Wages, Unemployment and Markets

Gavin R. Putland

[Reprinted from a World Bank online discussion on poverty, March 2000]

The state of the labour market is a leading determinant -- perhaps THE leading determinant -- of economic equality or inequality. If employers must compete with each other to attract labour, they offer the best wages and conditions that they can, and life is good for those who live by their labour. If labourers must compete with each other to obtain work, wages fall to subsistence levels. Thus the causes of unemployment are almost synonymous with the causes of poverty. Hence the importance of the question posted by Indrajit Roy (Tata Institute of Social Sciences, Mumbai, India), concerning the apparent link between free trade and mass unemployment:

For one thing, the rates of unemployment have actually increased in Pakistan, Bangladesh and Nepal from 3.1% to 5.4%, 1.2% to 2.5% and 3 to 5% respectively (between 1973-4 to 1996-7 for all). Even in India and Sri Lanka where this is not so, the quality of employment has shown a marked decline. The issues of underemployment, casualisation and immiserisation of employed labour, and educated unemployment, plague the employment scenario in South Asia. Other empirical evidence of a decline in the quality of life has also been registered.''

There are three basic ways to make a living:

(1) Work, and accept wages in money or in kind.

(2) Invest in productive capital, and take the profits.

(3) Acquire exclusive rights to a share of the finite resources of a nation, such as land, natural resources, natural monopolies, statutory monopolies and other government-created privileges. If your resource is tradeable, wait for the price to go up because of population growth, improvements in infrastructure, or an artificial shortage created by the activities of other people like yourself. Then sell the resource at the inflated price (or, if the resource is not directly tradeable, trade on the advantages given by your exclusive right to that resource).

Options (1) and (2) create wealth, and the trading of that wealth creates employment. Option (3) does not create wealth, but allows you to demand a share of wealth created by others. Option (3) creates UNEMPLOYMENT by withholding resources needed for the creation of employment, raising the prices of resources needed for the creation of employment, withdrawing other people's wealth from circulation, raising rents of commercial land (thus reducing the capacity of tenants to employ labour and pay wages), and raising the rents of residential land (hence increasing the cost of accommodation, provoking campaigns for higher wages while reducing the demand for goods and services offered by employers ...).

Indrajit Roy continues: ``Reduction in real wages in India due to an increase in the Consumer Price Index of 50% (Economic Survey, 1997-8)...''

Most of above-mentioned effects of Option (3) are inflationary.

Dr Greenspan has repeatedly said that low unemployment causes inflation by raising wages. I have never heard him acknowledge the inflationary effects of high economic rents. The elimination of rent-seeking is one of the very few ways to reduce inflation and unemployment simultaneously. And the way to eliminate rent-seeking is to TAX ECONOMIC RENT: tax the values of the above-mentioned resources, so that speculation in such resources is unprofitable. Revenues from taxes on economic rent allow the reduction or elimination of taxes on wages and profits, so that Options (1) and (2) become more attractive.

Now to answer the question: WHY HAS FREE TRADE FAILED TO CREATE FULL EMPLOYMENT?

When a country's economy depends on access to certain finite resources, the price of access to those resources rises to the highest level that can be sustained without political or economic collapse (or occasionally beyond ...), maximizing economic rents at the expense of wages and profits. Hence, in the absence of measures to tax economic rent, the entire benefit of free trade goes to the cartel of rent-seekers and does not filter through to workers and capitalists.

Advocates of the taxation of economic rent are almost invariably free-traders. Regrettably, the converse is not true. The most powerful advocates of ``free trade'' are rent-seekers of various kinds. But as long as rent-seeking is tolerated, trade is not really free.

Gavin R. Putland, Brisbane, Australia.