No Ticket, No Start---No More!

The Centrality of Labour Market Reform

Michael G Porter

Overview

Economic reform, as a popular cause, has been greatly, if unevenly, advanced in the 1980s, and in a wide variety of countries, including New Zealand, the United Kingdom and even Australia. However the actual achievement of economic progress in these countries has been far more limited than the rhetoric would suggest, and it is the central thesis of this paper that those countries or industries in which success has been substantial it has been in association with, and indeed facilitated by, a labour market and legal structure which respects individualised and enterprise level negotiations of labour contracts. What I shall label the 'Nicholls Agenda' is, then, argued to be fundamental to broader based economic reform.

This paper also sets out to undermine the analytical basis of policies based on terminology such as the real wage. It is central to the analytical basis of the 'Nicholls Agenda', that a myriad of centralised wages and conditions are generated as part of the information exchange within markets, exchanges which generate employment contracts, which in turn enhance productivity, profits and wages. For those wishing to save on negotiating costs, which can be considerable, there is, of course, a powerful case for sharing information, for labour associations and unions, and for uniformity of conditions when situations are repeated. But free associations, or unions, formed as part of this process would be competitive or contestable, to use the latest buzz word---and not subject to the monopoly or 'convenience' clauses which characterise our current structure. This 'Hayekian' view of labour markets is in direct contrast to the mechanistic view of wages and labour markets portrayed by advocates of the Accord, and indeed, by the bulk of the economics profession, which continues to talk about the wage. Macro-economic models and policies, from Keynes to Keating, have been preoccupied with issues such as 'getting the real wage down', the wage/tax trade-off, the basic wage and so forth, ignoring the microeconomic fundamentals. It is ironic, in a democracy in which tastes inevitably differ, needs vary, and training and other skills are quite diverse, that there should be a concern to set a wage and set of employment conditions centrally, and enforced across firms, industries and trades, as if we live in the homogenous one person society of some of our economic models.

It is the economics profession, in large part, which has entrenched simplistic understanding, based on simple models, in which there is a level of income, a level of employment, and a wage, all of which are determined in response to a level of government expenditure, a money supply and so forth. Rather than attempting to portray a market economy as based on exchanges between individuals with their own commercial analogue to a linguistic system---with a central feature being prices as signals of scarcity---the Keynesian branch of the economics profession, and the supporters of the Accord, have trivialised the information characteristics of a functioning labour market, and have continued to sanction the wage setting activities of the Conciliation and Arbitration Commission and other 'Higgins Habits', which actually prevent individuals from getting together to create mutually beneficial investment in capital and people.

Whereas economists across-the-board, and even in the Soviet Union, China and other Eastern Bloc countries, have come increasingly to see the error of their ways in relation to protection policies, state enterprise, regulation and so forth, the centralised labour market has been left largely above criticism; indeed, some have openly advocated extension of the corporate state structure which fits so neatly into the 'tripartite-wage rounds-Accord' style of thinking, and which always neglects the rights of individual workers and consumers. I am told, for example, that whereas in China free enterprise now gets a respectable hearing, and while it is possible to criticise freely state enterprise in such a communist country, there is nevertheless a centralised employment process setting the wage in China, or in parts of China, such that markets are prevented from doing their most valuable work---looking after the interests of individuals, individually and collectively, as they change in response to structural changes and shifts in market prices.

The Great Economic Debate

In order to understand both recent economic achievements and the shortfall, due to the non-reform of labour markets, it may be helpful to reflect on the circumstances that brought about this market-oriented change. Assisted by the experience and the analysis of three decades of increasingly costly government intervention and protection, in countries such as the United Kingdom, Australia and New Zealand, associated with declining rates of economic growth, the careful observer in these countries came to question the size and role of government and to see more clearly the virtue of markets. Think tanks, common sense, economists and even Treasuries contributed to this increased awareness of the superior organising and signalling power of markets.

In terms of the economic and political debate, the high ground became dominated by the economic rationalists, with Adam Smith ousting Maynard Keynes as the source of inspiration, with 'government waste' rather than 'market failure' being perceived as the major problem, and with the principle of 'user pays' challenging the 'perpetual pipeline from private pockets to the public purse' as the dominant theme of public policy debates. As a comment on the popularity of these new ideas, we have seen flocks of politicians joining in the free market chorus, often from parties of the so called 'left', and all very impressed with their reading of the new economic rationalism.

But it has been more than just 'Smithian' ideas that have been in the ascendance, intellectually. Many policy changes actually have been effected which reflect those ideas. The notable successes, in such countries as the United Kingdom, Australia and New Zealand, include financial deregulation (perhaps the easiest form of deregulation, given the diffusion of workers and the prior competition from the unregulated financial sector), lower tariffs, reduced quotas and diminished subsidies in key product markets, and the privatisation and corporatisation of many state enterprises. Even more reassuring to those battling the cause of economic rationalism is that the oxy-moronic meaning of the two words 'state enterprise' has become clear, and there has also been a broader recognition of the virtue of simpler and flatter tax regimes, which should apply across-the-board to all real incomes. But in all of the abovementioned cases, progress has not been as real as many would suggest. Nevertheless the collectivist, anti-market forces have definitely been on the back foot in the last decade; they have received some painful blows and have had to invent words such as 'New Right' and play other word games in the media, in a vain attempt to counter the decentralised market attack on regulatory privilege and power.

But my thesis, and it is hardly original in a gathering such as this, is that the results of this apparent shift to economic liberalisation have, in fact, been highly disappointing, and usually for very simple reasons centering on the failure to tackle labour market conditions. It took Arthur Scargill to induce Margaret Thatcher to re-order her economic priorities (having been saved by the war in the Falklands), and to take on both uncontestable unions and their friends---the nationalised enterprises. It took the traffic controllers strike in the United States to bring the Reagan administration out loudly and clearly on the side of labour markets, not union muscle; and it has probably taken the loss of office of Roger Douglas in New Zealand, prompted by the high and rising unemployment associated with corporatisation and reduced protection, to make the community at large, and even the economics profession---not to mention many politicians---wake up to the primacy of the labour market in structuring economic reforms.

In the case of Australia, where there has been increased centralisation of wages, associated with the Accord, the resulting suppression of wage relativities, the significant hand-over of cabinet power to the ACTU as part of the deal, and the failure to implement microeconomic reforms have all combined to prevent Australia from participating fully in a booming world economy. The Australian economy overheats, as at present, at very modest rates of economic growth, precisely because our labour productivity is abysmally low. This pathetic productivity growth, despite our massive resources; our squandering of labour, particularly youth; and our continued resort to state enterprises are, I suggest, all connected to the open unwillingness of our politicians in government genuinely to allow markets in the most vital areas when it comes to raising living standards---labour, education, training and skills.

The contractual approach to the employment labour, and the bundling of employment, training and lifetime skills accumulation, as in some of these Asian countries, including Japan and Korea, makes an interesting contrast with Australian labour 'market' arrangements. In Japan, as in South Korea, workers can start on modest wages in the unregulated sector, get a 'toe in the door' and gain training and industrial experience. Workers can also be bid away to the larger and longer term employers, employers which offer what has become known as 'cradle grave' employment. Not just employment, but training, education and housing may be packaged with the job.

The message that comes from these examples is that the firm has a major capital asset in its workers, and rational firms which do invest resources in training their workers also make sure that, should workers leave, they will lose considerable privileges. The implication in all of this is that were Australian employers not obliged to pay uniform wages but to reward performance, then it would be possible for employers to be far more generous, and even offer shares in the enterprise. An element of contract which would offer some safety valve to employers, in the case of such 'cradle to grave' employment, is the scope to adjust the bonus up and down, to reflect profitability of the firm. While no one should suggest immediate transplantation of systems from one country to another, given the differing cultures, the point in relation to the labour contracting arrangements in the successful Asian countries is that those arrangements are typically precluded in Australia. (The exceptions, such as Lend Lease, Fletcher Jones and some others, by their very rarity, prove the point, given the profitability of shifting towards a system without wage awards.)

It would seem, then, that the countries which are success stories, in economic reform, are those where labour markets were freed first, where individuals and groups of individuals were free to contract for their own labour, or simply to respond to market offers, rather than accept the decisions handed down from irrelevant benches. Countries with few labour market restrictions such as Hong Kong, Taiwan, South Korea and Singapore (except in 1979-80, see below) have experienced phenomenal economic growth with little labour market or welfare intervention, thereby pulling up wages as well as other forms of income. The prevalence of bonuses in Japan and South Korea, for example, for workers in highly profitable firms; the resulting capacity of relativities in Japan to adjust up (electronics) and down (aluminium) when new products emerge or old products fade; the capacity to bring in untrained workers at very modest training wages and so give them a 'toe in the door' while they train on the job, are all characteristics found in labour markets of our once poor, but now thriving, Asian competitors.

Labour Market Versus Product Market Reform

There is a genuine debate amongst economists and analysts of public policy regarding the question of whether product market or labour market reform should have priority. A recent tendency in economic debates has been to argue mat the most useful and strategic way in which to achieve labour market reform is to cut tariffs, reduce protection and so forth, since this exposes firms to the chill winds of competition. It forces them to change their labour market ways, it is argued. In New Zealand, Australia and in many other countries, it is common to hear economists argue that it is impossible effectively to tackle union power, and to rearrange labour markets directly so that individualistic and more enterprise oriented negotiations are possible. Union power simply does not allow this. But all is not lost, the argument goes, since with reduced protection in product markets, firms will seek to vary their own labour market arrangements so as to become more competitive. The weakness in this argument is that the same unions which have succeeded in lobbying for protection, typically with the support of their employers and industry associations, continue to have (political) power for a significant time after protection is reduced. Given that workers tend to be located in the same electorate, and given the capacity of the media to produce genuine cases of hardship and suffering associated with structural change and lower tariffs, for example, it takes a courageous politician to persist with free trade policies given the transitional difficulties. It follows that if monopoly union power persists, and if there is not the normal recourse through legal channels against unions abusing monopoly power, then the reduced level of protection can rapidly be reversed through union and local community pressure.

Far better than punting on lower protection, I suggest, is that priority be given to first facilitating labour market arrangements which allow, and indeed encourage, direct negotiation of enforceable contracts, with bonuses based on good performance, since this gives workers a vested interest not in the prior and inefficient structure, but in the profits of the new jobs.

Of course, nobody is suggesting that we should not take reform when we can get it---the Whitlam 25% tariff cuts were a good thing---even if they were partially reversed. Similarly, financial deregulation on its own is a good thing, partly because it exposes other areas of protection. Likewise, corporatisation is better than non-corporatisation even if it is inferior to privatisation. Political beggars such as free marketeers are not really free to be too choosey!

But the key point, in all of this, is that those who argue that labour reform is too difficult, and may lead to civil war, but who also argue passionately for reform in all other areas, are running a very real risk of losing the reforms they have achieved, such as lower tariffs and reduced quotas, because the residual union power continues to be capable of reversing the change.

Singapore---The Saga of Misguided Wage Intervention 1

Singapore is an interesting example of both the gains from liberal labour and trading arrangements, and of the severe costs of artificially, or centrally, setting wages by fiat. In 1979 the government of Lee Kuan Yew pushed up wages dramatically, in an effort, they said, to foster high technology and labour saving manufacturing. It was an explicit attempt to restructure the economy, and to raise (labour) incomes. The consequences, predictably, were nothing of the sort, with businesses used to competing internationally losing their edge, and with workers from Singapore crossing the Causeway to work in less regulated Malaysia. If ever there is a text book example relevant to the current debate on the centrality of labour market reform it would be Singapore at the start of the 1980s.

The Tasman Causeway

While Australia and New Zealand both have the (other's) labour market as a safety valve once the exchange rate, incomes or employment opportunities get out of line, the costs of centralised wage setting are not as stark as in the Singapore example, given that both labour markets are highly regulated and that relocation costs are rather high. Nevertheless, both the workforce and welfare force in Australia are known to be highly infiltrated by New Zealand labour at the moment, reflecting the currently limited labour opportunities in New Zealand. It is a sad irony, at present, that a country which has led the way in converting state enterprises into corporations, in shedding redundant labour in the forest industries, agriculture, transportation, communications and electricity, thereby increasing productivity and potential income, should nevertheless be unable rapidly to foster adequate new employment opportunities, because of an inability to negotiate new training oriented employment packages, or because of an inability to form enterprise unions with a vested interest in the new enterprise.

As in Australia, the New Zealand Cabinet, when it came to the crunch, and despite the writings and arguments of Roger Douglas, was not able to tackle those business and labour leaders who had grown comfortable riding the uniform wage train.2 In a protected economy, and New Zealand was nothing if not over protected in the Muldoon era, the fact that all firms faced the same (excessive) labour costs meant that they did not have to compete with each other in terms of labour market conditions. Firms in trouble would typically be competing against other firms in similar trouble, and with government, in effect, providing tailor-made protection of one form or another.

With the advent of dramatically reduced protection in manufacturing, and other industries, previously protected firms were obliged to face world markets and therefore to shed labour if they were to cut costs. But where could this labour go? It could not go to the state enterprise sector, since they too were (and are) shedding labour. Where it should go is to the many thousands of potential small new enterprises which characterise a dynamic service and computer oriented economy. But if minimum wages are high, if hours of work are severely regulated, if rostered days off, accident compensation, penalty rates and so forth are all imposed according to the judgements of social welfare lobby groups rather than through mutually acceptable negotiations, then such small firms which have blossomed all over the United States tend not to blossom or even to be conceived in the heavily regulated Australia and New Zealand. As a result, sans labour deregulation, the more effective the privatisation, deregulation and pro competitive policies, the greater the unemployment created.

With more unemployment, the political and social basis for a government oriented towards economic reform is undermined, as was nearly the case in the early days of Margaret Thatcher, and as the exit of Roger Douglas from Cabinet confirms. The very real danger, then, is that in the absence of real labour reform, the community will throw economic reforms away and revert to 'protection' all around, contrived low wages and 'secure' jobs in the newly protected sectors.

The Centrality of Labour Markets in Welfare Reform

In order to understand more fully some of the mysteries of unemployment and the misery of those in states of unemployment or poverty, it is necessary to look beyond the labour market barriers to frequent employment, and to understand the incentives to participate in the welfare system. Australia, in the 1970s, saw dramatic increases in the incentives for youth and adults not to work, the result of both contrived increases in wages and increases in welfare benefits, which had the effect of both reducing the number of job offers to less skilled people and increasing the benefits they received in the event that they did not work.

In the United Kingdom and New Zealand the incentives not to work also increased dramatically around this time. The victims of artificially imposed wages were not those with high skills, good connections or those at the top end of the tertiary education system, since they were typically earning far more than any minimum wages imposed from Nauru House. The victims were, rather, the less skilled, the aboriginal stockmen, the women attempting to rejoin the workforce after long periods out of work due to family obligations, and others who simply did not conform to the standards expected by employers obliged to pay high minimum wages.

In earlier times, so long as the minimum wages were modest, as indeed they were for much of the 20th Century in most countries, there was little by way of an unemployment problem, since those wage minima were largely irrelevant (as they are in most of the United States today). But as union muscle increased, as the group setting wages increased their claims as to what constituted a 'fair wage', and as the welfare industry succeeded in negotiating very generous welfare, compensation and other terms and conditions associated with not working, so unemployment in the western world exploded. (In the communist world, it was under employment which exploded.)

Structural Changes

Structural changes, such as those wrought by a dramatic shift in relative prices associated with the jump in the price of oil, for example in 1973 and 1979, lead to circumstances in which the flexibility of labour markets was critical in order to enable a community fully to employ itself and to achieve the maximum from its skills, capital and resources. Interestingly, it has been in countries such as Japan and South Korea that the real economic downturns associated with oil have been minimal, despite the fully imported nature of oil in those countries; whereas countries such as Australia suffered more in the longer run, despite their extraordinary endowment of energy intensive commodities.

Whereas Japan accepted cuts in the myriads of independent wages in areas made vulnerable, often via the technique of reduced bonuses, in Australia the automatic (CPI based) pressures, in the context of such temporary shifts in relative prices, took the form of increased wage demands as workers sought compensation for higher prices of petrol, for example. Rather than encourage on-the-job training for new firms and new industries to expand in the context of such a structural change, made possible by lower nominal wages allowing employers to add in a training component to take on unskilled, or unemployed workers, Australia had the habit of imposing high minimum wages which had exactly the opposite effect of the wage structure in our Asian neighbours. We were starting to lock ourselves out of the Asian miracle.

Again, we see that the preoccupation with the wage, as opposed to the process of searching out new occupations and opportunities, and associated packages of wages and training schemes, has meant that in Australia the debate always centered on the 'next wage deal', the best 'wage/tax package', or some other temporary fix.

Balance of Payments Problem---The Current Australian Challenge

To the economist it is a truism that the current account deficit of any nation is the excess of national spending over national production. It is also a truism that national production depends on the quantity of labour and its productivity which depends on the capital stock and therefore savings. While it is true then that government could improve the tax treatment of savings---and it has to be admitted that savings are heavily taxed relative to consumption in Australia (with the notable exceptions of the family home)---the result of this tax distortion is that Australians are excessively encouraged either to consume, or to invest in their house, or even worse, to work less hours at their specialised job and more on renovating their house for tax free capital gains, no doubt using labour from the cash economy.

Clearly these tax reform issues need to be addressed, and indeed, are being addressed, for example, in the National Priorities Project. But perhaps even more important than flattening the playing field and raising the quality and quantity of investment, is the development of policies which achieve more output from the given supply of labour, that is, higher productivity. But the very process of negotiating higher incomes in exchange for higher productivity in a particular work place is one which must take place at the enterprise level. It cannot be done at the industry level, since some firms may be state-of-the-art and others inferior, yet all may be sheltered behind some form of protective international trade barrier. Where a firm is able to negotiate its own highly efficient working arrangements it is able to do well in the domestic market and it may then expand into the foreign market---but it will do much better if it is able to expand locally at the expense of firms showing less initiative in designing innovative labour contracts. Under the current system, quite the reverse occurs, with innovative firms being 'picked-off' (for example, Mudginberri and Dollar Sweets), such that there is the possibility, or more accurately probability, that bankruptcy rather than high incomes result from their attempts to innovate.

Australia Poor White Nation of the Pacific?

Some will argue, for example, from the ACTU perspective, that we do not wish to adopt all the standards of Asia. Of course we do not, but that is hardly the point. What we do wish to adopt from Asia is the capacity to reward the highly productive worker with a bonus or special training opportunities, and to signal to those in down-market jobs that they should look elsewhere. We wish to pull labour out of unproductive areas by making it expensive for them to remain there, by enabling the highly profitable new areas to seek labour at any wage packet they like. Rather than have the Higgins team from Nauru House tell marginal firms or aboriginal workers that they would be better off on welfare, the Smith and Nicholls team, well represented in Asia, are arguing that the small firm, the entrepreneur, the unskilled worker, should be given a go. It is in the NICs (newly industrialised countries) of Asia in which the rate of growth in wages has been higher than any ACTU dream and there has been no need in the NICs for 'Button style' industry plans, or for VEDCs and W.A. Incorporated style redistributions from taxpayers to successful lobbyists of government. Government contrived sunrises, Multi Function Polis's and other attempts to imitate the successful features of economic growth in Japan, Hong Kong, Singapore and South Korea seem to completely miss the point. These countries have, I argue, raised themselves by their bootstraps by using two fundamental techniques:

1. Free labour markets, and

2. An orientation towards exports and the external market place.

Australia, New Zealand and the United Kingdom have talked about union power, comparative wage justice, protection from dumping and foreign competition and so forth---with the result that some of the suburbs of England, Australia and New Zealand are now at the edge of exhibiting a lower standard of living than the previously impoverished suburbs of our Asian neighbours.

MITI, Winner Picking and Corporate Statism

There are many who argue that the success of Japan is due to Japan Inc., that is, the complex relationships between MITI and the private sector, with government direction and selection of some key new industries, playing a major role in Japanese success. While one should not dismiss significance of cultural factors, and whilst it is true that Japan has made many sound strategic decisions, the question is whether Japanese success has been because of, or in spite of, MITI? Certainly, it can be said that the flexibility of the labour market, the capacity of successful Japanese firms generously to reward workers, and offer them incentives to stay on in exchange for on-the-job training, has lead to extraordinarily rapid accumulation of labour skills in Japan. (A competitive education system, with a large private tertiary sector, has also assisted.)

Furthermore, the absence of unionization and universal awards, in the context of the many small firms which back up Japanese manufacturing and supply components, has meant that there is a safety valve, or adjustment factor, in Japanese industry which is simply not present in Australia. In other words, relativities in Japan may adjust in a quite dramatic fashion relative to Australia, with the market's key signalling system being allowed to work.

Conclusion

The ascent of economic rationalism, or the 'rise of the dries', has been one of the real triumphs the 1980s. The associated, and not independent political successes of Margaret Thatcher, Ronald Reagan, Roger Douglas and to a lesser extent Paul Keating and Peter Walsh, has also caused spirits to lift in the free market camp. However, it is the burden of this paper that implementation of the agenda of market oriented governments, including such vital steps as:

• privatisation of state enterprises
• deregulation of transport and communications
• withdrawal of the public monopoly over tertiary education
• the use of vouchers in primary and secondary education
• the promoting of lower, flatter taxes with incentives to effort
• the levelling of the business tax and savings/investment playing field, and
• the general retreat from big government

hinges, quite crucially, on the prior reform of labour market, for example, to allow a more contractual approach to employment, with labour contracts reflecting diverging tastes and interests, tailor-made to the preferences of the potential workforce and the enterprise. It has been argued that countries such as Singapore, with its abortive attempt to set wages by fiat in an attempt to restructure the economy, demonstrated in a crystal clear fashion the consequences of putting the cart before the horse (wages before employment) when it comes to generating incomes.

New Zealand, in dramatically lowering regulation, corporatising many state enterprises, and removing many subsidies to agriculture and 'think big' enterprises, has released a lot of underemployed labour and so increased unemployment en masse. The prevalence of craft unions, convenience clauses and other priorities of the Industrial Relations Club, which have entrenched monopoly unions, have thereby undermined the very many moves towards free enterprise New Zealand.

So too with attempts to deregulate and privatise in Australia, not to mention attempts to get the government out of the business of education. The suggestion, then, and it should be an old friend to members of the H. R Nicholls Society, is that if politicians are not willing to make major moves to bring the labour market within the normal contractual structure of the law, then they will not merely be doing a disservice to workers who can be the major beneficiaries of high productivity---but they also will tend to prevent the achievement of their other economic goals, listed above, and so frustrate reforms capable of dramatically increasing income and wealth.3

Endnotes

1. I am indebted to Professor Richard Snape for reminding me of this classic case.

2. 'We had a protected economy which meant employers could pass on the going rate in prices because there was little imported competition. It was easier than risking the chance of industrial action. There was no point in trying to introduce issues like productivity. Nor did the decisions of the Arbitration Court encourage employers to take a firm line. When cases were referred, the court tended to concede the going rate so employers gave in, knowing they would eventually have to pay. Finally there was the role of Government itself. During the seventies in particular, it often intervened in wage-fixing and the overall base settlement figure was largely determined by the unions' and employers' perception of what the Government would accept without intervention. There were wage freezes or wage regulations or implicit threats they would be introduced if the wage round was not to the Government's liking.'
Roger Douglas, Towards Prosperity, David Bateman Ltd., 1987, page 95.

3. As I argued for the Institute of Public Affairs, 1988, in their submission to the Bishops Inquiry into Wealth, the potential benefits of combined labour market reform, lower tariffs, lower taxes and less regulation could add up to a 1.5% rise in the growth rate, meaning a lift in a worker's wealth of about $250,000 (1988 prices) over a full lifetime. While these numbers are mere projections, they are consistent with growth rates; achieved in countries unburdened by the likes of Henry B Higgins and those others who seek to impose their views on appropriate wages rather than allow individuals and associations of individuals the freedom to contract for the profitable employment of their labour and capital.