Labor and Management Remain Unequal

In the name of classical liberalism, Richard Epstein makes an economic case against unions. He assumes that both conventional firms with monopoly power and trade unions can be described as “monopolies” and that both can be analyzed adequately by the highly simplified generalizations of Econ 101. Epstein writes:

It is well-established in economic theory that the benefits to any monopolist do not come from increasing productivity, but from its ability to raise price above marginal cost, such that some beneficial transactions that would have taken place in competitive markets are eliminated to preserve monopoly power.

On the contrary, in the case of firms this statement is relevant, if at all, only in industries with constant or diminishing returns to scale. In industries with increasing returns to scale or network effects, like manufacturing or telecommunications, growth can enable greater productivity, which can then feed further growth, further market concentration, and further gains in productivity, while lowering prices and increasing quality for consumers. That—and not conspiracies on the part of inefficient, predatory monopolists—is why there are two major aircraft manufacturers and a handful of leading car manufacturers in the world, not hundreds or thousands.

Pure, impersonal market forces do not dictate either the exact prices they charge consumers or the exact distribution of their profits among shareholders, managers, and workers.

The formal theory of imperfect markets was developed by Edward Chamberlin and Joan Robinson a century ago. As early as 1939, John Hicks recognized that the absence of perfect competition in many sectors of the modern economy created a crisis for neoclassical economics of the simplified, formalistic kind that continues to be taught today:

It has to be recognized that a general abandonment of the assumption of perfect competition, a universal adoption of the assumption of monopoly [and oligopoly—ML], must have very destructive consequences for economic theory… It is, I believe, only possible to save anything from this wreck—and it must be remembered that the threatened wreckage is that of the greater part of economic theory—if we can assume that the markets confronting most of the firms with which we shall be dealing do not differ very greatly from perfectly competitive markets….At least, this getaway seems worth trying.

Unlike Hicks, who sought to rescue neoclassical economics by ignoring reality, intellectually honest people should reject “this getaway” and throw out the simple-minded dogma that prices, including wages, are typically set by competitive markets that tend to clear in a state of equilibrium. This is particularly important in the U.S., where a majority of workers are employed by large firms with more than five hundred employees. Many of these firms to some extent are price makers, not price takers, exerting a degree of monopoly power as sellers of goods or services and of monopsony power as purchasers of labor and other inputs. Pure, impersonal market forces do not dictate either the exact prices they charge consumers or the exact distribution of their profits among shareholders, managers, and workers.

Do higher wages for workers, as a result of unionization or any other cause, hurt consumers or businesses by raising the prices of the goods or services they provide? Undoubtedly, in some cases. In other cases, higher wages, whatever their cause, can incentivize employers to substitute technology for labor, or adopt more efficient business models, enabling them to produce more goods or services with better-paid workers at lower prices for consumers.

Oversimplified Econ 101 models also ignore the fact that workers are also consumers. A bigger paycheck for a unionized auto parts supply worker is likely to result in more sales for stores, restaurants, movie theaters, barbers and other businesses in the worker’s neighborhood.

The greatest of classical liberals, Adam Smith, recognized that prices, including wages, may be indeterminate within a broad range and must be “fixed by the higgling of the market.” Only in Econ 101 classrooms does the wage that an employer prefers to pay just happen precisely to match the marginal product of that worker’s labor. In the real world, the wage offered by the employer should be analyzed as merely the employer’s first move in a game of “higgling,” as in a Middle Eastern bazaar.

Smith observed that in negotiations over wages, employers usually have much greater bargaining power than workers:

In all such disputes the master can hold out much longer. A landlord, a farmer, a master manufacturer, or merchant, though they did not employ a single workman, could generally live a year or two upon the stocks which they have already acquired. Many workmen could not subsist a week, few could subsist a month, and scarce any a year without employment. In the long-run the workman may be as necessary to his master as his master is to him; but the necessity is not so immediate.

Another classical liberal, J.S. Mill, concluded from the fact that wages are set by “higgling” that relative bargaining power of employers and workers can be altered by institutions such as unions:

It is a great error to condemn, per se and absolutely, either trade unions or the collective action of strikes. Even assuming that a strike must inevitably fail whenever it attempts to raise wages above that market rate which is fixed by the demand and supply, demand and supply are not physical agencies, which thrust a given amount of wages into a labourer’s hand without the participation of his own will and actions. The market rate is not fixed for him by some self-acting instrument, but it is the result of bargaining between human beings – what Adam Smith calls ‘the higgling of the market;’ and those who do not ‘higgle’ will long continue to pay, even over a counter, more than the market price for their purchases.

“What chance would any labourer have who struck singly for an advance of wages?” Mill went on to ask, noting the necessity of “organized concert” by workers to enhance their bargaining power with employers. He concluded: “I do not hesitate to say that associations of labourers, of a nature similar to trade unions, far from being a hindrance to a free market for labour, are the necessary instrumentality of that free market; the indispensable means of enabling the sellers of labour to take due care of their own interest under a system of competition.”

Epstein calls himself a classical liberal, but his oversimplified beginner’s textbook version of labor economics marks a decline from the sophisticated and realistic understanding of the importance of bargaining power in wage negotiations shared by the classical liberals Adam Smith and John Stuart Mill.