Up (down?) the workers!

This piece from Ryan Bourne caught my eye this morning.

Whatever Next? Equal pay ruling makes no sense in the real world ( thetimes.com )

I wrote about this topic earlier in the year and attempted to highlight the core economics in the form of an interview question (link in the comments).? The majority of responses I received were DM which perhaps suggests that many people are nervous about commenting in public on this issue.

But surely one of the roles of an economist is to call out and challenge bad law or bad policy?? And this appears to be bad law – a view I can hold as an economist, irrespective of my personal desire to see a complete eradication of all forms of inequality.

In a nutshell, there is a business involved in two different activities which we can call retail and distribution.? Not all retailers are integrated into both of these activities (there is a separate distribution industry which is competitive).? Those retailers that integrate do so for efficiency reasons.? The business employs two types of people, retail workers and distribution workers, and each type of worker is free to decide which part of the business they work in.? The Court found that two labour markets exist (but it could be two segments of labour wider market) which are competitive, and the business paid those competitive wage rates to the two types of worker.? But, essentially, the Court also ruled that the business should pay the same wage rate to the two different types of worker because the two roles are deemed to be of “equal value”.? Note: this is not about paying the same wage rate to people who do the same job (which is obvious and found to be true).

So why is it bad law?

First, although not conclusive in itself, we should always be very worried when an “expert” determines that competitively determined prices are “wrong”.? Our whole economy, government economic policy, regulatory regimes (including the Competition and Markets Authority), our entire banking and financial system, much of our law and tax rules work on the basis that market prices are correct.? That is based on two hundred years of economics and many failed attempts to deviate from this.? Competitively determined market prices send the right signals and incentives within the economy and we only tend to deviate from these with great care, and when we have found some market failure (which the Court did not).? The most likely explanation for an expert saying that market prices are “wrong” is that the expert is wrong, and this is tested every second in the financial markets.

Second, as a practical implication of the first point, if a business is now not supposed to follow market prices what should it do?? Each business has to decide what wage to offer when recruiting, when promoting and when making annual inflation adjustments.? It does that by checking against the market.? But if it can’t now rely on the market (without incurring a legal risk) what information is available?? It would appear that each business will need to employ the same type of experts used by the Court for every wage decision.? I can’t be sure but I suspect that there are not enough of these experts (so presumably they must be underpaid…?) to make that work.? And what if a business attempts, for efficiency reasons, to acquire another business which undertakes different activities?? In addition to the increasingly long list of due diligence topics how does that business now assess whether wages need to change (from market levels) post integration? How is such due diligence possible?

Third, whatever the ethical motivations of the law, it won’t change market wages.? Remember that the core to this case is that a business which performs two different activities, employing workers from two different parts of the labour market, must pay equal rates; if the business wasn’t integrated into these two different activities there is no case.? So, by extension, if the business divests one of the activities it is then free to pay market rates to the activity it retains, and the new owner of the divested activity will pay the market rates for that activity.? Or, if the business itself won’t divest the activity, it can be acquired by another organisation that will; the reduction in artificially inflated wages would fund the acquisition premium.? In either case, wages rates for both activities will continue to be driven by market forces (that’s what tends to happen in competitive markets) but businesses that had integrated for efficiency reasons will not reverse those efficiency benefits to remain competitive.? (Obviously this depends on the relative magnitudes between the efficiency benefits and the wage differential but I’m pretty confident of my prediction in most markets and am happy to explain that in a different post).

So, we have a law that involves experts saying that market prices are “wrong”, and which flies in the face of pretty much everything else in the economy. ?As a result, businesses the undertake different activities now have no safe way to set wage rates or to efficiently implement the law and cannot trust market prices.? So, we will eventually see a reorganisation of businesses to find a new competitive equilibrium, which will leave market wages unaffected and result in lower productivity overall.?

And don’t think this is limited to retail.? In the current climate of aggressive litigation and class action, expect to see new cases coming to any organisation that undertakes different activities and employs workers from different parts of the labour market.? The economic damage will be very significant but market wages won’t move at all.? Good for the lawyers perhaps but not good for everyone else, including the workers.

(In passing, and I’m not an expert on the history of employment or equality laws, but I do believe that good laws survive when they complement commercial economics, I suspect the origin of these laws was to protect workers employed by monopsonistic employers – the public sector or quasi-public institutions.? In these situations, market rates would not be assumed to be “correct” and so an expert determination might make more sense.)