From Industrial Relations to Personal Relations:
The Coercion of Society

Keynesian Macroeconomics Discover Key to Business Success

Dr Gerald Garvey

I. Introduction and Background

Support for collectivist intrusion into the employer-employee relationship is increasing on the Australian policy front. The main form, as usual, is a set of rulings and policy documents that guarantee trade unions the right to interfere into agreements even though neither employer nor employee wish them to be present. The abrogation of anything remotely resembling normal business relations or even the rule of law is particularly striking in the recent Industrial Relations Commission decision to force Asahi Australia to negotiate with the Automotive, Food, Metals, and Engineering Union even though none of Asahi's employees had expressed the slightest desire to have them involved. As a victorious Mr. Tim Pallas, assistant secretary of the ACTU, put it:

"The union had proven in the commission that it genuinely sought an agreement but the company refused to negotiate with the union, solely on the basis that it had no members" (Russell, 1994)

It is hardly surprising that trade unionists should support decisions and policies which entrench their monopoly privileges. What is perhaps more surprising is that high-brow academic economists have recently been lending support to their cause. This essay will focus on two major written pieces of support due to the Nobel Prize winner, Robert Solow (1990) and to the prominent labour economists David Blanchflower and Andrew Oswald (1995). To support such measures as complex award rates and compulsory unionism, these authors offer the following set of arguments:

(i) First, assert that the case for freer trade between employers and employees rests on the textbook micro economics model with a wage rate that equates spot demand and supply for labour.
(ii) Second, make a host of arguments, some basically correct and others utterly misguided, to establish that the textbook model is incomplete. The idea is simply that the basic demand-supply model is an adequate description of the market for "commodities" such as fish and cabbage, but is seriously wrong for the special case of labour.
(iii) Finally, draw (i) and (ii) together to conclude that we should advocate free trade in fish and cabbage but that the special case of labour requires a host of paternalistic and restrictive measures.

In previous work, I have detailed the features of a richer economic model of the labour/employment market and shown how it provides the opposite conclusion; free trade is more and not less important in labour than in "simple" markets (Garvey, 1993; 1994a, b).l While it is true that a pure "textbook" model of the labour market is hostile to almost any labour-market policy or formal institution, newer "contractual" approaches to labour markets surveyed in Part Two provide substantially more insight into, and respect for, such policies and institutions. The key element of the standard model that remains, however, is the insistence that features be mutually voluntary. Employers and employees can agree, for example, to restrict entry into internal labour markets in order to support ongoing employee commitment and training. Unions and other expressions of collective worker voice may also arise naturally.

What is much harder to rationalise even under the richer contractual approach are government policies that mandate particular structures or outcomes. This approach can be justified theoretically only on the grounds of market failure, that is, by establishing conditions that generally lead transacting parties to adopt features that are not in their own best interests or in the interests of society as a whole. In practice, apparent market failures are in fact due to government policies. For example, the main impediment to training is not the inherent inability of workers and firms to structure contracts that share the costs and benefits of such investments appropriately. Similarly, the "free-rider" problem that is used to justify compulsory unionism only makes sense if it is impossible to exclude non- members from the benefits provided to paid-up union members. This is not in fact a difficult technical matter; the problem is rather that non-members would have to be allowed to "opt-out" of union status and conditions and thereby engage in ordinary competition with union members. The only disadvantage of a direct solution to the "free-rider" problem is that it would undermine the monopoly power of unions, a move that would be desirable in its own right.

The economic model is focused on the creation of wealth through exchange between free parties. Unless monopoly power is actually exerted at the contract-formation stage, it matters little that one party may be 'larger' than another. Unless we are willing to adopt the paternalistic position that a worker does not understand his or her own interest, there is no justification for viewing exchange as 'unequal'. Unless one side is actually defrauded or coerced into an 'agreement', outcomes appear unequal only because the parties entered the agreement with unequal wealth positions; both were made better off by the agreement. If we wish to address the issues of unequal wealth positions, then this should be done in an up-front way through tax or other explicit policies rather than turning over social-welfare decisions to the dictates of trade unions.

The alternative to an imperfect market is not an ideal set of 'centralised' agreements. Rather, it is an imperfect system administered by people who do not and cannot fully comprehend the particular circumstances that individual employers and employees face. Worse still, they do not, like the individuals involved, foot the bill for any errors they commit. The 'free choice' perspective does not need to maintain that employees are omniscient. All that is required is that they are better aware of their own interests and situation than the average member of the Industrial Relations Commission. Recall, also, that collective representatives can be appointed if parties feel they would gain from their expertise. The invisible hand also extends to the market for knowledge and expert representation.

Employers can hire more employees, hire better employees at the same cost to themselves, and so forth, by efficiently structuring their contracts and internal labour markets. Only two assumptions are required for this outcome. First, employers and employees actually must be free to vary terms of the agreement (including union representation, fringe benefits, and even the degree to which managerial prerogative is exercised). Second, employees must not be systematically duped by employers, or, milder still, they are better placed to judge their own best interest than are members of the industrial-relations bureaucracy, whom they did not even appoint.

The above summarises the three essential points in Garvey (1993;1994). To recapitulate, the first is that textbook microeconomics does indeed treat labour markets as essentially identical to those for commodities. Although the textbook treatment certainly does not capture all the richness and detail of the employment relationship, it makes the key point that all markets involve the mutually voluntary exchange of rights between human beings. Mutually voluntary exchange necessarily involves a gain for both parties. The employment relationship merely refers to the exchange of a particular set of rights.

Second, the past 30 years have witnessed an outpouring of theoretical and empirical research that explicitly recognises the fact that the employment relationship involves a particularly complex bundle of rights, and that the exchange can take place over many years. This research has greatly enhanced our understanding of such issues as career structures, the exercise of authority of 'managerial prerogative', and the contribution made by unions. Although such features of the employment relationship appear inconsistent with an idealised spot-market for labour services, they actually serve to support rather than to restrict exchange. Thus freedom of contract does not imply an institution-free labour market. Rather, institutional structures develop to support exchange.

Third, an understanding of the complexities and idiosyncrasies of the employment relationship in no way justifies the coercive features of the Australian approach to the labour market. Nor do proposals advocating enterprise bargaining necessarily fare much better. The arguments for allowing individuals free choice over the terms under which they work, including the right to join or not to join a trade, industry, or enterprise union, become more and not less compelling when account is taken of the unique problems and opportunities presented by the market for employment.

II. Intervention in the Labour Market is Justified Only if Employers are Stupid

1. General Arguments

The upshot is that serious labour market researchers should be opposed to and even outraged by the arguments made in favour of compulsory unionism and detailed, centralised awards. Here I want to argue that persons who matter far more than academics, namely individual Australian employers and employees, should be similarly outraged. The line of argument sketched above absurdly understates not only your intelligence and integrity, but your basic ability to look after yourselves. Simply put, you are all well aware of the ways in which your employment relationships differ from the purchase of cabbage or fish. As employers, you hardly need to be told that workforce morale and perceptions of fairness are important for your bottom line, not to mention your health and sanity at work. There is a great deal of competition between employers to provide a congenial workplace, particularly in an age where human capital and skills are so important. It pays you to have a happy workforce, often to such a degree that you profit by paying employees more than they could earn outside.

Oddly enough, Solow et al. use these rather trite observations to justify compulsory membership in industry unions, and strict regulation of individual agreements. From the argument that smart employers do not treat their employees like cabbages, the conclusion is somehow reached that governments should mandate exactly how individual employees should in fact be treated. How exactly this conclusion is reached is rarely stated honestly. And for good reason. The key missing link in the argument is stupidity of the average employer. Make no mistake, you are not simply being called "greedy". Since happy, stable employees produce benefits for themselves and bigger profits for their employers, greed will suffice to have employers look after fairness and employee morale. Only stupid or perverse employers would overlook this fact. And that is exactly what you are said to be doing. To illustrate, we now turn to two more specific arguments.

2. Some Specific Examples and What they Imply

1. Efficiency wages, profit-sharing, and rational employers. One of the most robust empirical findings in labour economics is that profitable employers pay their employees more. This relationship is generally only implicit, meaning that employees wages are raised on an ad hoc basis as the company succeeds, but is sometimes enshrined in explicit arrangements such as profit- or gain-sharing. The latter arrangements have many passionate advocates, whose rationales range from tax-avoidance to "worker-ownership of the means of production". Such schemes are of course opposed by some of the more traditional elements in the trade unions since they may serve to tie the employees more to their employer than to the unions.

Solow and company seem to argue the opposite, namely that unions and governments are required to force recalcitrant employers to adopt profit-sharing plans. They are certainly tax-advantaged in many countries. But the arguments in favour of profit-sharing are all based on the notion that worker productivity, especially elements of productivity that rely on "teamwork", will be increased. If so, employers gain from introducing such schemes. On the outside chance that you had never thought of such a plan before, here is a bit of free consulting. More likely, the advice is worth what you paid for it. Profit-sharing is not always profitable, if the implied risk of tying employee fortunes to your fickle markets makes them unwilling to take commensurate cuts in their other compensation, or if the motivational effects are small.

The above argument is again uncontroversial. Profit- and gain-sharing, and other "innovative" forms of employee relations, are surely a good idea for some companies and not such a good idea for others. The key question is who gets to choose which elements get introduced into which firms. Solow and company do not trust your judgement, even though you bear the gains and losses associated with your employee relations programs. Implicitly, they are saying that Laurie Brereton and Bill Kelty are in a position to decide how individual employees should be managed. Of course, this sort of decision-making process gave us demarcation in the first place. Equally amazing is the fact that some researchers in the organisational behaviour area (eg., Hellriegel, Slocum, and Woodman, 1989) use the fact that some employers do not immediately jump at the suggestion to introduce such systems, as evidence against employers' ability to make rational choices. I will leave the alternative explanation to you.

2. Exhortation by political leaders for employers to limit pay gains to those justified by productivity. At the end of the week of November 12 of this year, Prime Minister Keating made a series of statements to the effect that employers should assiduously seek out productivity gains and also resist excess wage pressures. The Accord has delivered employers a low-inflation, environment with "stable" industrial relations, and it is now up to employers to link wages to productivity, for the good of the nation. This was greeted with the usual head-nodding and sage commentary about the "shared" responsibility of unions, governments, and individual employers to achieve low-inflation and other desirable macro-outcomes. On closer inspection, such statements must be either inane or very disturbing. Inane, because they imply that employers have insufficient incentive to raise productivity and not to overpay employees. Equally important, it implies that the Prime Minister actually knows the productivity of individual work-teams or even individuals.2 If that were true, collectivist Chinese agriculture would have amply fed citizens from 1959-61 when in fact more than 50 million people starved to death (Lin, 1990). On a more theoretical and less emotive level, how would the government and the ACTU be able to tell which employers were paying wages justified by productivity and which were not? As you well know, one can never perfectly isolate an employees' contribution even at the workplace level. How could individuals at the national level ever know such facts? Even more to the point, what incentive have they to even try? Re-election and campaign support do not come from an ability to link employees' rewards to their contribution, over the long or the short-run. But these are key elements of successful (ie, profitable) private sector human resource management policies.

If the Prime Minister's statement is not inane, it is at least disturbing. The preceding argument assumed that you would be allowed to freely negotiate both compensation and work practices with your employees. More likely, you are going to be asked to somehow uncover pots of gold to pay for higher wage demands. This signals a revival of the most primitive version of the Higgins doctrine, that centralised wage-fixing will destroy all the "bad" employers and force the average ones to lift their games. Or perhaps it reflects a return to the days where you could petition for protection from overseas competition to help you afford the pay rise. It certainly does not represent a step forward.


I. As a student of so-called "textbook" markets like the stock exchange let me also register my outrage that such markets should be presented as trivial auction markets. Aitken, Garvey, and Swan (l995) show how long-term relationships, supported by deregulation of the brokerage cartel on the Australian Stock Exchange, have greatly improved the services it provides to its clients!!

2. During the 1992 US presidential campaign, candidate Clinton suggested a wage ceiling for corporate executives, which was to be suspended only if "justified enterprise". The foregoing is my recollection of the quote, which lacked the candidate's customary polish.

Thanks to Mark Harrison for some useful suggestions.


Blanchflower, D. and A. Oswald, (1995) The Wage Curve forthcoming, MIT Press.

Garvey, Gerald T. (1993) "The Market for Employment: Insights from Traditional and Modern Economics", in F. Hilmer (ed.), Working Relations, Business Council of Australia, 239-354.

Garvey, Gerald T. (1994a) The Market for Employment, Centre for Independent Studies, Policy Monograph 27, 1-86.

Garvey, Gerald T. (1994b) "Why Labour is not Different", Agenda, 1, 5-13.

Hellriegel, D. J. Slocum, and R. Woodman (1989) Organizational Behaviour West Publishing Company, San Francisco (5th edition)

Lin, J.Y. (1990) "Collectivization and China's Agricultural Crisis in 1959-1961" Journal of Political Economy 98, 1228-52.

Russell, M. ( 1994) "Bosses Forced to Deal with Unions" Sydney Morning Herald, December 20,1.

Solow, R. M ( 1990) The Labor Market as a Social Institution Basil Blackwell, London.

Why HR Nicholls?