The Best Protection for Workers is the Market

Robert Carle’s recent review in Public Discourse of Paul Osterman’s Disposable Workers: The Transformation of Employment summarizes Osterman’s argument that, over the course of the last century, companies have changed the terms of employment in America, moving from a system in which employers truly cared about the well-being of their employees and valued their contributions to the enterprise to one in which employers simply use workers for their own benefit, firing them whenever this makes the company better off. Jobs today are thus lower-paying and less secure, especially for so-called “gig” workers, the paradigm case of “disposable workers” in Osterman’s title. All of this is meant to explain the economic angst that people, especially younger people, currently feel. 

This story is fundamentally wrong. For one thing, many sources of economic worry have nothing to do with the employment relationship, regardless of whether the terms of that relationship have changed. Our ever-growing national debt, for example, increases the risk that the United States will someday monetize that debt (pay it off by printing money); the bond market reacts to such risk by pushing up interest rates, which makes it harder for people to borrow money to buy houses. The development of AI is a technological change that portends perhaps the largest-ever substitution of capital for labor in human history. Such substitutions produce immense gains for society as a whole and dramatically raise living standards (think steam-powered looms replacing manual labor in the first Industrial Revolution), but they are hard on the workers whose jobs disappear, especially in the short term. Neither of these things has anything to do with the employment relationship. 

If we ask how that relationship has changed over time, the story is obviously one of ever-increasing legal protection for employees. The Social Security Act of 1935 creates old-age pensions. The National Labor Relations Act of 1935 tilts the market in favor of unions and against employers. The Fair Labor Standards Act of 1938 mandates minimum wages, maximum hours, and mandatory overtime rates. The Medicare Act of 1965 provides government-funded health insurance for retirees. The Occupational Safety and Health Act of 1970 makes workplaces safer. The Civil Rights Act of 1964 protects employees against race and sex discrimination, and the Americans with Disabilities Act of 1990 requires employers to accommodate workers with disabilities. The Family and Medical Leave Act of 1993 guarantees workers time off for medical reasons. The Internal Revenue Code gives preferential tax treatment to retirement savings in 401(k) plans and IRAs that, along with changes in securities markets, allow employees to become capitalists by investing in the stock market, so that many workers now retire as millionaires. The list goes on. 

So why would anyone think workers were better off long ago? Carle mentions Osterman’s example of George Eastman, who in the early years of the twentieth century practiced “welfare capitalism” at Eastman Kodak. Because he “believed that the goodwill and loyalty of employees were important sources of Kodak’s prosperity,” Eastman “distributed bonuses and profit-sharing payments,” “established retirement annuities, life insurance, and disability benefits,” and even eventually gave much of his stock in the company to its employees. Things would be groovy if only more employers were like George Eastman. 

But the reality is that even though some rare souls give away large amounts of money, it would be foolish to design economic institutions on the assumption that employers generally will do this. Companies don’t pay their suppliers more than the market price for raw materials or their bondholders more than the market rate of interest just because this would be a nice thing to do. Similarly, they don’t pay their employees more than the market rate for their services, just as you don’t pay the plumber more than he bills you. Hoping your employer will pay you more than the market rate for your services is like hoping you’ll inherit a fortune from a rich uncle. You can dream, but dreaming is not rational economic planning. 

Furthermore, George Eastman probably wasn’t behaving quite the way Osterman and Carle thought he was. For one thing, the “welfare capitalism” that Osterman and Carle support is illegal under traditional principles of corporate law. Those principles, which are still the law today (at least in Delaware, the dominant corporate law jurisdiction), require directors to manage the business of the company for the benefit of its shareholders. The theory here is that some people (the shareholders) have entrusted assets to other people (the directors), and so the law imposes on the directors a fiduciary duty to manage those assets for the benefit of the shareholders—not for the directors’ own benefit and not for the benefit of any third parties, either. 

But this has never meant that directors must run the business in the manner of Ebenezer Scrooge, extracting as much value as possible from every counterparty in every transaction. On the contrary, treating employees and customers fairly and even generously is good for business. Businesspeople have always understood this (even before academics started explaining to them how to run their businesses), and judges have always understood it too. Hence, the legal rule has always been that companies may direct value to non-shareholders, even when not legally required to do so, if the directors think this is the way to maximize value for shareholders in the long term. As Baron Bowen explained in Hutton v. West Cork Railway (1883), if the company wants to send its porters and their families down to the country for a picnic, it may so do, provided the directors do it to build goodwill with the employees for the end of making the company more profitable in the future. “The law does not say that there are to be no cakes and ale, but there are to be no cakes and ale except as are required for the benefit of the company.” 

If George Eastman treated his employees well, it was probably because it was in the interests of the corporation to do so. On the other hand, if Eastman was paying his employees more than market wages because he thought this was a good thing to do, even if it harmed the company’s shareholders in the long term, he was violating his fiduciary duties to the other shareholders of the corporation. Henry Ford lost the famous case of Dodge v. Ford (1919) for just this reason. Of course, Eastman was entitled to give away his own money, as when he gave his stock to the employees, but he had no legal right to give away the corporation’s assets. Those he had to manage for the benefit of the shareholders. 

There’s more. During much of the twentieth century, Eastman Kodak had a nearly complete monopoly on cameras, film, and related products. Like all monopolists, Kodak made huge profits by limiting output and raising prices, which is legal, but it also consistently abused its monopoly position by trying to exclude rivals, which is illegal. The company entered into a consent decree with the federal government in 1921, lost in the Supreme Court in Eastman Kodak v. Southern Photo Materials in 1927, entered into another consent decree in 1954, lost again in court in Berkey Photo. v. Eastman Kodak in 1979, and lost a third time in Eastman Kodak v. Image Technical Services in 1992. Kodak lost its monopoly only when it failed to move quickly enough into digital photography in the 1980s. 

This explains Eastman’s supposed altruism to his employees. Because monopolists make abnormally large profits, they can afford to pay their employees more than companies that operate in competitive markets. If a company operating in a competitive market pays its employees more than the market wage, its costs rise above those of its competitors, meaning that the company has to charge more for its products than they do; over time, the company will lose market share and will ultimately go bankrupt. Unions, incidentally, are similar: by raising wages for workers, they make employers less competitive, eventually driving them out of business; this is why the percentage of unionized workers in the private sector has steadily declined from about 30 percent in the 1950s (when many American companies enjoyed protected markets) to about 6 percent today (when most companies face global competition). 

Monopolists, however, don’t have to worry about such things, and so they sometimes pay their employees above market wages. Kodak is one example. Xerox is another. It had a monopoly on photocopying machines in the 1960s and 1970s and redirected part of its monopoly profits to its employees, as well as to various charities. Similarly, the Big Three automakers had an oligopoly until the 1970s, and they provided their workers lavish salaries and benefits. These companies all basked in the adulation of academics for their supposedly enlightened views of the dignity of the American worker, but their altruism was really a product of their being flush with cash from their monopoly profits. 

Nor should anyone conclude that we ought to protect companies from competition so they can make monopoly profits and then pay their workers super-market wages. All that money comes from rooking the company’s customers, and it’s elementary in microeconomics that the harms monopolists impose on customers demonstrably exceed the benefits to the monopolist. Monopolists create net social costs, whether they pocket the monopoly profits themselves or share them with others. The benefits to the employees of Kodak, Xerox, and the Big Three were obvious, but the harms to everyone else, though difficult to observe, exceeded these benefits.  

The knock-on effects of monopolies can be even worse. Monopolists have reduced incentives to maintain quality and innovate. It’s no accident that Kodak failed to move into digital photography, that Xerox gave away its graphical user interface and mouse innovations (what we today call “windows”) to Apple and ceded the field of laser printing to HP, and the Big Three automakers produced such rotten cars in the 1970s and 1980s that they got trounced by Toyota and Honda. 

So what’s the solution? In my seminar on complex business transactions, I have my students read an employment agreement for a senior executive at a public company. Under that agreement, the executive is entitled to a generous base salary, but even though the parties expect most of the executive’s compensation to come from cash bonuses and stock options, the executive has no legal right to any such compensation. On the contrary, the agreement expressly provides that the executive gets only what the board of directors chooses to give him. When I ask my students why a sophisticated executive would accept such terms, they are generally stumped; when I tell them that such arrangements are common, they’re mystified. What my students are missing is that if the executive doesn’t get paid as much as he thinks he deserves, he’ll start looking for another job. If he is really worth as much as he thinks, some other company will pay him that amount, and if no one will pay him that much, then that’s the best proof that he doesn’t deserve more than he’s already getting. 

The lesson here is as simple as it is profound. The market, meaning the right to quit and get another job on better terms, is the best protection for the worker. Your employer pays you $65,000 per year because, if he didn’t, you’d be able to get that much from some other employer across the street. This is the same reason Toyota charges you $24,000 for a new Corolla: if it demanded $28,000, you’d buy a Civic from Honda for $25,000. Similarly, if you want a higher salary, you have to produce more value for your employer, whether by being smarter, becoming more creative, working harder, or whatever; then you’ll get paid more. Anything else is asking for a handout, whether from your employer or the government. In either case, it will have to be paid for by other people, and they don’t owe you a living. 

 Image licensed via Adobe Stock.