In the last lesson (#8), we made the (perhaps) shocking statement that the market for unskilled labor is perfectly competitive. By unskilled labor, we mean workers who are simply selling their labor time, without the advantage of any particular skill, union membership or governmental regulation that would improve their bargaining power. An economist will tell you that in a perfectly competitive market, profit is maximized when the price is equal to the seller's marginal cost. But what could that mean, in the case of labor? What is labor's marginal cost?
Marginal cost is defined as the cost of bringing an additional unit of the commodity to market. In the case of labor, that means, essentially, working another day, in order to survive -- the unskilled worker has no better alternative. So, while it is true that the worker is engaging (just like everyone else in a free market) in "profit maximizing" behavior, we must not forget the worker's very narrow range of options. "Profit maximization" in this case means working, instead of not working, and therefore starving. Any wage rate higher than mere subsistence will always be undercut by some other worker who is just a bit more desperate. The marginal cost of unskilled labor is subsistence, and that is its market-clearing price.
Clearly, just selling one's labor is no way to get ahead. Labor must either seek some sort of competitive edge, or find some way for the pressure of competition to be eased. And -- thank goodness -- a great deal of that has happened, at least in the world's developed economies. When the bosses get rich while the masses of workers are given just enough to survive, society tends to become unstable -- it gets into what is sometimes called a "revolutionary" situation. Nevertheless, wretched subsistence was the general condition of most workers during the rise of the industrial revolution in the 19th century. Over time, in the general interest of social stability, workers had to be given some relief from the crushing burden of pure competition in the labor market.
There were three basic ways in which this came about:
These attempts in society to ease the crushing burden of perfect competition in the labor market were largely successful. In the United States, Western Europe and Japan, they contributed to the creation of a large middle class, a huge group of eager consumers whose demand for goods created high levels of overall prosperity.
In a way, though, they carried the seeds of their own destruction. To see why, let's consider this matter from management's point of view. There was, in the labor market, an equilibrium, or "market clearing" price for labor: subsistence. Along come the labor unions (or the liberal politicians), saying the workers aren't paid enough. "Well, perhaps they aren't," the capitalist would reply, "but if I pay them more, I will lose profit!" But no matter! The strike, let's say, was successful in the end, and management has agreed to pay the workers more of the wealth that they produce.
But: when the workers went back to the factory after the strike, had they suddenly become more productive? No: they produced the same amount of wealth per day as before. Yet management had to pay them more! In order to get back up to the same level of profit, management had to find some way to get more wealth out of the same worker/hour. They had to invest in increased productivity.
Thus we see that an economy in which large numbers of workers can command high wages will tend to be innovative and highly productive -- and an economy in which most of the workers have no better opportunity than bare-subsistence wages will tend to have trouble getting out of its own way.
Nevertheless: markets do what markets do, and people seek to satisfy their desires with the least exertion. Or in other words, if employers are able to pay workers less, they will. They will seek to replace union workers with non-union workers... or to replace full-time, health-insured workers with part-timers with no benefits... or replace domestic health- and safety regulated workers with foreign competitors who work much cheaper. Although highly-paid workers tend, in the long run, to be good for overall productivity and progress, wages tend to drift downward. Labor's gains in the marketplace, hard-won though they are, get whittled away in the marketplace over time.
Why? Because the market for unskilled labor is perfectly competitive. That will be true as long as there are more workers than jobs for them to do -- in other words, as long as there is any unemployment at all.
Can anything be done about this dismal state of affairs? Perhaps. Or perhaps not. This question will take us onward into the realm of macroeconomics -- which we will consider in the next few lessons.
Background Questions