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Government as Regulator of the Labor Market

by William McGaughey


Economists today accept the role of the Federal Reserve System, or central bank, in regulating the supply of money. Unless there is a fairly constant relationship between money supply and the volume of goods and services in the economy, inflation will result.

The central bank, acting as a quasi-government agency, is thus able to regulate prices and interest rates in a closed economic system. By increasing money supply, more money becomes available to increase economic activity. The interest rate falls, loosening credit. Conversely, when prices rise, restrictions on credit dampen economic activity, reduce demand, and bring prices back in line.

What makes this work is government's ability to take action that affects the entire economy. National governments regulate national economies. There is, or has been, a closed system.

As we move into a global economy, however, this model of regulation begins to weaken. Money and credit spill over across national borders; and so does economic activity. There is no international regulatory body that can control global money supply to prevent the free market from pushing toward painful extremes.

How about the labor market? What happens if the free market brings forth high levels of unemployment and underemployment and falling real wages? The conventional view is that working people will just have to bear the pain. Individually, they may educate themselves into new and better jobs, but collectively little can be done except to apply economic stimulus in times of cyclical downturn. During recessions, government can spend more and jobs will be created in response to the new demand. Central banks can loosen credit.

The problem with this approach is that labor markets are becoming unbalanced over the long term. Fiscal and monetary stimulus are fixes to short-term problems. One cannot expect government to increase its spending indefinitely or for the central bank to create an endlessly expanding supply of money without unleashing a destructive inflationary cycle. Yet, as both domestic and global economic forces threaten the long-term security of U.S. workers, something needs to be done.

I would suggest that government create a regulatory apparatus to protect real wages and create favorable working conditions for the nation's working people. Labor is the moral foundation of whatever prosperity Americans have. Government should therefore make labor its preferential option. American workers should generally expect government to be on their side and introduce policies that will improve their situation over the long term.

To understand why the labor market is becoming unbalanced in the United States, we need to consider two long-term trends.

First is the substitution of capital for labor. To reduce labor costs, employers invest in "labor-saving" technologies that improve the productivity of labor. If each worker can produce more in an hour, the machine handles the extra production so additional workers are not needed. Over the long term, fewer people are able to handle the economy's useful work. The rest become a surplus population.

Second is the substitution of cheap foreign labor for high-priced U.S. labor. The nation's manufacturing base has been gutted as manufacturers have closed down factories in the United States and obtained products from factories abroad that pay their workers a fraction of the U.S. wage. Our free-trade policies allow such products to enter the U.S. market unburdened by tariffs. If workers in south China, for instance, are paid $.40 an hour to do what Americans do for $8.00 an hour, manufacturing firms are able to boost profits immediately and dramatically by outsourcing their work to such places.

Related to this is the problem of illegal immigration. If the prevailing wage for unskilled labor in Mexico is $.50 an hour, Mexicans can improve their economic situation by sneaking across the border with the United States and taking jobs at, say, $4 or $5 an hour, undercutting the U.S. wage rate. Instead of outsourcing work to a foreign country, the foreign workers come here. Instead of free trade, we have Republican administrations winking at illegal immigration to please their business constituencies; and Democrats doing the same to build political constituencies.

In either case, the American worker's interest is neglected by the government. One would think that working people would punish their elected representatives at the polls, but, in fact, the electorate is divided over so many different issues that the issue of economic interest is never heard. Meanwhile, moneyed interests dominate the political discussion by hiring lobbyists and financing campaign commercials for candidates supporting their agenda. An economic priesthood, housed in prestigious universities, assures the public that any and all proposals to help the average working man or woman are based on fallacious reasoning.

Can anything be done about those problems? Of course. We can call for government to regulate the labor market as it currently regulates the supply of money and controls the timing of economic stimulus. It can artificially shrink the supply of labor to drive up its price. It can impose taxes in the form of a tariff to reduce or eliminate the cost differential between producing in the United States and in low-wage countries abroad.

I have mentioned two different threats to U.S. employment: (1) labor displacement through investment in labor-saving technologies and equipment, and (2) outsourcing production to low-wage countries. The first threat is focused on the domestic economy; the second, on the international economy.

To address those two problems, we will need to have government operating within a closed system. National governments can regulate the national economy to the extent that its system is closed. Global economies will have to be regulated, if at all, through international political institutions (like the United Nations, International Labor Organization, and World Trade Organization) or through cooperation between national governments.

An appropriate measure to deal with labor displacement through automation is for national governments to encourage employers to reduce their employees' working hours. By "encourage", I do not mean jaw-boning but providing financial incentives for them to reduce hours. A model for this exists in the Fair Labor Standards Act. That federal law enacted in 1938 required employers to pay overtime wages to covered workers if those workers had to work more than forty hours a week.

If the present economy is failing workers today, then regulations might be changed to address the new situation. It has now been seventy years since the federal law was passed that established the forty-hour workweek; but labor productivity has increased many times during that period and the fixed-cost component of labor (such as health care) outweighs the extra cost of overtime work. Clearly the current financial incentives are outmoded.

What can be done?

The Fair Labor Standards Act can be amended in several respects:

(1) The standard workweek can be reduced from forty hours per week to some other number, such as thirty-five hours per week (5 days, 7 hours a day) or thirty-two hours per week (4 days, 8 hours a day).

(2) The overtime-penalty rate can be increased from time-and-a-half to double-time or some higher number.

(3) The exemptions to FLSA coverage can be minimized; notably, that pertaining to managerial and professional employees. Indeed, there is no compelling reason why coverage should not be universal among workers who do not set or control their own work schedules.

(4) The overtime "premium" - currently, the extra half-time wage - can be paid to the government in the form of an extra tax on wages instead of being paid to the employee. This would eliminate the employee's incentive to seek or accept overtime work.

Apart from amending the Fair Labor Standards Act, two other measures would help reduce working hours: (1) better enforcement of laws on the books and (2) decoupling health-care insurance from employment.

Would shorter work hours mean reduced income? It is impossible to predict impacts for the short term or for the individual enterprise, but in the long run reductions in hours have been accompanied by higher, and not lower, wages. The reason for this is that, as the supply of labor shrinks, its price - the worker's wage - increases by the law of supply and demand.

I must admit to a problem with this approach. If the U.S. government reduced working hours in the domestic economy, that additional regulation would create an incentive for U.S. employers to accelerate the outsourcing of production abroad. Employers unfailingly gravitate towards a "better business climate" and shorter workweeks are a negative indicator in those terms.

But never mind. The process of outsourcing is already advanced. There are ways to deal with employers who seek to evade government regulations. Produce where they will; businesses still need to sell their products.

That leads us to the second problem for U.S. workers, which is the outsourcing of production and jobs to low-wage countries. The solution is, in a word, "tariffs". A tariff is a tax on goods imported from another country, which is often paid when the goods pass through Customs. No matter how large is the cost advantage from producing in a low-wage country, the advantage can be eliminated by imposing a tariff on the product as it enters the U.S. market. which equals the savings from cheap labor.

I have proposed that the U.S. government impose "employer-specific tariffs" on such products. The idea is to calculate the labor cost in manufacturing a particular product in a particular factory abroad and compare this with the cost of producing the same product in a U.S. factory paying a "normal" American wage. The one cost subtracted from the other on a per-unit basis would comprise the basis of the tariff.

My concept was presented in two articles for the Green Party publication, Synthesis/Regeneration, in the 1990s. These articles are found on the web at: and

I do not propose necessarily that all the cost differential from producing in a low-wage country be offset by the protective tariff. Enough of the differential should be covered, however, to keep U.S. production from collapsing or, at least, enough to allow U.S.-made products to remain competitive in the U.S. market. The beauty of this scheme is that it provides an incentive for multinational companies to raise wages and reduce hours in the foreign factories where their goods are produced. The smaller the differential in labor costs, the smaller the tariff will be.

Such a tariff is therefore an instrument for increasing wages and reducing work hours around the world. Given today's computer technology and the increasing use of auditors to check work conditions in foreign factories, this proposal is practical. It could be a cornerstone of international cooperation in the future as the global economy continues to develop and living standards narrow among nations.

Now, of course, it is politically impossible to create such a system of tariffs in the near future because the United States is bound by free-trade "agreements" (quasi-treaties that were never ratified by the U.S. Senate) and by the rules of the World Trade Organization which forbid nation states to impose tariffs unilaterally. However, the world trading order can be changed to accommodate orderly development even as it was created at the Bretton Woods conference in 1944.

Something clearly must be done if the United States continues to rack up large and mounting trade deficits each year. Something must be done to restore a reasonable balance in our nation's trading accounts. For one nation (China) to produce goods and another (the United States) to consume them is unworkable in the long term.

So I am proposing both a domestic and an international fix for our nation's long-term employment problems. Like it or not, the United States government will have to cooperate with other nations to address our common problems; it cannot impose unilateral solutions. All nations face a challenge in providing adequate employment to their people. All nations face the problem of dwindling natural resources, of global warming, of water and air pollution, and other environmental limitations. The world's people must find a means of controlling such things through stronger and improved political institutions.

It is not inconceivable, therefore, that all or most nations could undertake reductions in work hours through domestic legislation similar to the Fair Labor Standards Act; and that all could impose tariffs like the "employer-specific tariffs" to penalize nations that industrialize without regard to the welfare of their people.

Government has a role to play in both the national and international economies. Wall Street zealots who took the fall of communism in the Soviet Union to mean the triumph of unfettered capitalism spoke too soon. There was then no "end of history"; nor shall there ever be so long as the human race continues.

We are working toward the goal of increased human freedom within the limitations of our natural environment. Notice that neither of my proposals envisioned that government would impose business decisions by legislative fiat. This is not "socialism" by which government takes over the means of production. It is simply government regulating the free market through tax incentives.

The extra wage "premium" for overtime work under the Fair Labor Standards Act is a government-imposed cost which could or should be a tax. Tariffs on imported goods are also a tax. This is the form of taxation which Alexander Hamilton created to protect America's infant manufacturing industries in the late 18th century and which was the federal government's main source of revenue throughout the 19th century.

I also note that American industry developed to a preeminent state in the world economy during that time in the late 19th century and early 20th century when average working hours were falling most rapidly. Henry Ford, an architect of our consumer economy, recognized the economic advantages of reduced hours, introducing them in his own factories unilaterally. In contrast, today's captains of industry, who preside over less successful enterprises, insist that such measures spell economic disaster.

Therefore, dogmatic economists who say tariffs won't work or who predict dire consequences if working hours were reduced are deficient in historical understanding. It is a political decision which way to go - whether the short-term advantage of the few or the long-term interest of the many will prevail.

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