Preserving Labor Market Flexibility

In my introductory essay, “American Workers Do Not Need Unions,” I took dead aim at the system of labor relations embodied in the National Labor Relations Act. Its regime of exclusive representation, given to a union that secures a majority vote within a given bargaining unit, creates a rigid system of cartel rule that frustrates the adaptability of labor markets and reduces overall social welfare: competition in labor markets beats monopoly. By way of offset, I noted that any so-called “company union,” if set up consensually within the firm, could serve as an effective conduit for facilitating cooperation between management and labor over a wide range of issues, without raising the specter of monopoly unions. Yet sadly these arrangements are barred under Section 8(a)(2) of the National Labor Relations Act. The repeal of that section is a simple and powerful first step to labor law reform.

The three esteemed authors who have written comments on my piece—Samuel Hammond, Mark Pulliam and Michael Lind—are, happily, agreed on one proposition: none of them wish to defend the current system of labor law that I have attacked. Instead, the common thread linking their three comments is their joint conviction that in my focus on the NLRA, I have missed some important possibilities of labor law reform because of my naïve faith about the existence of competitive labor markets and their efficiencies relative to any of the alternative schemes proposed by my three commentators.

By way of a general response, I am under no illusion that any market, labor markets not excepted, is free of all imperfections. Indeed, that cautious proposition reaches the status of a necessary truth given that transactions costs are, per Ronald Coase and “The Problem of Social Cost,” positive in all markets. But the payoff from that proposition is not that government coercion is needed to correct for inevitable market distortions. Rather, it is that markets have, by custom and practice, developed a wide range of devices—written contracts, standardized contracts and products, public disclosures, advertisement, recordation systems, knowledgeable intermediates, auctions, exchanges, and much more—to address these problems. The difficulty with all three papers is that each, in its own way, makes the same mistake: assuming that some clever scheme of public regulation can outperform the private adaptive responses that are available in the absence of regulation. What they all fail to recognize is that, so long as the restrictions against monopoly behavior are observed, various voluntary adaptations within and across firms can achieve positive social objectives and alleviate market distortions, all without requiring coercive state intervention. It is important to see how this theme plays out in connection with each of the three essays.

The False Promise of Sectoral Bargaining

Samuel Hammond starts off on the right foot when he notes that the United Auto Workers has never been able to unionize the Volkswagen plant in Chattanooga, Tennessee, in the face of implacable local hostility toward unions. He then laments that the sad condition of American labor law does not, given the ban on company unions, permit formation of the kind of work councils that VW deploys with great success around the world. Toward the end of his essay, he chides me for not considering the variations on unionized arrangements, including his German model, which he claims tend to push wages below marginal costs in an effort to boost exports. But there is no need to have any work council to achieve that wage outcome if it is desirable.

The firm could adopt that same wage scale unilaterally and avoid any of the transactional rigidities that come from the division of authority, which could hamper its flexibility in nonwage issues, including such key issues as the acquisition and divestment of various lines of business. Indeed, his proposal for “sectoral bargaining” is far from a bed of roses, because it is just a fancy way of saying that union leaders have agreed to use a cartel system to reduce wages across the board, which could mean that they have sold out their own workers to keep their personal positions of power. Hammond argues that firms that adopt this strategy can earn rents by finding ways to economize on other factors of production within that wage system. True enough. But these firms can earn the same Ricardian rents in a competitive market, by making similar adjustments in their businesses, without having first to clear their new programs with union leaders or even the rank and file.

And it is quite beside the point to note that in Nordic markets the unionization levels reach 70 percent through industry-wide collective bargaining. The question is whether that umbrella organization is more efficient than a system of wage competition, for which no supporting evidence has been offered. What Hammond’s observation may be best explained by noting that small countries like the Nordic states that are disciplined by competitive world markets tend to be more efficient than those that sell only in local markets, where there is less product and service competition.

Nor is there anything to Hammond’s general view that I ignore modern American writers like Oren Cass or Michael Lind, writing in this exchange. It is one thing to reject as they do the current model of labor relations, but as I have noted elsewhere, it is exceedingly frustrating to guess at the precise institutional structures that Cass, for example, wants to put into place. Hammond also raises the possibility of using unions as institutions for job training and social insurance, but these are tasks for which they have no particular comparative advantage over other specialized firms. Apprentice training, for example, certainly has been a staple of unions, but it is far from clear that unions have the flexibility and range of opportunities available in private vocational programs, which can look to the market as a whole and not to a specific firm or industry. Further, the thought that unions would be ideal, or even preferred, providers of some sort of social insurance seems fanciful at best, and dangerous at worst, given the sad record of so many unions in mismanaging their own pension funds. The point here is that the disaggregation of functions is the best way to propel the American work force forward. Hammond, not I, is stuck in the past because he asks the wrong question: He wonders how labor unions can adapt to new functions. The correct question, however, asks which of a full range of social institutions can pick up some of the functions that unions currently serve poorly.

Flexibility Is Not Peonage

Mark Pulliam also has a love-hate relationship with unions. His essay, “What Really Threatens American Labor,” spills much ink referring to authors who write in the same anti-union tradition that I do, and I commend him for noting that the flawed Marxian notion of exploitation underlies too much of modern American labor law, for public and private unions alike. But then, if I read him correctly, he takes a sharp switch in position and becomes hostile to two standbys in classical liberal thought: free trade in international markets, and domestic market innovations of the sort represented in the gig economy, both of which indirectly undercut the ability of workers, among other things, to form unions! I do not understand why he assumes that free trade deals like NAFTA should count, without evidence as “one-sided trade deals,” that have “decimated” once-thriving communities by exporting jobs to China, Mexico, and elsewhere.

The obvious fallacy in that claim is that the manufacturing plants of old often operated inefficiently precisely because of onerous union contracts or other forms of untoward regulation. They could not have survived under those burdens, foreign relocation aside. There is a huge internal migration of workers from the rust-belt states like Illinois that protect unions to southern states like Tennessee that are in general hostile to unions. And those plants that cannot relocate may well shrink or fold, which leaves local workers with fewer (if any) jobs and without someone at whom to point an accusatory finger. These firms cannot survive by baying at the moon; nor can the states in which they are located. Neither can they ask the world to stand still. Both must act to reform their local state laws and adjust their labor contracts to become more competitive. One unappreciated benefit of a free trade regime is that options of exit and entrance exert a powerful force for both regulatory and contractual reform.

Why regulate the labor market when it functions pretty well, especially now that labor mobility (COVID-19 aside) is on the rise?

Nor, contra Pulliam, does it make sense to impose tough restrictions on firms that operate in the so-called gig economy. This business model treats workers as independent contractors, who are not entitled to any statutory benefits, instead of as employees who get a raft of mandated fringe benefits. There is no doubt in my mind that the employer-employee relationship is, as between the parties, often the preferred way to proceed, so long as the set of collateral benefits is determined by contract and not regulation. But it is important to stress that the legal regime lards that contractual relationship with many mandates—you must supply this kind of medical coverage, this amount of vacation time, or family leave—that are not worth to the employee what they cost the employer. That cost/benefit differential is an implicit tax that reduces the gains from the transaction or forces parties to adopt an alternative business model to avoid the regulation, even at the cost of some lost market efficiency. So, the rise in the number of workers with independent contracting status reflects in large part the contractual efforts of workers and businesses to reduce the costs of regulation.

But the complete story surely includes the brute fact that, wholly apart from regulation, many workers prefer the flexibility available in the gig market, which allows them, for example, to complete an education or care for family members without having to shoulder the heavy burdens of a full-time job. Why that added measure of worker choice—remember, no one in a gig economy has to accept a particular assignment if they don’t want it—should be called a form of “peonage” beats me. The layoffs and confusions under Assembly Bill 5 in California fully confirm the proposition that unintended consequences often undermine supposedly high-minded reforms, which in this instance are passionately backed by unions who think that they can make further inroads into the market of these gig workers-become-employees.

Higgling Isn’t All That Helpful

The third of these papers is by Michael Lind, with the stark title, “Labor and Management Remain Unequal.” This confrontational and Marxian title indicates that Lind has taken a somewhat different approach that attacks the factual assumption that pure competition is the dominant form of market structure. On this topic, he is surely correct that there are important markets—natural monopolies like public utilities and common carriers—that do not operate best in competitive markets. Given increasing returns to scale, a single firm over the applicable range of output can supply the market better than two or more smaller firms. That powerful insight has sparked a body of law and practice to figure out both the practical use of and constitutional limitations on rate regulation. But that form of regulation was always and exclusively directed to the question of rates charged to customers, and it never addressed the question of what wages were owed to various workers.

The reason for the difference is not hard to grasp; people who could work for a particular public utility usually had lots of other job opportunities in firms that needed their skills even though they sold their goods and services in separate markets. Why regulate the labor market when it functions pretty well, especially now that labor mobility (COVID-19 aside) is on the rise? There is, accordingly, no reason to think that models of oligopolistic competition have a useful role to play in these discussions, which is why the topic never came up in the extensive case law and literature on these issues.

Indeed, Lind gives away the game when he switches focus from common carriers and public utilities to speak of large firms which employ more than 500 workers. At this point the argument is a pale shadow of the bigness-is-bad argument that goes back to Louis Brandeis and recently has been revived by Tim Wu in his book The Curse of Bigness: Antitrust in the New Gilded Age. But many questions remain: Why should those firms be regarded as having either monopoly power as sellers or monopsony power as buyers? Competitive markets have both large and small firms, competing on the full range of wages, terms and conditions, where the circumstances are so varied that there is no reason to suppose that the large firm always has the advantage over the small firm by paying higher (or lower) wages to current and prospective employees. Indeed, the high rates of turnover in the labor market suggest that there is no systematic advantage for one class of firms over another.

Lind then goes on to make other basic errors unrelated to the question of whether unions ought to receive special protection. It is surely the case that higher wages induce firms to switch to technology to minimize their costs. But there is no way to decide in the abstract whether that switch creates or destroys social value. If the labor is priced at monopoly levels, the shift could well be inefficient if the technological “fix” costs more than competitive wages. If labor is priced competitively, it could well be efficient. Similarly, it is wrong to think that higher wages necessarily help employers because those bigger paychecks will allow workers to purchase more in these or other markets. Those workers are a tiny fraction of their employers’ customer base, and firms can give their employees discounts on firm goods without any resort to unions whatsoever.

But speaking globally, any increased purchasing power of unionized workers is more than offset by the reduced purchasing power of both shareholders and would-be workers whom unions shut out from firm jobs. Unions do not make their workers better off by expanding the pie. They make their workers better off by giving them a larger share of a smaller pie.

Finally, Lind is wrong to assume that the efficiency of markets is necessarily enhanced by “higgling” to determine market prices or wages. Higgling is a form of transaction cost that arises because of a spread between the bid price and the asked price. The multiple iterations of negotiation slow down markets and produce indeterminate prices. That system might work for two farmers dickering about the price of a cow in the barnyard. But just imagine you’re going to a supermarket where customers come to the checkout counter with a load of groceries and sundries, eager to start higgling over the price of grapes and cereals. Mass markets for goods and credit use “take-it-or-leave-it” offers to expedite transactions. The firms who set these offers know that they have only one chance to get it right, for if they set the price too high, their customers will indeed desert them.

They face the same constraint with respect to workers who, the lower the wages, the greater the incentive to go elsewhere. In these cases, moreover, it is odd to think that either side would have the advantage because of a supposed ability to hold out for a longer period of time. Adam Smith, classical liberal though he was, was wrong to conclude that employers can, as a matter of course, hold out longer than workers. If employers have to harvest their crops before they rot, or if the maker of expensive equipment has to meet a delivery date to avoid liquidated damages, the bargaining advantage could easily run in the opposite direction. Alternatively, some firms are heavily leveraged, and in need of free cash to make their debt payments. Slow production or sales can put the solvency of the firm at risk. Nor is bargaining always between firm and worker. If two firms are bidding for the services of a single employee, the holdout model is inapplicable. In short, the many digressions in Lind’s paper give no reason to think that the current system of collective bargaining makes any sense. Nor does it provide any sensible blueprint as to what other alternative to competitive markets could improve the overall welfare of workers, or indeed, the overall system of production.

To conclude, it is wise to remember that all legal and economic disputes ultimately boil down to the question of which form of industrial organization has the fewest imperfections. And that battle is won, far and away, by competitive labor markets.

Reader Discussion

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on July 31, 2020 at 11:14:09 am

I was with Epstein until the very end, where he wrote "Adam Smith, classical liberal though he was, was wrong to conclude that employers can, as a matter of course, hold out longer than workers. If employers have to harvest their crops before they rot..." Of course there are certain kinds of exceptional cases where an employer is over a barrel, but Smith on the whole is right, and the larger the firm, the greater its advantage is likely to be, most of the time. The relationship of employer and employee is usually unequal. To leap to the conclusion "And that battle is won, far and away, by competitive labor markets" is to beg the question. What keeps them 'competitive'?

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on July 31, 2020 at 13:42:09 pm

What keeps them competitive? The ability of the worker to walk away. If big businesses REALLY had such bargaining advantages, all wages and compensation would be at government mandated minimums, yet they obviously are not. The employer has 0 power to compell anyone to work for compensation and in conditions he'd rather not...

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Image of OH Anarcho-Capitalist
OH Anarcho-Capitalist
on August 05, 2020 at 06:30:57 am

Without a credible system of social protection, an employee cannot always just walk out unless he is prepared to join the vast army of street dwellers. There are transactions costs of changing lifestyle.

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Image of Curious
on August 02, 2020 at 13:16:17 pm

"I do not understand why [Pulliam] assumes that free trade deals like NAFTA should count, without evidence as “one-sided trade deals,” that have “decimated” once-thriving communities by exporting jobs to China, Mexico, and elsewhere.

The obvious fallacy in that claim is that the manufacturing plants of old often operated inefficiently precisely because of onerous union contracts or other forms of untoward regulation. They could not have survived under those burdens, foreign relocation aside."

there is much that is correct in Epsteins analysis. Much, that is, in the general propositions he advances and supports. Yet, I suspect that he, like many others, fails to observe the wide range of "particular" circumstances that HAVE been adversely impacted by NAFTA, TPP, etc.
Let us consider the high tech electronics industry, with which I have some intimate familiarity.
1) This industry was not unionized (excepting for small electronic subdivisions of some major aerospace companies).
2) We were NOT inefficient. As an example, a medical ultrasound plant which I ran had achieved World Class, and I mean WORLD CLASS performance levels in quality, efficiency and product performance. This was equaled by NONE. The rest of our industry also achieved near similar levels of performance.
3) Wages were NOT inordinately high and in fact were significantly lower than the wages offered at the unionized Boeing plant in the area.
4) Executive compensation, while far greater than worker wages, were also not excessive.
5) The market was growing at a steady rate.
6) Regulatory burdens while significant were NOT sufficiently burdensome to cause undue pricing pressures nor delays / impositions on market / strategies.

YET, in successive order, ALL manufacturing was eventually offshored, first to Mexico for electronic assembly, later to Asia; higher level subassembly operations and some initial testing was also offshored. All that remained was final integration and system testing.
This reduced the labor component by 65%.
Where did those $25, 000 (1990 wages) per year employees go?
Where did those jobs go?
To the NAFTA sanctioned factories set up just across the border in Juarez and other Mexican locations.

Unions had nothing to do with it - nothing!!!!
Nor did regulations play a significant role in the demise of electronic manufacturing in the United States.

Nope - just the chance to get a simulacrum of manufacturing efficiency / productivity at a fractional cost.

We should always be mindful in our analyses of BOTH the general and the particular.
It may make us moderate our conclusions.

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Image of gabe
on August 05, 2020 at 06:36:39 am

If labour, including executive labour, got paid at no more than marginal productivity, why did the jobs go abroad?

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Law & Liberty welcomes civil and lively discussion of its articles. Abusive comments will not be tolerated. We reserve the right to delete comments - or ban users - without notification or explanation.