by Lindy Davies
( Show Glossary )
You think you are helping the economic system by your well meaning laws and interference. You are not. Let be. The oil of self interest will keep the gears working in almost miraculous fashion. No one need plan. No sovereign need rule. The market will answer all things. — Adam Smith, Wealth of Nations
Ah, the "magic of the marketplace"! No need to worry or plan, the "invisible hand" will guide us to "the best of all possible worlds" — such are the terms used to describe the wonders of a whole planet of human beings, unconsciously cooperating. Can all this really be true?
Whenever there is nothing stopping them from doing so, people tend to create efficient markets. Each person evaluates alternatives and chooses the activity which he or she believes will provide the greatest benefit. The tug-of-war between producers trying to maximize income and consumers looking for a bargain helps to create the best possible product at the right price.
This process works most wonderfully when there is plenty of competition. Economists refer to a market as perfectly competitive when it has many producers of goods that are easily substituted for one another, and all of them were equally free to sell their goods. Such a state of affairs gives consumers the best possible deal. Perfect competition is usually considered to be a theoretical ideal — but some markets, such as those for farm commodities, come close to it.
It’s not hard to see that selling goods in a perfectly competitive market is no way to become rich. Where they can, people will find relief from competitive pressure. A very common kind of market today is one in which there is a large number of suppliers, but the goods are strongly differentiated to the buyers — by having popular brand names, well-known advertising campaigns, special features or "fad appeal." Such markets, in which sellers do have some level of control over the prices of their goods, are termed monopolistic competition. Examples abound; the markets for personal computers, magazines, restaurant franchises and soft drinks are all examples of monopolistic competition. Another kind of "imperfect competition" that has great influence is oligopoly, in which a small number of suppliers cooperate to reduce competition among themselves. Their products might be virtually identical, like steel, or similar, like automobiles. Oligopolies usually develop around complex products that demand a lot of capital and technology. Oligopolists take advantage of the fact that it is quite difficult for competitors to enter the market. However, oligopolistic industries within one nation still face foreign competition — and a national policy of free trade can bring the benefits of competition to oligopolistic markets (or, a national policy of protectionism can preserve oligopolistic privilege).
The most severe curtailment of competition is the case of monopoly, in which there is only one supplier and competition is not possible at all. One example of an industrial monopoly was the ALCOA Company, which, because of its control over lands containing bauxite, the ore of aluminum, had a monopoly over the market for aluminum for many years. It could therefore sell aluminum for a monopoly price: as much as buyers were willing to pay rather than go without the product. A current example is the Microsoft Corporation’s monopoly over the PC operating system. Of course, land is a monopoly, because every land site is unique and irreplaceable -- and thus exchanges for whatever the market wuill bear.
Where there is plenty of competition, the free market provides for the most benefit for everyone. But people, seeking to satisfy their desires with the least exertion, try to find ways to limit competitive pressures. The level to which free competition is maintained and encouraged is the level to which "the magic of the marketplace" will truly benefit the whole community. Privilege is the antithesis of free competition — and when privileges are granted to individuals or corporations, overall prosperity suffers.It is often said that "perfect competition" doesn’t actually happen in the real world, that it is merely an abstract notion used by econ teachers to illustrate points. Producers of the goods that textbooks tend to cite as examples of perfect competition — agricultural goods such as wheat, corn, pork bellies, etc. — are often provided with public support in the form of subsidies or protective tariffs! The fact is that there are few, if any, goods that are sold in perfectly competitive markets, and firms in such markets seek to limit competitive pressure in any way they can.
Perfect Competition: Does It Ever Really Happen?
There is one market, though, in which perfect competition reigns supreme, and has for hundreds of years. In this market, the quality of one seller’s product is virtually identical to that of any other seller, and the number of sellers is very, very large. Competition forces the price right down to the good’s marginal cost. Not only that — this market is very important and ubiquitous; it is actually a fundamental building block of the economy.
What is it? The market for unskilled labor: workers who are simply selling their labor time, without the advantage of any particular skill, union membership or governmental regulation that improves their bargaining power.
Economists tell us that in a perfectly competitive market, profit is maximized when the price is equal to the seller’s marginal cost. But what does that mean, in the case of labor? What is labor’s marginal cost?
Marginal cost is defined as the cost of bringing an additional unit of the commodity to market. In the case of labor, that means, essentially, surviving another day — the labor power is measured in units of time. The worker is engaging in "profit maximizing behavior," just like everyone else. It's just the basic laborer has a very narrow range of options. "Profit maximization" in this case means working, instead of starving. Any wage rate higher than mere subsistence will be undercut by some other worker who is just a bit more desperate. The marginal cost of unskilled labor is subsistence, and that is its market-clearing price.
Clearly, just selling one’s labor is no way to get ahead. Labor has been forced to seek some sort of competitive edge, or find some way for the pressure of competition to be eased. And, thank goodness, a great deal of that has gone on — at least in the world’s developed economies. When the bosses get rich while the masses of workers are given just enough to survive, society tends to become unstable — it gets into what is sometimes called a "revolutionary" situation. Nevertheless, wretched subsistence was the general condition of most workers during the rise of the industrial revolution in the 19th century. Over time, in the general interest of social stability, workers had to be given some relief from the crushing burden of pure competition in the labor market.
There were three basic ways in which this came about:
These attempts to ease the crushing burden of competition in the labor market were largely successful. In the United States, Western Europe and Japan, they contributed to the creation of a large middle class, a huge group of eager consumers whose demand for goods created high levels of overall prosperity.
- Labor unions. Workers acted collectively — often at great risk — to stop or inhibit production until wages and working conditions were improved. Over time, their solidarity and sacrifice gave unionized workers better bargaining power. (In microeconomic terms we could say that unions restricted the supply of workers in particular industries, thus raising their equilibrium price.)
- Education. By enhancing their skills or gaining professional credentials, workers could raise their price. (In this case, workers took themselves out of the general labor market, seeking to enter less-competitive skilled-labor markets.)
- Welfare-state protections. Prominent among these are social security — which provides retirement benefits — workplace safety and health regulations, and minimum wage requirements. (These interventions effectively set a "floor" for wages — they were no longer allowed to fall to their market-clearing price, at least not for most workers; illegal immigrants and other "marginal" workers would still have to take what they could get.)
However, they carried the seeds of their own destruction. To see why, let’s consider this matter from management’s point of view. In the labor market the "market clearing" price for unskilled labor was: subsistence. Along come the labor unions (and later, the liberal politicians), saying the workers aren’t paid enough. "Well, perhaps they aren’t," the industrialist would reply, "but if I pay them more, I will lose profit!" No matter! The strike succeeds, let’s say, and management agrees to pay the workers more of the wealth that they produce.
But: when the workers went back to the factory after the strike, had they suddenly become more productive? No: they produced the same amount of wealth per day as before. Yet management had to pay them more! In order to get back up to the same level of profit, management had to find some way to get more wealth out of the same hour of work. They had to invest in increased productivity.
Thus we see that an economy in which large numbers of workers can command high wages will tend to be innovative and highly productive — and an economy in which most of the workers have no better opportunity than bare-subsistence wages will tend to have trouble getting out of its own way.
Nevertheless: people seek to satisfy their desires with the least exertion. If employers are able to pay workers less, they will. They will seek to replace union workers with non-union workers... or to replace full-time, health-insured workers with part-timers with no benefits... or replace domestic health- and safety regulated workers with foreign competitors who work much cheaper. Although highly-paid workers tend, in the long run, to be good for overall productivity and progress, wages nevertheless tend to drift downward. Labor’s gains, hard-won though they are, get whittled away in the marketplace over time.
Why? Because the market for unskilled labor is perfectly competitive.
But must it always be so? It is considered a truism that there will always be more workers seeking employment than there will be jobs for them to do. Henry George, of course, refused to accept that state of affairs as inevitable — and his analysis of political economy clarifies the question for us. Why, George asked, must abundant workers seek scarce jobs, when human desires are unlimited, and natural opportunities are being held out of use? The truth of the matter is that the private (and corporate) hoarding of land is the wedge that maintains "perfect competition" in the market for unskilled labor — but that wedge is removable. When we finally do remove it, then we’ll begin to see the prodigious benefits of free competition that Adam Smith, and all his intellectual descendants, have extolled so mightily.