The high wage economy: marrying social justice with economic success – Part 2

This post is part 2 of a discussion of the potential of the high wage economy to overcome conflicts between the progressive goals of achieving social justice and economic efficiency, or what could be called a widely-shared prosperity. It is inspired by Morris Altman’s book Economic Growth and the High Wage Economy. In part 1, I described his idea that even with perfect competition in product markets, firms can find themselves producing at a low-wage-low productivity equilibrium with little incentive to change this situation. Similarly, other firms may be producing at a high wage-high productivity equilibrium, with the two types of firms able to produce at the same output price, but with the second type operating at a greater level of X-efficiency. This is due to the incentives provided by higher labour costs for workers, managers and owners to combine their efforts in the organisation of the workplace in order to work “smarter”. Increased worker effort is incentivised by labour market institutions which prevent cost-cutting, or more accurately labour cost-cutting, as a path to competitiveness. This is a supply-side theory of economic change.

Altman spends much of his book applying his theory to a variety of economic situations. Here is a brief account of some of them.

Technological change

Higher wages can induce faster technological change among firms, as they are compelled to innovate or adopt new technologies to maintain competitiveness, and cutting labour costs is less of an option.

Reducing inequality

If higher labour costs induce greater efficiency and productivity, then policies and institutions that increase equality by raising wages among low and middle income groups can sustainably raise economic growth.

Economic convergence

Firms, business sectors and whole economies can be “stuck” in either a high wage-high productivity or a low wage-low productivity equilibria. This offers an explanation for the lack of economic convergence between rich and poor regions or economies, including developing countries.

Culture and economic performance

Cultural factors can be introduced into the model so that a culture of high wages, maximum work effort, low corruption, high environmental standards and sustainability need not dominate in society and the economy. Instead, a low wage culture, low work effort etc. can persist in the absence of institutional change led by the state or a strong labour movement.

Amartya Sen and capabilities

Economist Amartya Sen has written of the idea of human “capabilities” and “functionings” in the process of economic development and the attainment of a broad conception of freedom. This can be linked to Altman’s idea of X-efficiency and his behavioural-institutional model. The increase in some aspects of freedom, particularly labour rights and private property rights, can spur rising productivity and development. Democracy requires and makes possible improved labour rights and working conditions. Sen’s human “functionings” which underpin aspects of freedom can be improved if there is institutional pressure in the labour market and production system which increases X-efficiency.

The benefits of globalisation

Altman challenges the notion that globalisation is necessarily bad for workers’ wages and working conditions. Indeed, it can potentially enhance labour power, particularly if aggregate demand makes labour markets sufficiently tight. It can therefore increase the socio-economic well-being of workers and their capabilities, efficiency and productivity, as long as governments do not restrict labour’s ability to organise and push for improved wages and working conditions. Institutions, particularly those in the labour market, are vital for this process to occur.

The balance of power in the workplace and resistance to change

Employers or the owners of firms may have no incentive to increase X-efficiency if they get plenty of benefit, or maximise their personal utility from their position in the organisational hierarchy. This can mean that a low wage-low productivity path can be sustainable in the absence of institutional pressure from trade unions or the state to increase X-efficiency. If this resistance to change is overcome, it can potentially make workers better off and employers or managers at least no worse off. This shift in the balance of power can therefore be resisted even if it is likely to produce a richer economy, since the low wage equilibrium can suit decision makers by maintaining their incumbent position and power. A private utility maximisation on their part can thus be socially damaging.

Economic “freedoms”

Economic “freedoms” can be a mixed bag. Big government and significant labour market regulations can benefit the growth and development process or are at the least not a hindrance to it in the model considered here. But in some surveys they are classed as restrictions on economic freedom. Altman argues that property rights and sound money (low and stable inflation) tend to be correlated with increased per capita income and growth. Which mix of specific “freedoms” are necessary for improved economic performance can vary over time and with the stage of development. This makes the relationship between freedom and prosperity a complex one. It is simply not the case that all measures of freedom are positively correlated with economic growth.

Adam Smith

The author of The Wealth of Nations argued that high wages and improved working conditions can induce increased workplace efficiency and productivity, and that “free” (ie non-slave) labour and tight labour markets are important in a capitalist economy.

Unemployment and high wages

Traditional models of the labour market posit that in the absence of market imperfections and in individual markets, higher wages will reduce employment. There are plenty of models in economics which contradict this, including Keynesian macroeconomic models and imperfectionist arguments. However, Altman’s model suggests the possibility that higher labour costs, if they induce greater X-efficiency and productivity, will shift out the market supply curve and create space for higher aggregate demand to increase employment even as wages rise and decent working conditions are maintained. This offers a striking riposte to arguments in favour of reducing wage levels, deregulating labour markets and weakening trade union power in order to increase employment.

The welfare state and economic efficiency

A more generous welfare state and unemployment benefits can potentially improve the efficiency of the job search process, since the newly unemployed will have the time and opportunity to find the best job matches available rather than being forced too rapidly into unsuitable positions. To the degree that they also put upward pressure on wages and increase the market power of workers they can, according to Altman’s model, thereby increase X-efficiency and productivity in the workplace and in production.

Summing up

Altman’s work on the high wage economy describes an original approach to the impact of labour market institutions and policies on the behaviour of the workforce. By applying his behavioural-institutional framework to standard neoclassical models, he is in some ways more able to challenge parts of mainstream economics “from within” as compared with some more radical theories which adopt an entirely different framework. His theories are also widely applicable.

Much of Altman’s book is theoretical and there is a need for more detailed empirical work to establish the effects that high wages have on productivity in the workplace, which are at the core of his ideas. There are obviously limits to this process: wage growth could be too rapid and end up squeezing profits before it has time to stimulate more efficient working practices and raise productivity.

Despite this being a supply-side theory in economic terms, Altman does emphasise the importance of sufficient aggregate demand in the economy, so that the supply potential promoted by the high wage economy is fully realised. Labour markets need to be “tight” enough. His model can thus be made more comprehensive by incorporating Keynesian theories of demand.

Overall, Altman’s ideas are refreshing, innovative and offer hope to progressive practitioners of economics and political economy, without being particularly radical. They touch on but still limit their engagement with the role of the state, power and the tension between conflictual and cooperative processes in the relationship between capital and labour, or owners, managers and workers.

What is particularly interesting in his theory of the high wage economy is the idea that firms, regions and national economies can remain “stuck” in either a high wage-high productivity equilibrium or a low wage-low productivity one, and that market forces can be insufficient to change these outcomes. Government policies and institutional reforms that strengthen labour bargaining power and working conditions can be required to encourage such changes to take place. Thus progressive or regressive labour market structures can result in the production of outputs that are equally price competitive even if the former results in and sustains higher living standards alongside greater efficiency.