If all employees were paid the market wage, there would be no unemployment. Well, maybe some unemployment, because there are always people who are in between jobs for one reason or another. They are looking for work and not willing to accept the first thing that comes along, so there is a period during which they are unemployed, even when there is no doubt they can eventually find something. Even when demand for labor is strong, people quit, get laid off and get fired. Businesses fail, government agencies are abolished, etc. There is always a minimum amount of unemployment, what economists call “natural” unemployment.
The market wage is the least amount the employer must pay to attract and keep a full work force. In the private sector, these “low” wages allow employers to reduce the price of their products and increase sales. To keep up with demand, they have to hire more workers. In the public sector, reducing wages to the market rate reduces the tax burden on citizens, leaving them more money to spend on other stuff. Producers of that “other stuff” have to hire more workers to keep up with demand. This is how the market wage reduces unemployment.
I know it is counter-intuitive, but lowering wages to the market rate increases the average real wage. That is partly because the calculation of the average includes fewer unemployed workers - workers whose wages are zero - and partly because prices are lower. More people working means total production is higher, and since production and income are two sides of the same coin, total income is higher.
But wait, there's more. Putting the unemployed back to work not only eliminates their downward pull on the average wage, but also reduces the social costs that go with unemployment. So at the same time the average (real) wage goes up, taxes go down.
The lower prices that come from a free labor market also help our trade balance. Foreign demand for U.S. products goes up, causing exports to increase, and imports decrease because U.S citizens increasing “buy American” – not as a show of patriotism, but because U.S. products are the best bargain.
We have an example here in Michigan that demonstrates how the market wage creates jobs. (My "Point of View" on the matter was published in the Lansing State Journal on October 3, 2010.) In 2007, the United Auto Workers signed new 4-year contracts with Chrysler, Ford and GM. One provision created a 2-tier hiring system which allowed new production workers to be paid $14 per hour rather than the $28 veteran production workers were getting. This was a huge concession on the part of the UAW, but although the bankruptcies of GM and Chrysler were still a couple of years away, the automakers were already struggling and the UAW knew that they had to come up with some way to help keep them in business. The first tier $14 per hour jobs were to be restricted to "non-core" work such as material movement, general stores management, finished vehicle driving, chemical management and subassembly. However, a special agreement was made in regard to the idle GM plant at Lake Orion, Michigan. GM promised to move production of the subcompact Aveo from South Korea to Lake Orion if the union allowed GM to allocate 40% of the production jobs to first tier workers. In June 2010, in his final speech to the UAW after eight years as president, Ron Gettelfinger said that because union sacrifices had made wages more competitive, GM would soon be the first automaker to assemble a subcompact car in the U.S.
The Aveo, which starts rolling off the production line this fall (2011), got a redesign and was renamed the Sonic. The plant will have 1,550 hourly and salaried workers – U.S. jobs that would not have existed without the wage concession. The Center for Automotive Research estimates that each new production job creates as many as 6 additional jobs – “indirect jobs, such as goods and service suppliers and their suppliers, and . . . consumer expenditure-induced jobs, which result from the direct and indirect employees spending their earnings.”
We can assume that $14 per hour UAW workers in other plants can take some of the credit for the post-bankruptcy resurgence of the domestic auto makers even though they comprise only about 7,000 of the 112,000 hourly workers at GM, Ford and Chrysler (Detroit Free Press, August 15, 2011). Not only that, but the lower wage may be encouraging foreign automakers to make new investments in the U.S. Volkswagen is building a new plant in Chattanooga, Tennessee where workers will be paid $14.50, according to a July 7, 2011 report from The Associated Press.
Is $14 the market wage for production workers in auto plants? It seems so. Although there have been reports in Michigan of high turnover rates for second-tier workers, it has also been reported that there is no shortage of applicants for those jobs – understandable when there are 488,000 unemployed in Michigan (May 2011). In the AP report mentioned above, an employee of an already-operating Volkswagen plant in Chattanooga says the pay is fair and the benefits are generous. When VW announced 2000 job openings at the plant paying $14.50 per hour, 85,000 applications were received (Reuters, 9/22/2011). And a July 10, 2010 NPR report quoted a $14 per hour worker at GM’s Lordstown, Ohio plant as saying "This is like the best job around the area, and it's very hard to get in, so I'm very fortunate and lucky to get in here." More recently, a story about Ford’s Louisville Assembly Plant (Detroit Free Press, August 27, 2011) said:
Memo to the nearly 17,000 people who applied last month for $15-per-hour Ford factory jobs: If you haven't heard by now, Ford will not be calling . . . With 30 times as many applicants as available jobs, "You have to be really lucky to get one of those spots," said Rick Elliott, who had hoped to leave his $9-per-hour security guard job for the $15.51 hourly starting pay at Ford . . . Without overtime, the new Ford jobs would pay more than $30,000 per year. That's a far cry from the more than $55,000 per year -- or $28 an hour -- Ford pays current UAW workers, but the health care and other benefits under the UAW contract are better than workers are likely to find elsewhere.
Volkswagen and several other “foreign transplants” have been producing automobiles in the southern U.S. for years, and they paid $21-26 per hour, about twice the local rate for factory work, just to keep the UAW at bay. They didn’t have to pay much less, because without the legacy costs of the domestic manufacturers, they still enjoyed a substantial labor cost advantage. It will be interesting to see if the established factories reduce wages now that more and more workers are being hired by the domestic manufacturers at $14 per hour. If not, that cost advantage will shrink until it disappears altogether.