In 1998 Boeing and MCI WorldCom, to mention only
two, announced plans for massive layoffs. Boeing actually cut 48,000 jobs.
Throughout 1998 there were many announcements of intended mergers e.g.,
Exxon with Mobil and Chevron with Shell most of which included plans for
substantial job cuts. Total layoff announcements in the U.S. in 1998 exceeded
600,000. To those who receive such announcements it must seem that their
personal fortunes are ruined and the economy is falling apart. No one wants
to leave a job involuntarily, and when one hears of others to whom it has
happened one quite naturally is sympathetic. The perceived instability of
employment in free-market economies is a major reason why many Americans
support government intervention in the labor market.
Yet, in any market-based economy there will always be layoffs and there
will always be hires. Moreover, this is to be celebrated. It is a sign of
economic health. Given the pace of change in what is known, in what is discovered
to be possible, in consumer tastes and preferences, and in the extent of
competition, labor, like all productive resources, must constantly be recycled.
The popular press always stresses the downside of the recycling of labor.
This is because bad news sells better than good news, and because each specific
plant closure or massive layoff is very visible. It is easy to capture on
film and videotape. The hiring that is the upside of recycling is more diffuse
and less visible. Nevertheless, most of the time the upside outweighs the
downside. For example during 1998, in spite of all the layoff announcements
1, 583,000 net new jobs were created in the American economy. That's an
average of 131,916 more jobs created than lost each month.
The Market Process
The labor market, like any other market, is a process of interaction between
forces of demand and supply. The buyers of labor are employers, and the
sellers of labor are job seekers and job holders. When employers "buy"
labor, they hire the productive services of workers. Labor is employed,
along with materials and supplies and the services of capital goods, to
produce output that employers, in turn, sell to customers. Workers supply
labor services to employers in exchange for compensation packages that include
wages and salaries and benefits.
The maximum amount that an employer is willing to pay for labor services
from a worker is called his demand price for the labor. It depends on the
increment to output that the worker's services make possible and on the
prices for which the employer can sell the additional output to customers.
Suppose that employer expects that an additional worker makes possible the
creation of ten additional units of output per day, and that when those
ten additional units are sold the employer will receive $120 of extra revenue
net of all other incremental costs. Hiring cost is the sum of compensation
paid to the worker and employment taxes paid to government. The employer
would not be willing to pay $120 per day or more for the worker's services,
but at any hiring cost less than $120 per day, the employer would add to
profits by hiring the worker. From the employer's point of view, the lower
the hiring cost the better so long as he can hire the quantity and quality
of labor he wants. The lower the hiring cost, the more eager the employer
will be to hire additional workers if he can get them.
If workers' productivity declines because, for example, of a change of technology
that makes their services less important, or if the prices that the employer
receives from customers decline because, for example, the customers decide
they want to buy different products, the employer would have to cut labor
costs by layoffs and/or by reducing rates of compensation. The latter is
likely to cause many workers to quit because they have no reason to think
that the reduced compensation is the best they can do. Both those laid off
and those who quit will begin a process of job search.
The minimum compensation that an employee will accept from an employer is
called his supply price for the job. It depends on his perception of his
alternative employment (and unemployment ) opportunities. Other things equal,
the better his alternatives the higher his supply price. If you know that
you can get $15 per hour from Employer X for doing a job, you will not accept
anything less from Employer Y for doing the same job. If your alternative
to working for Employer X is to be unemployed (a very unlikely situation),
you will have a higher supply price if your family will support you during
unemployment than you will if your best alternative is to become homeless.
So, there is an upper limit on what an employer will pay for a worker's
labor services, and there is a lower limit on what a worker will accept
in payment for his labor services. The actual rates of compensation paid
and received depend on the relative strengths of two types of competition
in the relevant labor market competition among employers to hire and competition
among employees to be hired. For a given level of competition among employees
to be hired, the greater the extent of competition among employers to hire
the higher will be the compensation rates offered and accepted. Conversely,
for a given level of competition among employers to hire, the greater the
competition among employees to be hired the lower will be the compensation
rates offered and accepted. Every hiring of every worker is an employment
contract based on voluntary exchange. Every employer and every employee
enter into such contracts because they expect to be better off than they
would be if they did not do so.
Bargaining Power
From an individual worker's point of view, the best of all possible labor
market situations is to be the only one who can do a particular kind of
work (no competition among employees to be hired) and to have hundreds of
employers who are competing with each other to hire someone who can do the
job. Such a worker would have tremendous bargaining power, and any one employer
would have almost no bargaining power. Similarly, from an individual employer's
point of view, the best of all possible labor market situations is to be
the only buyer of a particular kind of labor service (no competition among
employers to hire) and to have a plethora of workers competing with each
other to be hired to do the job. Such an employer would have tremendous
bargaining power, and any one worker would have almost no bargaining power.
Bargaining power in any market depends on the alternatives available to
the actors therein.
Entrepreneurship and Labor
Entrepreneurs are the key actors in all markets. The role of an entrepreneur
is to discover and grasp profit opportunities. Every problem that emerges
in a market is a profit opportunity for an entrepreneur who first notices
how to solve it and undertakes the solution. Successful innovations by entrepreneurs
elicit imitation, and imitation by more and more people means that, in free-market
settings, problems inevitably give way to solutions. Entrepreneurs do what
they do in pursuit of profit; but when they are successful, and therefore
make profit, the rest of us benefit from their innovations.
Entrepreneurship involves creating new products, creating new technologies,
creating new productive resources, assembling new combinations of productive
resources to produce old and new products, adopting new forms of organizational
architecture, and entering new markets and exiting old ones. Buyers and
sellers in all markets must keep abreast of more innovation now than ever
before. In today's markets, successful innovation at one place in the world
rapidly affects most other places of the world. Entrepreneurship, and responses
to entrepreneurship lie behind the recycling of labor (and of other productive
resources).
Suppose that the proposed merger of Exxon and Mobil takes place. In the
face of falling prices for petroleum and its products (which itself is due
to successful innovations in the discovery, production and refining of crude
oil as well as the discovery and implementation of alternative energy sources),
the decision authorities in the new firm will have to cut out duplicative
operations. This means that many employees of the merged firm will receive
layoff notices. Perhaps some will be able to stay on by agreeing to accept
cuts in compensation, but most will quite reasonably think that it is possible,
after some job search, to find other satisfactory jobs that pay as much
or more as the ones they have lost. They will undertake a process of search
for their alternatives, during which they will be included in the unemployment
statistics. Some job seekers will find new employment very quickly, others
will not. For example, the median duration of unemployment in November 1998
was 6.7 weeks. If , after some initially planned period of search, some
job seekers find no satisfactory new jobs, they will reevaluate their prospects
and lower their supply prices. Or, perhaps they will become convinced that
their best strategy is to undertake retraining so they can find different
sorts of jobs.
Employers in markets for new products and products for which customer demand
is rising also engage in search. They search for new employees who can do
what needs to be done. They could attract a lot of applicants right away
by offering very high compensation packages, but most will quite reasonably
think it would, at least for awhile, be cost-effective to offer normal compensation
packages and spend some time sampling the workers that apply. Recycling
labor is not a simple matter of throwing all applicants into a common bin.
They must be sorted according to abilities, interests and costs. If after
some initially planned period of search the employers do not find enough
satisfactory employees, they will then offer better compensation packages
to attract more applicants.
The key insight is that every unemployed worker who wants to work is a potential
profit opportunity for an entrepreneur who discovers ways of employing him.
Even workers who have a hard time finding new work are potential profit
opportunities. They are likely to be available at modest levels of compensation,
making it cost-effective to hire and train them. And when they are trained
they acquire additional bargaining power with their employers and with potential
new employers. This is why, in a market-based economy, layoffs do not usually
result in a growing number of unemployed people and falling average rates
of compensation. Unemployment is like a pipeline. There are always people
entering the pipeline, but there are always people exiting it too. Even
if the number of people in the pipeline at any moment were always the same,
the faces on those people would be constantly changing.
Entrepreneurs, like all people, make mistakes. Some entrepreneurs think
they perceive profit opportunities and hire additional labor to try to grasp
those opportunities. When losses instead of profits emerge, they have to
pass out layoff notices. However, the historical record suggests that under
normal circumstances entrepreneurial successes more than make up for entrepreneurial
failures. After all, entrepreneurs are self-interested; therefore, they
are keenly motivated to try to avoid mistakes and the losses that result.
Of course, there are occasional periods during which unemployment increases
relative to employment, but these are the result of faulty government policies
that cripple the labor recycling process. If, for example, the government
inflates the money supply and thus distorts the price signals to which entrepreneurs
respond, lots of entrepreneurs will hire labor that later, after the market
corrects the distorted prices, they will have to lay off. Excessive taxation
and regulation are other ways in which government can cripple the labor
recycling process.
Government Doesn't Create Jobs
It is entrepreneurship in the context of freedom, not government, that creates
increasing employment opportunities. Try to imagine what would happen to
the labor recycling process if entrepreneurs had to get permission from
some government authority before they could enter or exit markets, expand
or contract employment, create new products, change technologies, or change
their organizational structures. The pattern of production of goods and
services would become less and less consistent with the pattern of goods
and services people want to have available. Innovation would shrivel. Lots
of people would continue to be employed doing what they always did, but
they would increasingly produce things for which there would be no demand.
There would be very few job opportunities for new people in the labor force.
Production would be aimed at keeping government authorities, not customers,
happy.
American presidents like to assert that they are elected to "run the
economy." We should be grateful that that is merely their conceit.
No one "runs" a successful economy. In fact, its success depends
on no one being in charge of it all. At the same time, its success depends
on everyone being in charge of their own production and exchange activities
dealing with others on the basis of voluntary exchange.