"ENOUGH TO BUY BACK THE
PRODUCT"
AMATEUR WRITERS on economics are always asking for "just"
prices and "just" wages. These nebulous conceptions of
economic justice come down to us from medieval times. The
classical economists worked out instead, a different concept—
the concept of functional prices and functional wages.
Functional prices are those that encourage the largest volume of
production and the largest volume of sales. Functional wages
are those that tend to bring about the highest volume of employment
and the largest real payrolls.
The concept of functional wages has been taken over, in a
perverted form, by the Marxists and their unconscious disciples,
the purchasing-power school. Both of these groups leave
to cruder minds the question whether existing wages are "fair."
The real question, they insist, is whether or not they will work.
And the only wages that will work, they tell us, the only wages
that will prevent an imminent economic crash, are wages that
will enable labor "to buy back the product it creates." The
Marxist and purchasing-power schools attribute every depression
of the past to a preceding failure to pay such wages. And at
no matter what moment they speak, they are sure that wages
arc still not high enough to buy back the product.
The doctrine has proved particularly effective in the hands of
union leaders. Despairing of their ability to arouse the altruistic
interest of the public or to persuade employers (wicked by
definition) ever to be "fair," they have seized upon an argument
calculated to appeal to the public's selfish motives, and frighten
it into forcing employers to grant union demands.
How are we to know, however, precisely when labor does
have "enough to buy back the product"? Or when it has more
than enough? How are we to determine just what the right sum
is? As the champions of the doctrine do not seem to have made
any real effort to answer such questions, we are obliged to try to
find the answers for ourselves.
Some sponsors of the theory seem to imply that the workers
in each industry should receive enough to buy back the particular
product they make. But they surely cannot mean that the
makers of cheap dresses should get enough to buy back cheap
dresses and the makers of mink coats enough to buy back mink
coats; or that the men in the Ford plant should receive enough
to buy Fords and the men in the Cadillac plant enough to buy
Cadillacs.
It is instructive to recall, however, that the unions in the
automobile industry, in the 1940s, when most of their members
were already in the upper third of the country's income receivers,
and when their weekly wage, according to government
figures, was already 20 percent higher than the average wage
paid in factories and nearly twice as great as the average paid in
retail trade, were demanding a 30 percent increase so that they
might, according to one of their spokesmen, "bolster our fastshrinking
ability to absorb the goods which we have the capacity
to produce."
What, then, of the average factory worker and the average
retail worker? If, under such circumstances, the automobile
workers needed a 30 percent increase to keep the economy from
collapsing, would a mere 30 percent have been enough for the
others? Or would they have required increases of 55 to 160
percent to give them as much per capita purchasing power as
the automobile workers? For let us remember that then as now
enormous differences existed between the average wage levels
of different industries. In 1976, workers in retail trade averaged
weekly earnings of only $113.96, while workers in all manufacturing
averaged $207.60 and those in contract construction
$284.93.
(We may be sure, if the history of wage bargaining even
within individual unions is any guide, that the automobile workers,
if this last proposal had been made, would have insisted on
the maintenance of their existing differentials; for the passion
for economic equality, among union members as among the
rest of us, is, with the exception of a few rare philanthropists
and saints, a passion for getting as much as those above us in the
economic scale already get rather than a passion for giving those
below us as much as we ourselves already get. But it is with the
logic and soundness of a particular economic theory, rather
than with these distressing weaknesses of human nature, that
we are at present concerned.)
The argument that labor should receive enough to buy back
the product is merely a special form of the general "purchasing-
power" argument. The workers' wages, it is correctly
enough contended, are the workers' purchasing power. But it is
just as true that everyone's income—the grocer's, the
landlord's, the employer's — is his purchasing power for buying
what others have to sell. And one of the most important things
for which others have to find purchasers is their labor services.
All this, moreover, has its reverse side. In an exchange economy
everybody's money income is somebody else's cost. Every increase in
hourly wages, unless or until compensated by an equal increase
in hourly productivity, is an increase in costs of production. An
increase in costs of production, where the government controls
prices and forbids any price increase, takes the profit from
marginal producers, forces them out of business, means a
shrinkage in production and a growth in unemployment. Even
154
where a price increase is possible, the higher price discourages
buyers, shrinks the market, and also leads to unemployment. If
a 30 percent increase in hourly wages all around the circle forces
a 30 percent increase in prices, labor can buy no more of the
product than it could at the beginning; and the merry-go-round
must start all over again.
No doubt many will be inclined to dispute the contention
that a 30 percent increase in wages can force as great a percentage
increase in prices. It is true that this result can follow only
in the long run and only if monetary and credit policy permit it.
If money and credit are so inelastic that they do not increase
when wages are forced up (and if we assume that the higher
wages are not justified by existing labor productivity in dollar
terms), then the chief effect of forcing up wage rates will be to
force unemployment.
And it is probable, in that case, that total payrolls, both in
dollar amount and in real purchasing power, will be lower than
before. For a drop in employment (brought about by union
policy and not as a transitional result of technological advance)
necessarily means that fewer goods are being produced for
everyone. And it is unlikely that labor will compensate for the
absolute drop in production by getting a larger relative share of
the production that is left. For Paul [-I. Douglas in America and
A. C. Pigou in England, the first from analyzing a great mass of
statistics, the second by almost purely deductive methods,
arrived independently at the conclusion that the elasticity of the
demand for labor is somewhere between 3 and 4. This means,
in less technical language, that "a I percent reduction in the real
rate of wage is likely to expand the aggregate demand for labor
by not less than 3 percent."1 Or, to put the matter the other
way, "If wages are pushed up above the point of marginal
productivity, the decrease in employment would normally be
from three to four times as great as the increase in hourly rates"2
so that the total incomes of the workers would be reduced
correspondingly.
1C. Pigou, The Theory of Unemployment (1933), p. 96.
2Paul H. Douglas, The Theory of Wages (1934), p. 501.
Even if these figures are taken to represent only the elasticity
of the demand for labor revealed in a given period of the past,
and not necessarily to forecast that of the future, they deserve
the most serious consideration.
But now let us suppose that the increase in wage rates is
accompanied or followed by a sufficient increase in money and
credit to allow it to take place without creating serious unemployment.
If we assume that the previous relationship between
wages and prices was itself a "normal" long-run relationship,
then it is altogether probable that a forced increase of, say, 30
percent in wage rates will ultimately lead to an increase in
prices of approximately the same percentage.
The belief that the price increase would be substantially less
than that rests on two main fallacies. The first is that of looking
only at the direct labor costs of a particular firm or industry and
assuming these to represent all the labor costs involved. But this
is the elementary error of mistaking a part for the whole. Each
"industry" represents not only just one section of the productive
process considered "horizontally," but just one section of
that process considered "vertically." Thus the direct labor cost
of making automobiles in the automobile factories themselves
may be less than a third, say, of the total costs; and this may
lead the incautious to conclude that a 30 percent increase in
wages would lead to only a 10 percent increase, or less, in
automobile prices. But this would be to overlook the indirect
wage costs in the raw materials and purchased parts, in transportation
charges, in new factories or new machine tools, or in
the dealers' mark-up.
Government estimates show that in the fifteen-year period
from 1929 to 1943, inclusive, wages and salaries in the United
States averaged 69 percent of the national income. In the fiveyear
period 1956-1960 they also averaged 69 percent of the
national income! In the five-year period 1972-1976 wages and
salaries averaged 66 percent of national income, and when
supplements are added, total compensation of employees averaged
76 percent of national income. These wages and salaries,
of course, had to be paid out of the national product. While
there would have to be both deductions from these figures and
additions to them to provide a fair estimate of "labor's" income,
we can assume on this basis that labor costs cannot be less than
about two-thirds of total production costs and may run above
three-quarters (depending upon our definition of labor). If we
take the lower of these two estimates, and assume also that
dollar profit margins would be unchanged, it is clear that an
increase of 30 percent in wage costs all around the circle would
mean an increase of nearly 20 percent in prices.
But such a change would mean that the dollar profit margin,
representing the income of investors, managers and the selfemployed,
would then have, say, only 84 percent as much
purchasing power as it had before. The long-run effect of this
would be to cause a diminution of investment and new enterprise
compared with what it would otherwise have been, and
consequent transfers of men from the lower ranks of the selfemployed
to the higher ranks of wage-earners, until the previous
relationships had been approximately restored. But this is
only another way of saying that a 30 percent increase in wages
under the conditions assumed would eventually mean also a 30
percent increase in prices.
It does not necessarily follow that wage-earners would make
no relative gains. They would make a relative gain, and other
elements in the population would suffer a relative loss, during
the period of transition. But it is improbable that this relative gain
would mean an absolute gain. For the kind of change in the
relationship of costs to prices contemplated here could hardly
take place without bringing about unemployment and unbalanced,
interrupted or reduced production. So that while labor
might get a wider slice of a smaller pie, during this period of
transition and adjustment to a new equilibrium, it may be
doubted whether this would be greater in absolute size (and it
might easily be less) than the previous narrower slice of a larger
pie.
This brings us to the general meaning and effect of economic
equilibrium. Equilibrium wages and prices are the wages and
prices that equalize supply and demand. If, either through
government or private coercion, an attempt is made to lift
prices above their equilibrium level, demand is reduced and
therefore production is reduced. If an attempt is made to push
prices below their equilibrium level, the consequent reduction
or wiping out of profits will mean a falling off of supply or new
production. Therefore any attempt to force prices either above
or below their equilibrium levels (which are the levels toward
which a free market constantly tends to bring them) will act to
reduce the volume of employment and production below what
it would otherwise have been.
To return, then, to the doctrine that labor must get "enough
to buy back the product." The national product, it should be
obvious, is neither created nor bought by manufacturing labor
alone. It is bought by everyone — by white collar workers,
professional men, farmers, employers, big and little, by investors,
grocers, butchers, owners of small drugstores and gasoline
stations—by everybody, in short, who contributes toward
making the product.
As to the prices, wages and profits that should determine the
distribution of that product, the best prices are not the highest
prices, but the prices that encourage the largest volume of
production and the largest volume of sales. The best wage rates
for labor are not the highest wage rates, but the wage rates that
permit full production, full employment and the largest sustained
payrolls. The best profits, from the standpoint not only
of industry but of labor, are not the lowest profits, but the
profits that encourage most people to become employers or to
provide more employment than before.
If we try to run the economy for the benefit of a single group
or class, we shall injure or destroy all groups, including the
members of the very class for whose benefit we have been
trying to run it. We must run the economy for everybody.
PRODUCT"
AMATEUR WRITERS on economics are always asking for "just"
prices and "just" wages. These nebulous conceptions of
economic justice come down to us from medieval times. The
classical economists worked out instead, a different concept—
the concept of functional prices and functional wages.
Functional prices are those that encourage the largest volume of
production and the largest volume of sales. Functional wages
are those that tend to bring about the highest volume of employment
and the largest real payrolls.
The concept of functional wages has been taken over, in a
perverted form, by the Marxists and their unconscious disciples,
the purchasing-power school. Both of these groups leave
to cruder minds the question whether existing wages are "fair."
The real question, they insist, is whether or not they will work.
And the only wages that will work, they tell us, the only wages
that will prevent an imminent economic crash, are wages that
will enable labor "to buy back the product it creates." The
Marxist and purchasing-power schools attribute every depression
of the past to a preceding failure to pay such wages. And at
no matter what moment they speak, they are sure that wages
arc still not high enough to buy back the product.
The doctrine has proved particularly effective in the hands of
union leaders. Despairing of their ability to arouse the altruistic
interest of the public or to persuade employers (wicked by
definition) ever to be "fair," they have seized upon an argument
calculated to appeal to the public's selfish motives, and frighten
it into forcing employers to grant union demands.
How are we to know, however, precisely when labor does
have "enough to buy back the product"? Or when it has more
than enough? How are we to determine just what the right sum
is? As the champions of the doctrine do not seem to have made
any real effort to answer such questions, we are obliged to try to
find the answers for ourselves.
Some sponsors of the theory seem to imply that the workers
in each industry should receive enough to buy back the particular
product they make. But they surely cannot mean that the
makers of cheap dresses should get enough to buy back cheap
dresses and the makers of mink coats enough to buy back mink
coats; or that the men in the Ford plant should receive enough
to buy Fords and the men in the Cadillac plant enough to buy
Cadillacs.
It is instructive to recall, however, that the unions in the
automobile industry, in the 1940s, when most of their members
were already in the upper third of the country's income receivers,
and when their weekly wage, according to government
figures, was already 20 percent higher than the average wage
paid in factories and nearly twice as great as the average paid in
retail trade, were demanding a 30 percent increase so that they
might, according to one of their spokesmen, "bolster our fastshrinking
ability to absorb the goods which we have the capacity
to produce."
What, then, of the average factory worker and the average
retail worker? If, under such circumstances, the automobile
workers needed a 30 percent increase to keep the economy from
collapsing, would a mere 30 percent have been enough for the
others? Or would they have required increases of 55 to 160
percent to give them as much per capita purchasing power as
the automobile workers? For let us remember that then as now
enormous differences existed between the average wage levels
of different industries. In 1976, workers in retail trade averaged
weekly earnings of only $113.96, while workers in all manufacturing
averaged $207.60 and those in contract construction
$284.93.
(We may be sure, if the history of wage bargaining even
within individual unions is any guide, that the automobile workers,
if this last proposal had been made, would have insisted on
the maintenance of their existing differentials; for the passion
for economic equality, among union members as among the
rest of us, is, with the exception of a few rare philanthropists
and saints, a passion for getting as much as those above us in the
economic scale already get rather than a passion for giving those
below us as much as we ourselves already get. But it is with the
logic and soundness of a particular economic theory, rather
than with these distressing weaknesses of human nature, that
we are at present concerned.)
The argument that labor should receive enough to buy back
the product is merely a special form of the general "purchasing-
power" argument. The workers' wages, it is correctly
enough contended, are the workers' purchasing power. But it is
just as true that everyone's income—the grocer's, the
landlord's, the employer's — is his purchasing power for buying
what others have to sell. And one of the most important things
for which others have to find purchasers is their labor services.
All this, moreover, has its reverse side. In an exchange economy
everybody's money income is somebody else's cost. Every increase in
hourly wages, unless or until compensated by an equal increase
in hourly productivity, is an increase in costs of production. An
increase in costs of production, where the government controls
prices and forbids any price increase, takes the profit from
marginal producers, forces them out of business, means a
shrinkage in production and a growth in unemployment. Even
154
where a price increase is possible, the higher price discourages
buyers, shrinks the market, and also leads to unemployment. If
a 30 percent increase in hourly wages all around the circle forces
a 30 percent increase in prices, labor can buy no more of the
product than it could at the beginning; and the merry-go-round
must start all over again.
No doubt many will be inclined to dispute the contention
that a 30 percent increase in wages can force as great a percentage
increase in prices. It is true that this result can follow only
in the long run and only if monetary and credit policy permit it.
If money and credit are so inelastic that they do not increase
when wages are forced up (and if we assume that the higher
wages are not justified by existing labor productivity in dollar
terms), then the chief effect of forcing up wage rates will be to
force unemployment.
And it is probable, in that case, that total payrolls, both in
dollar amount and in real purchasing power, will be lower than
before. For a drop in employment (brought about by union
policy and not as a transitional result of technological advance)
necessarily means that fewer goods are being produced for
everyone. And it is unlikely that labor will compensate for the
absolute drop in production by getting a larger relative share of
the production that is left. For Paul [-I. Douglas in America and
A. C. Pigou in England, the first from analyzing a great mass of
statistics, the second by almost purely deductive methods,
arrived independently at the conclusion that the elasticity of the
demand for labor is somewhere between 3 and 4. This means,
in less technical language, that "a I percent reduction in the real
rate of wage is likely to expand the aggregate demand for labor
by not less than 3 percent."1 Or, to put the matter the other
way, "If wages are pushed up above the point of marginal
productivity, the decrease in employment would normally be
from three to four times as great as the increase in hourly rates"2
so that the total incomes of the workers would be reduced
correspondingly.
1C. Pigou, The Theory of Unemployment (1933), p. 96.
2Paul H. Douglas, The Theory of Wages (1934), p. 501.
Even if these figures are taken to represent only the elasticity
of the demand for labor revealed in a given period of the past,
and not necessarily to forecast that of the future, they deserve
the most serious consideration.
But now let us suppose that the increase in wage rates is
accompanied or followed by a sufficient increase in money and
credit to allow it to take place without creating serious unemployment.
If we assume that the previous relationship between
wages and prices was itself a "normal" long-run relationship,
then it is altogether probable that a forced increase of, say, 30
percent in wage rates will ultimately lead to an increase in
prices of approximately the same percentage.
The belief that the price increase would be substantially less
than that rests on two main fallacies. The first is that of looking
only at the direct labor costs of a particular firm or industry and
assuming these to represent all the labor costs involved. But this
is the elementary error of mistaking a part for the whole. Each
"industry" represents not only just one section of the productive
process considered "horizontally," but just one section of
that process considered "vertically." Thus the direct labor cost
of making automobiles in the automobile factories themselves
may be less than a third, say, of the total costs; and this may
lead the incautious to conclude that a 30 percent increase in
wages would lead to only a 10 percent increase, or less, in
automobile prices. But this would be to overlook the indirect
wage costs in the raw materials and purchased parts, in transportation
charges, in new factories or new machine tools, or in
the dealers' mark-up.
Government estimates show that in the fifteen-year period
from 1929 to 1943, inclusive, wages and salaries in the United
States averaged 69 percent of the national income. In the fiveyear
period 1956-1960 they also averaged 69 percent of the
national income! In the five-year period 1972-1976 wages and
salaries averaged 66 percent of national income, and when
supplements are added, total compensation of employees averaged
76 percent of national income. These wages and salaries,
of course, had to be paid out of the national product. While
there would have to be both deductions from these figures and
additions to them to provide a fair estimate of "labor's" income,
we can assume on this basis that labor costs cannot be less than
about two-thirds of total production costs and may run above
three-quarters (depending upon our definition of labor). If we
take the lower of these two estimates, and assume also that
dollar profit margins would be unchanged, it is clear that an
increase of 30 percent in wage costs all around the circle would
mean an increase of nearly 20 percent in prices.
But such a change would mean that the dollar profit margin,
representing the income of investors, managers and the selfemployed,
would then have, say, only 84 percent as much
purchasing power as it had before. The long-run effect of this
would be to cause a diminution of investment and new enterprise
compared with what it would otherwise have been, and
consequent transfers of men from the lower ranks of the selfemployed
to the higher ranks of wage-earners, until the previous
relationships had been approximately restored. But this is
only another way of saying that a 30 percent increase in wages
under the conditions assumed would eventually mean also a 30
percent increase in prices.
It does not necessarily follow that wage-earners would make
no relative gains. They would make a relative gain, and other
elements in the population would suffer a relative loss, during
the period of transition. But it is improbable that this relative gain
would mean an absolute gain. For the kind of change in the
relationship of costs to prices contemplated here could hardly
take place without bringing about unemployment and unbalanced,
interrupted or reduced production. So that while labor
might get a wider slice of a smaller pie, during this period of
transition and adjustment to a new equilibrium, it may be
doubted whether this would be greater in absolute size (and it
might easily be less) than the previous narrower slice of a larger
pie.
This brings us to the general meaning and effect of economic
equilibrium. Equilibrium wages and prices are the wages and
prices that equalize supply and demand. If, either through
government or private coercion, an attempt is made to lift
prices above their equilibrium level, demand is reduced and
therefore production is reduced. If an attempt is made to push
prices below their equilibrium level, the consequent reduction
or wiping out of profits will mean a falling off of supply or new
production. Therefore any attempt to force prices either above
or below their equilibrium levels (which are the levels toward
which a free market constantly tends to bring them) will act to
reduce the volume of employment and production below what
it would otherwise have been.
To return, then, to the doctrine that labor must get "enough
to buy back the product." The national product, it should be
obvious, is neither created nor bought by manufacturing labor
alone. It is bought by everyone — by white collar workers,
professional men, farmers, employers, big and little, by investors,
grocers, butchers, owners of small drugstores and gasoline
stations—by everybody, in short, who contributes toward
making the product.
As to the prices, wages and profits that should determine the
distribution of that product, the best prices are not the highest
prices, but the prices that encourage the largest volume of
production and the largest volume of sales. The best wage rates
for labor are not the highest wage rates, but the wage rates that
permit full production, full employment and the largest sustained
payrolls. The best profits, from the standpoint not only
of industry but of labor, are not the lowest profits, but the
profits that encourage most people to become employers or to
provide more employment than before.
If we try to run the economy for the benefit of a single group
or class, we shall injure or destroy all groups, including the
members of the very class for whose benefit we have been
trying to run it. We must run the economy for everybody.
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