Today, and in some of the next few columns, I want to talk about labour market reform and the strong role it could play in rejuvenating the South Australian economy.

Indeed, it is hard to see a more rapid and effective way for South Australia to reduce its unemployment rate than to reduce the extent of labour market regulation in South Australia.

I am aware that this is presently a political no-go zone. The brutally-effective trade union political campaign against Work Choices means that labour market reform is now, in former Prime Minister Tony Abbott’s phrase, “dead, buried and cremated”.

This outcome has been adverse to the growth of jobs and living standards in Australia, doubly so in an economically-struggling State like South Australia. Does it make sense that average wages are rising second-equal fastest in South Australia when we have the highest unemployment rate?

If there were no trade-off between the size of the wage paid and the number of jobs on offer, we would all be employed billionaires. Fair Work Australia necessarily pays regard to the adverse effects on the numbers of jobs of it setting wage rates too high. But they pay regard to a lot of other things, as well. It does not set pay rates that will maximise employment. This is a great pity.

In a competitive labour market (like Australia’s, where there is strong competition for workers in all labour markets, with the possible exception of some parts of the public sector!) employers are not able to dictate pay rates. At some point, as they cut wages, they will not be able to employ all the people that they want to employ.

It is competition in the labour market that maximises employment at wages that people are willing to accept, not regulators or “the Government”. Bodies like Fair Work Australia will always set wages that meet other objectives – including, especially, ideological objectives to do with their conceptions of fairness.

We could reduce unemployment significantly in South Australia if we were to allow employees and their own employers to make unfettered pay and conditions deals between themselves. The floor for any particular wage will be set by the willingness of workers to accept it – in the face of alternative wage offers from other employers.

In the end, this system of free bargaining leads to employment being at a maximum because businesses are producing the highest output that people are willing to buy.

As University of Canberra Professor Phil Lewis noted last year:

Firms hire extra labour when the value of the extra output produced is greater than the wage. Firms will only increase output if activities which were not previously profitable are made profitable. One of the corner-stones of economics is the Law of Diminishing Returns. This states that each extra worker employed produces less output than the worker previously employed given that all other inputs are held constant… Therefore, extra output and extra employment requires a fall in labour costs and conversely a rise in labour costs will make otherwise profitable activities no longer profitable so firms hire less people and produce less.¹

The only ways that employment can rise if wage rates are rising are if the prices of what workers produce increase or workers produce more (their productivity increases). Hence, business investment (and increasing business profitability) are required for wages to increase without unemployment rising.

Labour market reform means granting greater freedom to enterprises and employees to develop their own workplace arrangements, including wages and conditions of work. It should restrict the right of third parties, such as Fair Work Australia, to intervene in the employment relationship between an enterprise and its own employees.

Over the past 35 years, Australia has enjoyed a spectacular turnaround in its economic and social fortunes (at least until the Rudd-Gillard-Rudd governments put government back in charge), thanks to the liberal democratic reforms (including labour market reforms) introduced by the Hawke-Keating and Howard governments,

The essential case in support of further labour market reform proposals is that it is good for the particular people employed by particular enterprises to work out their own salvation together, rather than to be told what they must accept by some outside party. The insiders know the score; the outsiders don’t.

Waterside Workers Union secretary Charlie Fitzgibbon said in 1986: “The one thing that no ideologue or anybody else can ever overcome is a feeling of being part, of being fairly treated, and seeing the advantage of the enterprise also meaning an advantage to the individual.”

Bill Kelty, secretary of the ACTU, said in evidence to the Australian Industrial Relations Commission in 1990: “[We must] create a new wages system … involving … a diminution in the authority of bodies such as the ACTU; bodies such as the conciliation and arbitration systems of Australia, as more and more is done where more and more has to be done, and that is in the workplaces of this country.”

Businesses have to pay the market rate to their workers if they are to stay in business. A business is not likely to pay more than it needs to, but it is not likely to pay less, either, because to do so means that it would not be able to employ the workers that it needs for it to operate successfully.

This market wage may be less than a wage posited to be “fair and just” by some outside third party, but the result of enforcing a wage that is higher than the market wage is that that job will no longer be available.

1. Phil Lewis, Agenda: A Journal of Policy Analysis and Reform, 21:1, 2014.

Richard Blandy is an Adjunct Professor of Economics at the University of South Australia.