Epstein on Labor Relations

Richard A. Epstein

March 8, 2005

When the Employment Contracts Act of 1991 was passed, after extensive fanfare and debate, unions and some politicians suggested the sky would fall in on ordinary working-class people.

That statute has since been displaced by the Employment Relations Act of 2000, in part because opponents have insisted that the ECA was one-sided in its key provisions and, thus, proved advantageous only to employers.

I was involved in the debate about the ECA during my first trip to New Zealand in July 1990. Now, as then, I am an academic and an employee.

My goal in thinking about labour relations has no partisan twist. Rather, it is to maximise the sum of employer and employee surplus generated in the labour market.

It would be foolish and irresponsible to support legislation that made employers richer at the expense of employees.

The aim should always be to create a system of ex ante opportunities from which both sides will be able to profit through voluntary exchange.

Although it should have gone further, this objective is exactly what the Employment Contracts Act went a long way to achieving.

How did things work out in practice? Before 1991, New Zealand had a highly unionised workforce with strong monopoly protections.

The elimination of those privileges was bound to result in a transitional decline in the wages of some unionised workers until improvements in productivity over time drove them up again.

This impending loss of privilege accounts for the fierce political resistance to change. But that partisan fear is not a reason to regard the legislation as unjust. Quite the opposite - it served to reveal the artificial nature of the previous state of affairs.

The ECA exposed unions as being less attractive to workers in the long run, even if they could secure some immediate redistribution in favour of their members. It underlined the fact that supply and demand, and long-run improvements in productivity, determine wages and other employment conditions, not union power. Only about 12 per cent of private-sector workers now belong to a union.

Even though the ECA did not permit contracts at will (meaning the right to quit or fire for good cause, bad cause or no cause at all), unions felt threatened by changes that moved employment law in the direction of straightforward contracts. Yet labour markets operate like most other markets and the decision to retain a mandatory for-cause regime - and extend it to employees on individual contracts - was neither efficient nor fair.

It is true that people dismissed unjustly under a simple contractual system may experience personal and psychological setbacks, but even a regime that allows for personal grievance procedures can result in harsh decisions. People will always point to hard cases with any system.

Yet beware of the limits of arguing by anecdote. As a matter of sound policy, it is more instructive to assess in a fairly dispassionate way if those mistakes are likely to occur with greater or lesser frequency under one system than another.

Employers who know they cannot dismiss someone without showing just cause are less likely to take the risk of hiring a person with a spotty employment history.

Ironically, finding another job will be easier for people with reputational problems in a contract-at-will world than in a labour market with extensive "protections".

Such a regime may make dismissals more frequent and more traumatic in some cases, but it will make re-contracting easier.

Of course, nobody should be forced into at-will contracts. Many firms might have such contracts as a matter of law but, informally, they might adopt more elaborate internal procedures to decide on salaries, promotions, dismissals, grievances and similar matters.

Other firms, for good reasons, might not use such procedures or might write them into contracts.

If all this occurs voluntarily, what will be gained by imposing restrictions on how people arrange their affairs? A rule that supplants something that is done voluntarily will seldom come out right in all circumstances.

The voluntary system may require that you do A, B and C. The mandatory system will oblige you to do B, C and D. You know that A is better than D, whereas the Government does not - but you cannot escape the requirement it lays down.

The best way to prevent exploitation of workers is to make hiring and firing easy, facilitate new entry by firms into all markets and promote full employment - a worker with other available job opportunities is difficult to exploit.

What of the transition from the ECA to the Employment Relations Act 2000 and recent amendments to it? I do not believe the manifold changes help workers. With globalisation, the gains from unionisation and collective bargaining are sharply curtailed by competition in product markets.

Because unions work by exercising market power (they often hanker after multi-employer contracts), rather than improving productivity, they make local industries more vulnerable to external competition.

For domestic firms to succeed, a cartel mentality bent on achieving monopoly wages and obtaining a larger slice of a given pie must be abandoned in favour of a production mentality focused on the efficient operation of firms.

Rhetoric in New Zealand about labour markets seems much more subdued now than it was in 1990. At the time, there was impassioned support for retaining compulsory unionism and national awards and even for pay equity legislation.

Facts overtook the debate as the ECA ushered in a period of strong employment growth, a rapid fall in unemployment and, from 1993, a pick-up in total factor productivity.

Today, only a few diehards yearn for a return to the sort of suicidal behaviour associated with the old system, so much so that it is bizarre to hear the Labour Government is still toying with pay equity legislation.

The 1991 ECA was not perfect, but it was a big advance and it certainly did not cause the sky to fall in.

New Zealand should heed its lessons: labour markets are not special; they are not characterised by unequal bargaining power; common law provides protections against fraud, misrepresentation and duress; and voluntary contracting is in the best interests of firms, workers and the unemployed - if not in the interests of protected unions.

Richard Epstein is the James Parker Hall Distinguished Service Professor of Law at Chicago University and the Peter and Kirsten Bedford Senior Fellow at the Hoover Institution. This article is based on a talk he gave at Wellington last August on a visit hosted by the New Zealand Business Roundtable.