5.5 Labour Market and Competitiveness
In our discussion of competitiveness in Chapter Four we used the Annual Competitiveness Report 2000 of the National Competitiveness Council as our starting point for looking at how a Basic Income policy would affect the competitiveness of the Irish economy. Of the seven aspects of competitiveness mentioned in that report, we determined that three have the possibility of being influenced by a Basic Income policy: Social Partnership; People; and Costs. Many of the factors that fall into the People and Costs categories relate to labour market issues. As we stated in Chapter Four, the labour market aspects of these competitiveness categories will be analysed in this Chapter.
In Appendix 5.A we look at the theoretical issues involved in how social welfare and tax policy influence labour market outcomes. Here we see that tax and social welfare policies generally will affect the labour market in two general ways: the demand for labour by businesses; and the supply of labour offered to employers. The People category of competitiveness indicators highlights Work Incentives as an important factor in competitiveness. These incentives mostly relate to the willingness of workers to offer their labour to employers, although tax policy can also theoretically influence the willingness of employers to hire workers.
The first aspect of people considered by the NCC is education. Higher education and life long learning are very important for the “New Economy” and one of the projected flexibilities that the new labour markets will need is the ability for workers to continue to improve their human capital (acquire new skills and training). Traditionally, once a student has finished their higher education they received their diploma and were mostly done with their formal education (although it should be noted that many of the professions require continuous education of some form or another, and most non-professional occupations provide most of the necessary skills on the job site). The new model is for moving between paid employment and further education. A Basic Income supports this new labour market as those who want to get retrained, either in their present field, or changing fields, will be able to have the Basic Income payment to live on while they are earning less or no income. Furthermore, a Basic Income makes it easier for low-income households to send their children to Tertiary Education, as they will not need the income these teenagers and young adults would have contributed to the households. A basic income policy supports this type of flexibility as it allows individuals to attain higher levels of education, and to return for more training and skill attainment after their formal education is completed. This flexibility comes from the basic income payment, which comes without stigma3 and which helps to support the worker who has left the paid labour force to re-enter education. Thus a basic income system promotes greater investment in human capital4 by supporting access to higher education. Furthermore, by supporting parents in “home duties” a basic income system promotes primary and secondary education, as it allows parents to take a more active role in their children’s education.
We have already discussed many of the factors the NCC report discusses regarding work incentives. A Basic Income system reduces the “tax wedge” on low and moderately paid workers, has a minimal impact on the Tax/GDP ratio, reduces the effective tax rate for most workers, especially low and moderately paid workers and has a marginal tax rate that does not act as a disincentive to taking up a job or increasing ones hours worked. Our Basic Income proposal will have no effect on the non-labour costs, as these remain the same. However, it provides an important adjustment to the rise in the incidence of part-time employment. This rise is a reaction to the need for flexibility in the labour market and there is very little that can be done to change this trend (outside of dramatically increasing the level of regulation of the labour market). The problem, of course, with this rise in the incidence of part-time employment is that not all of it is voluntary, that many of the part-time workers need a full-time income but are only able to get part-time work. A basic income system helps to support these workers as it supplements their income. It also helps to support those part-time workers who want to limit their hours worked because of family responsibilities, thus allowing them to have more choice in their labour supply decisions. Our Basic Income proposal would likely lead to a reduction of hours worked in paid employment by married females, though we will also likely see in many households a redistribution of paid work and home duties for both adults living in a household, as a basic income system provides considerably more flexibility in making these decisions. Recent government publications have implicit arguments that it is necessary for there to be an increase in married women’s paid labour market participation and the NCC report explicitly argues for such an increase. These arguments assume that the current contributions of those in home duties or caregivers is not valuable and does not make a valuable contribution to society and that instead these people should take up a paid job so as to contribute to the market economy. This reasoning ignores the real value of household production and the social economy. Reductions in these activities will certainly lead to higher costs elsewhere in the economy and society and before Ireland goes down this road there needs to be a full and open debate on this issue.
5.52 Labour Costs
In Chapter Four we reviewed the role of labour costs in the overall competitiveness of the Irish economy. We saw that it was one of the contributing factors in Ireland’s recent economic success (though certainly not the only factor). In Table 4.2 we saw that Ireland’s total hourly compensation was well below the USA, the United Kingdom, France, Germany, Netherlands and Japan and in Graphs 4.5 and 4.6 we saw that the trend in unit labour costs in Ireland has been downward, while the trend for Ireland’s trading partners has been rising (although both the OECD and EU, since 1995, have had falling labour costs when compared with the USA). In this section we will look at how a basic income policy might affect labour costs in Ireland.
A review of the literature on basic income shows that there are two arguments advanced in relation to how a basic income system would affect labour costs. On the one hand, economists such as James Meade have argued that a basic income system would promote full employment because it would allow wages to fall (in effect creating wage substitution) and according to standard economic theory when the price of something falls (in this case the wage rate) than the demand for it will go up. Critics of basic income from the left frequently see this as a major drawback of a basic income system, while conservative supporters of basic income see it as a plus.5 On the other hand, many promoters of a basic income system argue that it will support the lower end of the wage scale, thus increasing wages for those in low income, and thus leading to less income inequality. Clearly both of these effects cannot happen, so a key question is how will a basic income system influence wage rates and labour costs. Wages are not simply the price of labour, and wages are not determined in the same manner as commodity prices or other prices that are determined in competitive markets. The institutional structure of any particular labour market plays a key role in determining wage levels, both absolute and relative. As Ireland now has a statutory minimum wage a basic income policy cannot lead to wage substitution, at least not below the minimum wage levels. For workers with wages above the average there is little evidence to suggest that a basic income policy could lead to wage substitution. These workers often have considerable bargaining power and would be able to successfully resist any such attempt. Workers with low to moderate wages typically do not have the protection of unions and other forms of institutionalised power and thus have more of a risk. Under the current climate in Ireland, with unemployment at historically low levels, there is no reason to believe that wage substitution would take place, as labour is currently scarce. If unemployment was high, this might be a concern, though again it would depend on specific characteristics of each job category and labour market. With a tight labour market it is more likely that a basic income system will strengthen the lower end of the labour market rather than hurt it.
The strengthening of the lower end of the labour market is a concern among many economists and government official in most OECD countries. The fear is that a rise in wages will lead to either falling cost competitiveness or inflation. Both fears are valid only if we look at wages outside of the context of productivity growth. However, in the context of high productivity growth (according to the NCC’s report, Ireland leads all the countries considered in their report in productivity, growing at a rate of 3.75% from 1994-99, compared with the EU average growth rate of 1.6%) it is possible to have both rising wages and falling labour costs. Given the developments discussed in Chapter Six, especially the growth in wage inequality and the declining share of labour income as a percentage of total income, some attention should be paid towards strengthening the lower end of the wage scale. A basic income system directly helps these individuals and could possible indirectly help them if it has this effect. The ultimate goal should be to increase the productivity levels of Irish workers to the levels of other OECD countries and not to be permanently in the position of competing through a low wage strategy.
Tax and Social Welfare and the Labour Market: Theoretical Issues
The general rise in unemployment rates in the developed capitalist economies since the 1970s has generated an explosion in theoretical and empirical investigations into the causes and possible solutions to this major economic problem. At the same time there was a decline in the influence of the ideas of John Maynard Keynes and the more macro-economic explanations of economic growth, inflation and unemployment and a rise in the more micro-economic explanations based on pre-Keynesian economic theory. This shift in economic perspective mirrored the rise of in political power and influence of the “free-market” ideology best exemplified by Margaret Thatcher in England and Ronald Wilson Reagan in the United States. This ideology starts off with the belief that markets generally work, as long as the government gets out of the way, and by work they mean reach a market clearing equilibrium. For the labour market this means that there is a natural tendency towards full employment and if full employment is not being experienced it must be due to some barrier to the workings of the market forces that would, under normal conditions, produce full employment. (It should be noted that these same theorists redefined full employment as the natural rate of unemployment, that is, the rate of unemployment below which inflation would accelerate). Thus the majority of economists have attempted to understand this rise in unemployment as the result of some market imperfection that prevented the “natural market forces” from working. The existence of high unemployment meant that something had shackled the “invisible hand” of the free market. The two main culprits that had shackled the market, in most of this type of analysis, were government tax or benefit policy and labour unions and labour regulations.6 That all this was an attempt to blame the victims (workers) or governments for what is a natural tendency of capitalist economies (boom and bust of business cycle) seemed fairly obvious to all without a graduate degree in economics.
Under this view of the economy, the labour market is seen as any other market. There is the supply of labour, which is a function of the wages and other factors that influence the willingness of workers to work (such as tax and benefit levels). The demand for labour is also a function of a price variable, the wage rate, and the productivity of workers. Given the workers’ aversion to work (work is seen as a disutility) and the productivity of workers, the wage rate will adjust up and down until it reaches a level in which the quantity of workers willing to work at a specific wage is equal to the quantity of workers employers want to hire at a specific wage rate. Unemployment, in this view, is defined as a situation in which there are workers who are willing to work at a specific wage rate who are not being hired by employers (a surplus of workers). If market forces are allowed to work the wage rate would fall until both some of the unemployed get hired by employers at the lower wage rate, and some of the unemployed drop out of the labour market because the wage rate has dropped (is no longer high enough to compensate them for the disutility of work, according to their preferences. They are no longer involuntarily unemployed). A good example of this view of labour markets can be seen in the TWIG report (1996, p. 172): “It is not surprising that unemployment rose in the OECD area during the early part of the 1980s given the severity of the recession. However, the persistence of unemployment from that period is surprising. Conventional economic theory suggests that unemployment caused by a downturn in economic activity does not persist indefinitely. Eventually, self-correcting forces lead to a fall in unemployment back to its pre-recession level as employment expands in response to changes in real wage costs. As the unemployment data indicate, the EU labour market (including Ireland) did not react in this manner and, as a consequence, structural unemployment increased. Many reasons are put forward to explain the persistence of unemployment in Ireland and the EU. While no consensus exists, institutional features of the labour market, including tax and welfare systems, are central to most explanations found in the literature.” Here we see a clear example of pre-Keynesian thinking on the causes of unemployment. The central conclusion of Keynes’s macroeconomic analysis is that there are not self-correcting mechanisms in many markets, especially the labour market, thus we should not be surprised that the data indicates that they did not in fact correct themselves. Furthermore, if labour markets behaved as the TWIG report assumes, and wages fell (the change in real wage costs mentioned above) this would cause spending to fall, causing inventories to build-up and producers to cut production and eventually leading to more lay-offs. Institutional features of the labour market are important, and can cause a decrease in social participation, but they were not part of the cause of high unemployment rates in the 1980s.
Explanations of high unemployment based on the view of labour markets that underscores the TWIG report, and so much other labour market analysis in the OECD countries, has been unsuccessful in both explaining the underlying problem of unemployment and offering useful solutions. The reason is that actual labour markets have almost none of the characteristics of the type of markets in which flexible prices cause the market to clear, such as commodities, seemed to be beside the point.7 As Anthony Atkinson (1995, p. 15) has noted:
Outside the comfortable world of an Arrow-Debreu [general equilibrium] economy, it is no longer necessarily the case that taxes and transfers are distortions–imposing costs on an otherwise efficient allocation. It is quite possible, when we allow for real-world phenomena like incomplete information and the absence of markets, that the payment of benefits, or the levying of taxes, may improve the allocation of resources. In such a situation, the sum of the losses may not exceed the sum of the gains. There may indeed be circumstances in which tax/transfer policy can make everyone better off–even viewed in terms of their own narrow economic interests.
We should keep in mind that during the middle and late 1990s Irish unemployment fell dramatically while the government was increasing social welfare payment levels, and thus increasing what replacement ratios are supposed to measure.
1For a detailed analysis of the issue of labour market flexibility the best starting point is Guy Standing’s new book Global Labour Flexibility (1999).
2 A few years ago Ireland had such a situation, where certain individuals faced marginal tax and loss benefit rates of over 100%. This happens when the benefit withdrawal rate
, coupled with the tax on earned income, exceeds the increase in earned income. Under this type of situation an unemployed or low-income worker would face a situation in which their gross income would go up and their net income (after taxes and benefits) would go down. Clearly high marginal tax rates would discourage those outside of the labour force from entering the labour force and act as a poverty trap.
3The lack of any stigma of a basic income has many benefits. People on public assistance are less competitive in the job market merely because they were on public assistance. This is one of the reasons for the low take up of FIS, for it signals the employer of an inadequacy in the employee. As everyone receives a basic income, there is no attached stigma.
4There is an argument that a basic income might reduce the investment in human capital because it reduces income inequality, thus reducing the relative benefit of higher education. This argument ignores the realities of the “New Economy” where most workers will require higher credentials, thus the differential of a college degree should go down. However, preserving the income differential of a university degree by limiting access to higher education would be economic suicide for Ireland.
5See Clark and Kavanagh’s “Basic Income, Inequality and Unemployment: Rethinking the Linkages between Work and Welfare” Journal of Economic Issues, June, 1996, Vol. 30, pp. 399-406, for a discussion on the conservative and liberal arguments for and against basic income.
6These efforts to explain the rise in unemployment in terms of micro-economic factors has been very unsuccessful
, driven more by the ideology of the period than good research. The fact of the matter is that it is very easy to explain the rise in unemployment in simple Keynesian aggregate demand terms. The rise in energy prices caused a reduction in the aggregate demand for goods and services in most of the OECD countries, causing about 20% of the reduction in aggregate demand (Eatwell 1995). The efforts to fight the inflation caused by the energy price increases with monetary policy alone dramatically increased real interest rates. The end of the Bretton Woods system of fixed exchange rates also contributed to this rise. Flexible exchange rates dramatically increase the level of speculation in the world economy, taking over the currency markets, thus generating considerably more risk and uncertainty, which leads to higher real interest rates. Higher interest rates lead to lower levels of investment, further depressing aggregate demand.
7As Eileen Appelbaum has written (1979, pp. 115-116):
The labour market is not a “market” as the term is usually understood, for the labour market does not posses a market-clearing price mechanism. Variations in either money wages or in the real wage rate are unable to assure a zero surplus of labour, and thus eliminate unemployment. In the context of 1) an industrial structure that is largely oligopolistic, 2) fixed technical coefficients in production and 3) mark-up pricing, the demand for labour depends on the level of aggregate economic activity. It has little, if anything, to do with the marginal product of labour. The supply of labour, meanwhile, depends largely on demographic and other sociocultural factors, though it is sometimes responsive to changes in employment opportunities
It should be noted that if wages actually did rise and fall due of changes in market conditions, say like stock prices, the economy would be unbearably chaotic, making all long term commitments of households, like mortgages, nearly impossible. Just imagine if we had to look up our market clearing wage rate every day to know how much we would get paid that day.