relationship because both parties expect to benefit from entering a contract: otherwise why would they enter into it?’ Des is not the first person to ask that question; nor am I the first to answer it.

Before I do so, however, I should like to remind you of the historical context wherein the common law was at least partially displaced. The common law is hostile to collectivism in the labour market. Trade unions (unless strictly confined by their rules to the functions of friendly societies) are unlawful combinations in restraint of trade. In the 19^th century, statutes were enacted which permitted them to exist and, to that extent, overrode the common law. This left somewhat open, however, the question of what unions could do, by way of collective action, to advance the interests of their members, especially by strikes. The House of Lords in the case known as Taff Vale (decided in 1901) answered that question. A trade union that induced its members to strike was liable in tort for causing them to break their contracts. Whatever the legal merits of the decision, depriving the individual worker of collective protection was not sustainable industrially, socially or politically. Labour legislation of the 20^th century can be interpreted as a response to the pro-employer stance of the common law. In Britain, the remedy was simple: the Parliament simply prohibited actions in tort in respect of acts committed in contemplation or furtherance of ‘trade disputes’ – that is, strikes and lockouts. The various Australian Parliaments imposed systems of conciliation and arbitration for reconciling the conflicting interests of employers and employees. The Unites States created a statutory scheme of collective bargaining. I am not now discussing whether any of these ‘solutions’ was better than the others or denying that all three have been under strain in the last quarter of the 20^th century. Rather, I am pointing out that the common law had its chance and was repudiated because it was biased in the employers’ favour. 

Employment relations are more affected by considerations of power than are most other market relations - a fact recognised by a series of economists from Adam Smith onward. Power is relevant at two levels. One is in fixing the terms of employment - for example, wages and hours; the other, in relations at the workplace. As to the former, the interventionist argument is that the employer has greater bargaining power than the worker, and that the terms of the contract registers this inequality. At the workplace, the worker is subject to the employer’s power to command. Sir Otto Kahn Freund, an eminent British labour lawyer, put both points better than I can: 

‘The relation between an employer and an isolated employee or worker is typically a relation between a bearer of power and one who is not a bearer of power. In its inception it is an act of submission, in its operation it is a condition of subordination, however much the submission and the subordination may be concealed by that indispensable figment of the legal mind known as the “contract of employment.” The main object of labour law has always been . . . to be a countervailing force to counteract the inequality of bargaining power which is inherent and must be inherent in the employment relationship. Most of what we call protective legislation - legislation on the employment of women, children and young persons, on safety in mines, factories, and offices, on payment of wages in cash, on guarantee payments, on race or sex discrimination, on unfair dismissal, and indeed most labour legislation altogether - must be seen in this context. It is an attempt to infuse law into a relation of command and subordination.’

Des responds to such perceptions by disputing the reality of employer power. Employers, he says, are subject to forces of competition: those who try to enforce wages and other conditions below the prevailing standards will find that they cannot recruit or hold workers. Moreover, the modern employer – perhaps unlike his or her forebears – appreciates the importance of a co-operative labour force and adopts workplace and remuneration policies that are likely to secure the goodwill of the workers.

The argument for labour market intervention has relied too much – at least in modern times - on the phenomenon of employer power. Competition is a constraint, inadequately factored into the debate. That said, there remain instances where individual employers can exert significant bargaining power, restrained in some cases by the trade union power that Des would destroy. Companies such as CRA, BHP, Telstra, Patricks Stevedores and Qantas have power in the labour market; and the limits to it have as much to do with the countervailing strength of unions as with the force of competition. Outside the major cities, smaller employers are also able to dominate local labour markets, subject to the dictates of awards (which they sometimes try to avoid).

Moreover, the worker is subject to other manifestations of employer power that withstand the restraints of competition. The notion of negotiation at the point of hiring is, in most instances, nonsense: the employer offers and the potential employee accepts or refuses. If the relation were reversed, the outcomes might be similar. But there is a matter of dignity. Terms of employment which are set through negotiation with a union or prescribed by an independent tribunal are more consonant with industrial citizenship than terms which are dictated by the employer’s fiat, however constrained it may be by the impersonal force of competition. At the workplace, the worker must obey the directions of the employer and his agents. In the world of common law, the employee is subject to the employer’s power to dismiss without reason. Consider the position of a young woman working as a bar attendant who is told by her employer that she has to work topless. She refuses. There may be room for debate whether the instruction accords with the contract of employment. If it does, the woman has repudiated her contract and the employer can dismiss her without notice. If not, so what? Her only remedy, under common law, is to claim a period of notice or pay-in-lieu. (In the United States, incidentally, common law does not even require the period of notice – contracts are ‘at will’ and can be terminated by either party at any time and without reason.)

But we must, as Des insists, take account of the restraint of employers by the forces of competition. The results of competition are not necessarily to be admired. Amartya Sen, a Nobel Laureate in Economics, has said that the prices generated by competitive markets may be both perfectly efficient and perfectly disgusting. Low wages, long hours, harsh and dangerous working conditions, job insecurity and the employment of children can be unlovely despite being the outcome of competitive processes. The empowerment of trade unions and the creation of tribunals to enforce fair wages and conditions may be explicable as much by the goal of altering competitive market outcomes as by concerns about the possession and exercise of power. For example, we may want a more equal distribution of income and wealth than the competitive market generates.

To this, Des says two things (I hope that I represent him fairly). One is that what happens in the labour market is predominantly the result of economic forces, whatever the regulatory regime. The other is that when the government or its agencies try to override market forces or allow trade unions to do so, their actions have adverse effects on economic performance. Here he identifies several kinds of effects, but he emphasises unemployment and I shall do the same.

The differences between Des and me, in this context, are differences of degree. I agree, for example, that if we want to understand why the average Australian worker in 2000 enjoys a higher real income than his or her counterpart in 1900 or in India today, we should be looking at the differences in productivity over time and space, and that all else is secondary. I also agree that the forces generating pay differences in Australia are similar to those at work in other countries, although the wage structures are by no means identical. The principal causes of unemployment, inflation and economic growth also transcend national boundaries. What we need to identify is the difference that policies make to the impact of forces stronger than the policies themselves.

This is not an easy task. Some researchers have tried to find answers in cross-country comparisons. Des is one. He makes much of the successes of the American economy, which he sees as a clue to the virtues of a less regulated labour market. There are hazards in this, due largely to the impossibility of holding other factors constant. One relevant difference, for example, is the much higher level of incarceration in the United States. It is likely that the jails contain many people who, if they were not in prison, would contribute to the unemployment statistic. A second is the more stringent system of unemployment benefits, which causes some workers to be less choosy in taking jobs and others simply to withdraw from the labour force. A third is the success of the Federal Reserve System in reducing inflationary expectations, leaving room for more expansionist fiscal policy. Moreover, the comparisons are time-sensitive. In the last few years, the American unemployment level has fallen relatively to most of the rest of the world; but the United States has not always enjoyed lower unemployment than the more regulated western Europe and Australia. There have not been dramatic changes in labour market regulation over the period in which the United States has performed better. I shall return to this point. Another reminder of the riskiness of simple comparison is New Zealand. Five years ago, it was widely cited as an economic wonder generated by deregulationist policy. Today’s assessments are more sober; and the relative decline predates the change of Government.

To illustrate more broadly the dangers of cross-country comparison, I take the relation between inequality of pay and the level of employment. The argument has been advanced, by Des and others, that the steps taken in Australia to compress pay differences, and especially the protection of the low-paid, have reduced employment. The United States has minimum wages, but they are set at lower levels (relative to average pay) than in most other countries, including Australia. I ask you to look at the chart below,

which plots the employment levels (measured by relating the numbers employed to the population aged 15-65) of 19 OECD countries against the degree of pay dispersion (measured by the ratio of the 9^th to the first decile in the pay distribution). This chart is based on data for the mid-1990s. If we had up-to-the-moment data, the details would be altered, but I doubt that the impression would be different. You can see that Australia did have a more compressed pay structure than the United States; and it also had a lower employment level. But you can also see that across the full range of 19 countries there was literally no relation between employment and pay inequality. Now I should acknowledge that an analysis which takes in only two variables – employment and inequality of wages – is inconclusive. If we used statistical techniques that take account of other factors as well, some relation between employment and wage inequality might emerge. It might not. My message here is simply the unreliability of two-country comparisons.

But I should like to say something more about the United States. As I have said, the advantage which it now possesses, in respect of low unemployment, has not always existed. The levels of unemployment that Australia and Europe used to equate with ‘full employment’ – in the range 1-3 per cent – were never achieved in the United States. In 1965, I attended a seminar at Princeton University about the very question why the United States could not get its unemployment levels down to those of Western Europe. In the 1970s, of course, unemployment rose sharply in most developed countries, but much less in the United States. In the last quarter-century, the United States has enjoyed faster employment growth than a number of other countries. Associated with that, until recently, was the worst record of productivity growth of any OECD country. But it is only in the 1990s that the United States has moved close to the lead in the pursuit of lower unemployment. Distinguishing between economic boom and normality is not easy.

Secondly, there is, within the United States, a diversity of opinion about the country’s labour market performance. Des would certainly have friends. But he would also have opponents. The Industrial Relations Research Association devoted a recent number of it quarterly Perspectives on Work to the issue of the social contract at work. Tom Kochan, who will be known to some of this audience, is Professor of Work and Employment Relations in the Sloan School of Management at the MIT and an editor of the journal. He explains that the labour created under the New Deal have been challenged, and in large measure destroyed, by economic change. ‘As a result’, he says, ‘the old social contract has given way to a long period of stagnant real wages, increased inequality of income and wealth, falling health and pension coverage, increased job insecurity, decline in union coverage, increased litigation and conflict over government regulations and their enforcement, increased polarization between business and labor on core values and issues, and a sustained impasse over labor policy’. There is some good news:

‘Innovations in how work is organized are spreading gradually to more workers; knowledge workers . . . are doing well in today’s labor markets; the sustained macroeconomic growth and tight labour markets are now producing modest improvements in real income and job opportunities for low-income workers; labor-management partnerships are helping some unions and companies adapt to their changing circumstances; and flexible employment arrangements and practices are helping some families and employers integrate family and work responsibilities.’

The good news, in Kochan’s view, is in the main the result of an economic boom, which may not last:

 ‘The tight labor markets of the last several years have been successful in improving the lives of those near the bottom of the income and occupational ladder and those moving from welfare to work. In some respects, the macroeconomic policy makers have bailed out our profession. But we cannot assume the macroeconomic boom will do the job for us forever.’

That perspective on the American story should at least be considered. If we want to know why the United States now has lower unemployment than Australia and most other OECD countries, we should be looking at all of the sources of its economic boom and not focusing simply on its labour market arrangements.

Let me now confront more broadly the argument that labour market regulation, other than the common law variety or something akin to it, causes unemployment. Economic theory says that there must be some alteration in the terms of employment – some adjustment of real wage levels and relativities, for example - which will eradicate unemployment. It will do so partly by increasing the benefit to employers of hiring people and partly by causing actual and potential employees to withdraw from the labour force. Theory does not attach any quantities or time dimension to this process. The responsiveness of employment to changes in the average and relative prices of labour may be so slight as to require enormous changes before the necessary adjustment of demand and supply is achieved. Nor, indeed, does theory tell us whether the necessary alterations in the terms of employment would actually happen. There are forces in the labour market other than supply and demand, trade unions and regulators. They include custom and practice and strongly held conceptions of fairness. The desire of employers to get the most out of their employees, which Des notes, may deter the employers from treating workers simply as commodities to be bought at the lowest possible prices.

The question whether there exists a labour market with the inherent flexibility to accommodate the changing pressures of demand and supply, and to reduce unemployment to a level that would cause little or no concern - a flexibility that is nullified by unions and regulators - cannot be answered from theory. It demands a deep – and inevitably disputable - empirical understanding of realities. Here I can say only two things. One is that my own studies of the labour market – of which the chart that I showed earlier is a small sample - have made me sceptical about the efficacy of the allegedly suppressed adjustment mechanism. Perhaps that is a major point of divergence between Des and me. The other anticipates a claim by protagonists of deregulation that I am setting up a straw man. It may be said that no one argues that deregulating the labour market will restore full employment. Rather, the promise is merely that if we deregulate, we shall achieve an improvement; maybe that unemployment will fall to American levels - say 5 per cent, when we adjust for differences between Australia and the US in rates of incarceration. No one really knows whether that is a reliable promise; and I have already mentioned the hazards of international comparison. We might be buying a pig in a poke. And if it were true that deregulation equals the US, we might think that the side effects, especially the degree of inequality, are too high a price to pay.

I conclude on a different theme. It is said by some, including Des, that if our attitude to labour market deregulation is affected by concerns about social inequality, we should look to social security as the better instrument of alleviation. To this I make the following brief response.

First, there is no law of nature that dictates an either/or choice. Social welfare and wage policies are complements, rather than substitutes. We may think that employers and their customers, as well as taxpayers at large, bear responsibility for the working poor.

Secondly, prevention of poverty is not the only - or even the most important - purpose of interference. Inequity has other dimensions. Take, for example, the matter of gender-related pay differences. If the labour market were sensitive to demand and supply, there never would have been pay differences related solely to gender. For it was always open to employers (except perhaps in wartime) to pay women above the award rates. The removal, or at least reduction, of gender discrimination in the labour market is directly traceable to arbitral decisions in 1969 and 1972. That employers did not restore the pre-existing differences by paying more to men is, of itself, evidence that 'market forces' were not the predominant cause of the earlier gender-related pay differences.

Thirdly, the advocacy of social security as a substitute for wage policy would carry more conviction if its adherents were not typically exponents of small government; and, indeed, if they did not object to the disincentive effects of social security. Des, in his report to the Ministers, says that ‘with Australia’s comprehensive social security system, there is no basis for the AIRC being given the role of social-welfare judge in determining “safety net” wage increases for the low paid’. Elsewhere in the same report, he says that the main query about the potential for deregulation to reduce unemployment ‘arises from the strong disincentive effects to work from the social security system’. Deregulation, he says, would be less effective ‘if it was not accompanied by action to reduce the disincentives to work under social security and associated arrangements’. The implication of this diagnosis is that deregulation would be accompanied by a decrease, rather than an offsetting increase, in the effectiveness of the social security safety net.

None of this is to say that the particular form of labour market regulation now existing in Australia is ideal. If I were making labour market policy, there would be major changes. But there would not be a reversion to 19^th century common law.

 

Keith Hancock

21 October 2000