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Acton Commentary

Flexible wages are one path to a more humane market

In recent years, conservative criticism of the free market has amplified. In a widely noted column, R. R. Reno of First Things wrote, “The dynamism, velocity, and mobility of capitalism are destabilizing our societies.… Capitalism has a marvelous capacity to innovate, create wealth, and expand prosperity. But it lacks the capacity to give people stability, solidarity, and a sense of belonging. In fact, in its current form, global capitalism seems positively hostile to these fundamental human needs.” In other words, the free economy lacks room for the permanent things, to recall Russell Kirk’s use of T. S. Eliot’s expression. Families and communities need certainty about the strength of familial and neighborly ties as much as—even more than—they need affordable goods and services.

Prudent, just employment practices, recognized in public policy, are essential for orienting today’s capitalism to the flourishing of those permanent things. Flexible wages, we contend, are one important strategy for achieving this goal.

The scourge of unemployment

Most economists, left, center, or right would agree: Wage rigidities cause unemployment. When wages go above the (marginal) productivity of labor, unemployment ensues. The longer it takes for wages to adjust to the productivity of labor, the longer the unemployment will last.

Most economists, left, center, or right would agree: Wage rigidities cause unemployment.

Catholic social teaching (CST) points to the calamitous effects of unemployment on the person, family, and local community, especially when there is mass unemployment. The principle of the common good helps us see the tragedy of unemployment. The Second Vatican Council defines the common good as “the sum total of social conditions which allow people, either as groups or as individuals, to reach their fulfilment more fully and more easily.” Yet each group within society—families, businesses, corporations, schools, religious communities, for example—has its own particular common good.

Unemployment erodes the spiritual as well as material goods that ought to exist within these groups. Describing the elements that are essential for persons’ temporal welfare, in Evangelii Gaudium Pope Francis includes employment “above all,” for “it is through free, creative, participatory and mutually supportive labour that human beings express and enhance the dignity of their lives.” The presence of common spiritual and material goods is most readily seen in family life, which CST recognizes as the most fundamental community within society and in which the “permanent things” are cultivated and enjoyed.

It is tempting to say that unemployment affects the family’s material wellbeing most directly, but it affects the spiritual and relational aspects of a family’s common good at least as much. Work not only brings the family material resources but also cultivates their spiritual resources, which include the know-how, practices, and virtues needed to flourish as persons and as a family, to appreciate the value of their material resources, and to ensure the wise use of future resources. Work establishes relationships with other families, often through institutions of civil society. It is in fact good that much of this work—the organization of the home, the education of children, and the daily maintenance of physical, psychological, and spiritual health—is not directly remunerated because it more clearly shows the essential character of work as a service to others undertaken voluntarily and motivated by love.

Flexible wages promote employment

Wage flexibility minimizes unemployment by preserving existing jobs during economic downturns and increasing compensation during economic expansion. Thus wage flexibility should be an unabashed aim of public policy.

By wage rigidity, we mean that wages adjust to the marginal product of labor on an annual or longer basis. By wage flexibility, we mean that wages adjust to the marginal product of labor on a semi-annual or shorter basis. Flexible wages fluctuate as prices fluctuate, according to the preferences of consumers and the supply of goods and services. When demand increases and prices rise, employers increase product output and thus increase labor input, by hiring more workers and/or increasing wages, in order to increase revenue. When demand decreases and prices fall, employers reduce product output and thus reduce labor input, in order to avoid losses.

If labor is paid above what consumers are willing to pay, then wages are too high. The wages are above the marginal product of labor, and the firm takes on losses. In this case, the firm has two options: reduce wages or fire workers. When wages are rigid, the firm cannot reduce wages, so it must lay off workers to remain viable. If labor is paid below what consumers are willing to pay, then wages are too low.

If wages are fixed and profits uncertain, firms will manage labor costs by hiring and laying off workers rather than adjusting wages. They will also hesitate to increase wages in profitable times as they cannot be brought down quickly in bad times. If firms increase (fixed) wages and profits turn to losses, then firms will lay off more workers than they would if wages had not increased. Hiring more employees will be preferred to a general increase in fixed wages, as the new employees can be laid off if profits are fleeting. The absence of fixed-wage increases in good times results in a lower unemployment rate in bad times.

Some may respond that, rather than arguing for making wages flexible, we should have a fixed wage and rigid labor market, thereby allowing any increases in employment to be permanent. Such policies are often described with phrases like “workers’ protections” or “workers’ rights.” A fixed wage and rigid labor market give an incentive to firms to increase neither employment nor wages. We end up in the worst of worlds where increases in profits result neither in higher wages nor higher employment.

European countries such as Spain, France, and Italy have historically had both fixed wages and rigid labor markets. The results have been historically high youth unemployment and natural unemployment rates. Countries such as Denmark, Switzerland, the United States and Singapore have flexible labor markets and have much lower youth unemployment rates and a lower natural unemployment rate.

The drawbacks of other approaches

Wage flexibility, a microeconomic solution, has rarely been tried. Instead, monetary and fiscal measures—macroeconomic solutions—have been the focus of government policy as it attempts to ameliorate and avoid economic shocks. The negative side effects of such macroeconomic solutions often outweigh the benefits. One approach is to increase the money supply. The new money stokes inflation, which temporarily decreases the purchasing power of money and thus decreases the purchasing power of the wage, pushing the real wage below the productivity of labor. It is a solution that runs out of steam once people recognize that prices are going up and the purchasing power of their wages is going down; labor then demands higher wages.

Fiscal solutions to economic shocks, such as increasing government spending on job programs, also have counterproductive side effects. Even where government spending might be seen as productive, the government’s means of amassing income may erode any benefits of government job creation.

Fiscal and monetary solutions provide short-term relief for a chronic illness by throwing costs on the rest of society as if no other solution were possible. Policy should provide long-run solutions when a manifestly long-run solution is available: making wages more flexible. It is better to have flexible wages with low and steady unemployment than inflexible wages with significant and fluctuating unemployment.

A case study of flexible wages: Singapore

Since the 1980s, the nation of Singapore has recognized the truth of both the classical and Keynesian schools: sticky wages prevent recovery. Singapore chose to encourage a flexible wage scheme in order to bring about quick market equilibration.

The flexible wage scheme has been voluntary and has undergone improvement. It has grown in acceptance with some ninety percent of firms adopting it and continues to change since it was initiated in the late 1980s. Singapore’s policy is voluntary, so companies that will not benefit need not adopt it.

Singapore advocates flexible wages with the support of both employer and employee representatives through the National Wages Council (NWC). Founded in 1972, the goal of the NWC was to bring about national harmony on wages and industrial policy. The NWC is based on flexible wages and tripartism: employees, employers, and the government. All members agree to follow the suggestions of the NWC, which are voluntary in order to avoid the divisiveness of majority voting—that is, there is unanimous consent to the rules and voluntary implementation. Increases and decreases in wages are understood by all groups as achieving low unemployment, maximizing productivity, and achieving the common good. The result has been the elimination of strikes and achievement of industrial harmony.

What are the results of Singapore’s approach? It has one of the lowest unemployment rates in the developed world

What are the results of Singapore’s approach? It has one of the lowest unemployment rates in the developed world: Since 2010 the unemployment rate has ranged between 1.8 and 2.2 percent. During the Asian financial crisis unemployment reached a high of 3.4 percent. Between 1990 and 2014 the range for the median duration of unemployment for residents in Singapore was between 4 and 12 weeks, while the range for the United States was 4.8 and 25.2 weeks. Since 2009 Singapore’s has been consistently at 8 weeks, while the United States peaked at 25.2 weeks in June 2010 and began 2019 around 9 weeks. Singapore’s recovery was spectacular, while the United States’ was lackluster.

How should the United States pursue a flexible wage policy? First, the government should not choose what kind of flexible wage scheme should be enacted. Second, the tax incentive should be open to all flexible wage schemes. Third, any policy should overestimate the need for flexible wages, rather than underestimate. There are no downsides to overestimating, apart from lower tax revenues for the government, but if we underestimate the need for flexible wages we achieve little benefit. A variety of tax incentives could be enacted, such as: 1) lessen or abolish income taxes on flexible wages; 2) enact a tax credit for employees and employers based on what proportion of the wage is flexible; 3) abolish or lessen corporate taxes for firms with flexible wages; or, 4) classify flexible wages as dividend income taxed at the long-run capital gains tax rate, exempt from income and FICA taxes.

If such policies lessen cyclical and structural unemployment, the policies could very well pay for themselves as fewer people accept welfare and unemployment insurance and more people are employed, paying taxes and increasing production. The political need for counter-cyclical fiscal and monetary policies will decrease as will government programs financially supporting the poor. Families and communities will be resilient, subsidiarity will thrive, and the need and desire for the government to intervene will pass.

Flexible wages in defense of the permanent things

The notion that there must be a tradeoff between thriving communities and the free economy is false. The true tradeoff is not between stagnation with stable employment or growth with labor displacement, but between variable wages or variable employment. Greater dynamism in wages stabilizes employment and counters the greatest economic threat to any community: prolonged, structural unemployment. Wage flexibility protects employment and facilitates adjustments in the allocation of labor at a humane pace.

We have proposed a solution—not the solution—to the disturbances of modern capitalism. Our solution does not oppose or undermine the foundations of a free economy: private property, the freedom to exchange, the existence of sound money, or the free formation of prices. Rather we seek to defend and strengthen the free formation of prices, specifically the price of labor (the wage), in service of family and community.

This commentary is excerpted and adapted from Profits for All: Flexible Wages in a Free Economy, the latest volume in Acton’s Christian Social Thought Series. 

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Michael Szpindor Watson is an assistant professor of economics and the director of the Philosophy, Politics, and Economics program at Belmont Abbey College in North Carolina.

Grattan Brown is a Roman Catholic theologian and the academic dean of Thales College in Raleigh, North Carolina.