The Return to Reality
It should be obvious that we cannot found a scientific economics on fictitious commodities. You cannot treat as commodities things that, manifestly, are not commodities, do not respond to supply and demand curves, and are not elastic. Mostly, you cannot reduce the economy to a series of exchanges and eliminate the need for distributive justice. The best you can hope for in that direction is not science, but science fiction. Economics cannot be made a science along the lines of physics, where everything can be reduced to number, but is a humane science, one that requires humane considerations.
But if we are to return economics to a more realistic base, which path should we follow? Three broad paths have been suggested by various schools of thought, each one of which tends to concentrate on reform of one of the fictitious commodities. The Georgists would reform our understanding of land, the institutionalists would reform our understanding of labor, and the followers of Major Douglas and other monetary reformers look to the elimination of usury and banking reform. Which of these paths should a proper reform take? The answer is, “All of the above.” That is, you can start from any of these positions, and as long as you reach out to and include the other positions, you will end in roughly the same place. And that place will be a lot closer to reality—will be more scientific—than anything neoclassical or Austrian economics has to offer.
What unites all three of these approaches is that they all embody, explicitly or implicitly, some notion of distributive justice. The Georgists would reclaim the values of land that are produced by the community and redistribute them to the community that produced them; the institutionalists would ensure that the worker gets a just proportion of what he produces; the monetary reformers would eliminate usury, that is, fortunes that are based not on producing any useful goods or services but instead appropriate, through financial manipulation, the wealth produced by others. But is there a term which unites and includes all three sets of reforms? I suggest that there is. This term is the Just Wage. The just wage involves the idea of the proportionality of rewards that lies at the heart of distributive justice, and depends for its implementation on a reform of the notions of property and the elimination of usury.
Although “just wage” is the more common term, we could just as easily call it “just returns” and thereby include the returns to capital, since capital is labor in another form. Or it could be called the “just price,” as it was by the scholastic economists, since a price includes the just rewards to both labor and capital and eliminates any economic rents (wealth without work). But in its modern form, it is known as the just wage, and the idea originates not from within economics, but with a priest, Leo XIII, the pontiff of the Roman Catholic Church. He wrote his teaching in the encyclical Rerum Novarum (“Of New Things”) in 1891. An encyclical is a moral instruction from the Pope to the Church and the world.
A Scandalous Encyclical?
The Pope defined the “new things” of his encyclical as the fact that it “gradually came about that the present age handed over the workers, each alone and defenseless, to the inhumanity of employers and the unbridled greed of competitors… so that a very few rich and exceedingly rich men have laid a yoke almost of slavery on the unnumbered masses of non-owning workers.”1 This is a densely packed sentence, focusing on the inhumanity and greed that made the mass of humanity into virtual slaves, and its tone would have pleased even Karl Marx. Nevertheless, the encyclical as a whole was a largely conservative document. Leo upholds private property as a sacred right; he is suspicious of unions; he condemns Socialism outright and in very round terms; he condemns the call to revolutionary and violent action. On the other hand, Leo has a revolutionary call of his own. In making the just wage the linchpin of Catholic Social Teaching, the encyclical began a controversy which continues to this day.
Just what is this “just wage”? Leo defines it as an amount sufficient to support a “thrifty and upright” worker and his family without having to put his wife and children out to work at paid labor.2 Furthermore, the wage must be sufficient to allow a thrifty worker to save and acquire some property of his own.3 By this means, says the Pope, there will be a more equitable division of goods, and the differences between the classes will be lessened.4 Leo makes no attempt to justify his views in economic terms. He does not situate his just wage requirement in any economic theory. Rather, he advances it as a purely moral requirement of the economy, and leaves it to the economists to work out the theoretical details.
But the just wage is just the sort of moral entanglement that the economists were seeking to avoid. Rerum Novarum came at the precise moment when the economists believed that they had reduced all economic questions to a science of free exchanges, a science that eliminated all questions of distributive justice. They were seeking to avoid the ethical requirements that Leo was laying upon them. Now, either Leo's encyclical constituted a scandalous religious interference in the affairs of science, comparable to the Galileo affair, or else the Pope had located the flaw in the (then) new economics. So had the Pope overstepped his competence and his authority? To judge that, we will have to look at how the new economics treated wages.
The Neoclassical Theory of Wages (and Everything Else)
In Leo's day, economists were working on several varieties of equilibrium theory, all of which reduced wages to a question of “free” exchanges. One of the best known formulations of the theory comes from J. B. Clark's The Distribution of Wealth, published in 1899, just 8 years after Rerum Novarum. According to Clark, both wages and profit are allocated by a “deep-acting natural law”:5
Where natural laws have their way, the share of income that attaches to any productive function is gauged by the actual product of [that function]. In other words, free competition tends to give labor what labor creates, to capitalists what capital creates, and to entrepreneurs what the coordinating function creates.6
Clark asserted that the “natural” wage of labor was the return an employer could get on the “marginal man,” that is, the last man that could be profitably hired. In explicating this iron law, the task for Clark was to show that the marginal wage, the wage of the least productive person represented the “specific product of labor,” and of labor alone. 7
Clark reasoned that this “marginal man” could be hired “with no change in the amount or character of capital goods.”8 Therefore, the amount he added to production—and this amount alone—was the only part of production attributable to labor alone and constituted the “specific product of labor.” Labor was therefore entitled by “natural law” only to this part of the produce. Clark made no attempt to fix the “specific product of capital”; he merely assumed it was the whole product minus the wages.9
Clark believed that the forces of free competition would force prices to equal the cost of production, driving the rate of profit to zero, so that the entrepreneur would earn little more than the worker.10 In other words, wages and profits would be normalized to each other, with the capitalist earning roughly what the worker did; there would neither be great wealth or great poverty. The productivity of both capital and labor would be fairly rewarded, and rewards for each would change at a rate exactly corresponding to the rate of the change in productivity.
Critique of the Theory
The simplest critique of the theory is that we never seem to see it in practice. Returns to wages and capital in a capitalist society do not seem to be normalized to each other, nor do they seem to be well related to productivity. For example, productivity for all classes of labor has exploded in the last 40 years, yet the real wage of the median worker has stagnated; he or she simply has not gotten any real gains from the real gains in productivity. At the same time, wages at the top of the scale, the upper executive level, have exploded. The executives have gained all that the worker and the investor have lost. Yet there seems to be little empirical evidence that these high salaries are related to their productivity, since they seem to make the same high salaries whether they drive the company up or down.
The defenders of neoclassical equilibrium theories might sidestep this critique by pointing out that the theory depends on a perfectly free market, a market that does not in fact exist. Therefore, there can be no empirical confirmation or refutation of the theory. This sounds like a cop-out, but let us nevertheless accept the defense for the sake of argument and critique the theory on its own grounds.
The first problem that we notice is that the procedure Clark used is arbitrary. He attempted to figure the “marginal productivity” of the last man employed and then merely assumed that capital gets all the rest. But why not reverse the procedure? Why not figure the marginal productivity of the last dollar employed and assume that labor gets all the rest? Either procedure would be equally valid.
Or rather, each would be equally invalid. The theory tries to figure the “independent productivity” of capital and labor, but this number is in fact the only precisely known number in all of economics: It is precisely zero. Neither capital nor labor produces anything without the other. The proof is simple. Take any item of capital, a truck let us say, and watch it all day to see what values it produces by itself. It will produce none, unless and until a driver mounts the cab to make some pick-ups and deliveries. The independent productivities are a mythical quantity, which is why they have never been empirically measured; you may as well attempt to measure the wingspan of a gryphon or the height of a dragon. Capital without labor is sterile, and labor without capital is simply another name for unemployment. Production is a social process, occurring only at the intersection of land, labor, and capital. The productivity of a given process may be reliably measured and compared with other production processes, but the productivity of factors within the process cannot be reliably measured; one can only make a judgment about them, a judgment that cannot be reduced to mathematics.
Nor is there any reason to believe that wage contracts and free bargaining would fairly reward actual productivity. Indeed, Adam Smith had debunked this argument more than 100 years before Clark made it. Concerning labor negotiations, he said,
It is not, however, difficult to foresee which of the two parties must, upon all ordinary occasions, have the advantage in the dispute, and force the other into a compliance with their terms. ... A landlord, a farmer, a master manufacturer, a merchant, though they did not employ a single workman, could generally live a year or two upon the stocks which they have already acquired. Many workmen could not subsist a week, few could subsist a month, and scarce any a year without employment. In the long run the workman may be as necessary to his master as his master is to him; but the necessity is not so immediate.11
In other words, negotiations tend to be about power, not productivity. This is true of contract negotiations in general, which always tend to give the stronger party the better deal. In a capitalist society, and absent strong laws, functioning labor unions, or ready alternatives to the jobs offered, capital tends to have more negotiating power than labor, and hence tends to get a larger share of the rewards. When this happens, as it usually does, capital tends to be over-compensated. Capital then accumulates faster than wages, while the broad consumer market narrows, meaning there is less real investment opportunity for the over-supplied capital. At this point, economic equilibrium is impossible, and the economy must rely on the non-economic means of balancing supply and demand, that is, on charity, welfare, and usury.
The Wage Contract
Having said all that, we could wish that Clark was right. We could rightly wish that free bargaining alone was enough to establish a just wage, while also ensuring a just return in an environment of just prices, that is, prices that do not produce an economic rent. We could wish that there was a way to overcome Smith's objection and balance the negotiating power between the parties. The question that has to be dealt with is not productivity, but power. Increasing the productivity of the worker has not, in the real world, led to an increase in his wage. But increasing his power nearly always does. So if we want Clark's vision of a link between productivity and wages, we will have to balance the negotiating power of the worker and the employer. Are there ways that this has been done successfully? Yes. There are three methods: strong laws, strong unions, and the distribution of property.
Australia has had, for the last 100 years, a methodof setting wages by a system of special courts designed for that purpose.12 Sweden and New Zealand have had similar systems. These courts operate independently of the government, and they encourage the parties to work out their differences without coming to the courts. The mere existence of the courts is usually sufficient to get the parties to agree, since both sides understand the rules by which the court will make its decisions.
The economies that use this system tend to have highly productive workforces and relatively stable economies. Opponents of the system argue that it reduces incentives to work, but this is not borne out by the facts. The mere existence of these systems, and their long-standing success, is sufficient refutation of the idea that wages are best set by a free-market system. As a methodological point, whenever we are dealing with practical problems, it is always a good idea to look at the real world and see what alternatives exist and how well they work. Economists and others are often trapped in theories that are poorly related to real-world conditions, an intellectual disease they could cure by simply looking up from their books now and then and seeing how the real world works.
Nevertheless, the Australian system, and others like it, have exhibited problems from time to time. The system is highly dependent on unions, which has both strengths and weaknesses (see the next section). These systems also increase the power of the state and may forestall necessary reforms in other areas, such as banking and land ownership. Still, it is an option that, because of its long-standing success, deserves careful attention.
When the unions were strong in this country, wage rates were higher. Most men were able to earn a decent living without putting their wives to work. The truth is that when labor is united, it turns out to be much stronger than capital. However, this very strength turns out to be labor's greatest weakness. Labor unions often ask for too much, and because of their inherent power, they get it. The problem with unions is that they institutionalize the division between capital and labor, just as much as the corporation does. Unions, in fact, tend to be mere mirror images of the corporations on the other side of the table, each seeking its own ends but using the same methods. But the sign of a successful labor system is that it overcomes this opposition. Capital, after all, is just “stored-up labor” and its rights and rewards spring from the same source.
A perfect example of the problems with unions is the labor contracts reached with the auto industry in the 70's. These were nothing more than mutual suicide pacts, by which labor got more than the companies could possibly give without damaging their viability. Eventually, the system had to come to an end, with catastrophic consequences for both sides.
Moreover, it is incorrect to talk about a united labor movement, because divisions within the movement can be greater then their divisions with the companies. For example, the interests of unions of skilled workers can be contrary to the interests of the unskilled workers, and since the skilled workers have greater bargaining power, they can get privileges that come at the expense of other workers.
This is not to be taken as an argument against unions per se. It is, however, an argument against a divisive labor movement, divided within itself and against capital. What is required is a strong sense of solidarity, not only with all other workers, unionized or not, but with the poor, and even with capital itself. The unions must take responsibility not only for the welfare of the workers, but for the welfare of the firm as well, since the two are mutually dependent. Management, for its part, aids this solidarity by practicing open-book management, that is, by giving all the members of the firm access to the books. Only in this way can all members of the firm—workers, managers, and owners—be assured that decisions are being made with the common good in mind. As John Paul II pointed out, “A labour system can be right... in the sense of being intrinsically true and also morally legitimate, if in its very basis it overcomes the opposition between labour and capital.”13
The Distribution of Property
The simplest way to overcome the opposition between capital and labor is simply to dissolve the difference between the two, to make the workers the owners of the capital they create. Our current system erects a high wall between the owners of capital and the workers, and allocates all rewards above the wage to capital. Yet this system is neither necessary nor natural. The current system makes good Clark's assumption that everything earned above the lowest possible wage belongs to capital. And certainly, there would be no production without capital. But neither would there be any use for capital without labor.
Nor is the current system particularly efficient. In fact, in creates huge dis-economies in the form of agency costs. Agency costs are incurred when one party acts as the agent for another. In such contracts, there are rewards and sanctions to encourage the agents to act in the best interests of the principals. But the agents may have their own agendas and take their own interests to heart more than those of the owners they are supposed to serve. According to John Bogle, the founder and former CEO of the Vanguard Funds, a large mutual fund company, this is exactly what has happened today, with the upper echelons of management taking an inordinate share of the rewards to the detriment of both capital and labor.14 When owners and workers are the same persons, these inefficiencies tend to disappear, which gives worker-owned firms a competitive advantage over their more capitalistic and agency-ridden counterparts, a point we will examine in more detail later on.
When some people hear about the “distribution of property,” they automatically think “Socialism!” But nothing could be further from the truth. In a capitalist system, there are few owners of the means of production, but in a socialist system, there is only one, the state. Socialism, in fact, forms sort of a natural terminus for a capitalistic system, as the interests of the state bureaucrats and the corporate bureaucrats tend to converge. Historically, both bureaucracies wax fat together, rather than one being a check on the other. But in a distributed system of property, there are many owners. Ownership becomes the “natural” condition of people in that society. When workers have access to their own tools, land, and capital, the problems of unfair labor contracts are overcome. A mechanic, for example, who owns his own tools and his own land can evaluate any offer of employment he receives against the money he can make by himself and the freedom of movement that he has, and make a decision as to whether the offer is in his and his family's best interest. The compulsion of the labor contract, the problem that Adam Smith pointed out, disappears.
As for the mechanics of the distribution of property, we have many successful examples to go by. The “Land to the Tiller” programs of Taiwan and Korea, the Georgist policies of Singapore and other places, the Mondragón Cooperative Corporation, thousands of successful Employee Stock Ownership Plans, etc. We will examine these methods in a later chapter; for now, it is enough to say that we know the problems can be overcome (and relatively easily) because they have been overcome.
The Just Wage and Equilibrium
The just wage represents people taking out of the system in consumption no more than they put in by production. This, by definition, constitutes equilibrium. But how do we know that just wages are those wages which will support a family? Directly, we don't. But indirectly, we do, because the contrary proposition is absurd. If we assert that wages in general should not support the family, then economics becomes an absurd science with no real purpose. If economic systems in general just don't work, then we must choose between chaos or Keynesianism. To have a sane economy, that is, an economic system that fulfills its economic purposes, you must have either distributive justice, as is Distributism, or re-distributive justice, as in Keynesianism.
The entire economic problem always comes down to a question of wealth without work. If you have people with vast incomes who produce little, then you must have people who produce much but get little income. This wealth without work takes many forms is economic rent, and it comes in many forms: ground rents, speculation, usury, the looting of companies by the executive class, etc.
The reader will note that I have not stated a number for the just wage. This is because the just wage is not really a number at all. Rather, it is a standard of judgment. It is impossible to give a generalized number for the just wage because it will vary from place to place, time to time, and culture to culture. Further, even in any specific setting, there are just too many jobs, companies and specifics to be able to set a number on the just wage. Nor should we. Rather, we can judge that the just wage is fulfilled under the following four conditions: One, that working families, as a rule, appear to live in the dignity appropriate for that society; two, that they can do so without putting wives and children to work; three, that they have some security against periods of enforced unemployment, such as sickness, layoffs, and old age; and, four, that these conditions are accomplished without undue reliance on welfare payments and usury. While it may be difficult to give precision to any of these factors, it is certainly possible to make reasonable judgments and set reasonable standards.
1P. Leo XIII, Rerum Novarum (Boston: St. Paul Books and Media, 1891), para. 6.
2Ibid., para. 63.
3Ibid., para. 65.
4Ibid., para. 66.
5J.B. Clark, The Distribution of Wealth: A Theory of Wages, Interest, and Profits (New York: Augustus M. Kelly, 1899), 2.
6Clark, The Distribution of Wealth: A Theory of Wages, Interest, and Profits, 3. Italics in original.
11Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (Amherst, New York: Prometheus Books, 1991), bk. I, Ch. VIII
12Hugh Stretton, Economics: A New Introduction (London and Stirling, Virginia: Pluto Press, 1999), 407-8
13P. John Paul II, Laborem Exercens, 1981, para. 13
14Cf. J.C. Bogle, The Battle for the Soul of Capitalism (New Haven & London: Yale University Press, 2005)