Do residential care workers deserve the big pay increase they are getting?

The recent historic pay equity deal for aged and residential care workers raises a tricky clash between quite different accounts of how the economy should work. Many people think that workers should be paid at a rate that reflects their social worth; others – mostly economists – think they are paid at their marginal product,  which I explain below.

It is easy to believe that your rate of remuneration measures your social worth – if you are on a high income. But is a person who earns $2m a year, say, a hundred times more valuable to a community than someone on $20,000? Are they even more valuable? Positive economics cannot answer that question; for it involves a value judgement which a scientist cannot make.

There is an economic argument which says that, under a particular set of assumptions, a person’s income equals their marginal product, that is the value their effort adds to the economy. While this can easily be explained in, say, a first year economics course, it turns out to be a circular argument. A wage may equal marginal product but how do we know what is the value of the marginal product? The answer is that it is measured by the wage the market pays.

It also ends up with paradoxes. We do not generally pay for parenting so is it valueless? Surely not. A couple of housewives take in each other’s washing and pay each other and suddenly their value to the economy increases. Again, surely not. Every time one gets a wage rise – as building workers are currently receiving because there is a shortage of them – does the same job becomes more valuable? Really?

Economics has a sophisticated theory of how prices and wages are set but it does not say anything about social value. (To confuse matters, when such things were more muddled in the nineteenth century the theory of price determination was called ‘value theory’ and it still is.) Hence the claim that ‘economists know the price of everything and the value of nothing’. To which they can justly retort that ‘we do know the difference’.

Despite the careful work of economists, the public continues to confuse the two. My guess is that were we to survey what people thought jobs were actually worth, the  sum total of their assessments would exceed the total market production of the economy (even though they may think some jobs are overpaid  – e.g. economists’, financiers', journalists’, politicians’). They are talking about different things: value is not price.

You may be pleased that those residential care workers are getting a pay boost. It is, if I may say so, often a shit job and I am constantly surprised by the cheerfulness and commitment of those I meet doing it. But are they being paid at what they are socially worth? When I think about the question rigorously, my answer is that I do not know.

So is their pay hike, of between around 15 and 50 per cent depending on their qualifications and experience, justified? I am going to delve into another bit of economics to explain why I think it might be.

It involves the notion of monopsony, a kind of monopoly which is the sole purchaser of, in this case, labour. It can use their market power to depress the price (i.e. wage) of what is being purchased because the sellers have no alternative.

It happens that, for all intents and purposes, there is a monopsonist in the residential care industry. The bulk of the funds of residential care suppliers are provided by the government. Which is why the government has to legislate and fund the new system.

Frankly, I am embarrassed that my government uses its brute market power to suppress wages of those who are, in effect, it employees. Sure, as a taxpayer I have been a beneficiary – on average by $2 to $3 a week – but I have never got any pleasure by passing a false coin. (Okay, I have introduced a value judgement, but I have been open about it.)

Up to 1988 the government was scrupulous about not using its market power when setting the wages of its direct and indirect employees. There was a complicated system of benchmarking. For instance, the pay rates in New Zealand Railways were set by a comparison with comparable occupations in the private sector. (There was high inflation at the time and other public sector payrates – including those of university teachers – were indexed to the railway ones. But every five years or so they went through a separate benchmarking exercise.) The government then passed on to the relevant department (or whatever) the funds to enable the maintenance of the parity.

In 1988 the government switched to a system where it granted each department an annual sum and told them to set their own payrates. By squeezing the amount it provided, the monopsonist could squeeze the pay of those it employed. That was, in effect, the finding of the courts in the case of residential care workers.

Does this mean we are inching back to a benchmarking regime? I am not sure. There are, no doubt other occupations queuing for a similar treatment. (This issue really only applies to the public sector, not the private sector.)

There is one final bit of economics to add. A number of commentators have suggested that the new payrates for residential care workers will flow into other sectors. They may to some degree, but I would be cautious.

Equal pay for public servants was introduced in 1960. It was a response to a disgraceful case involving Jean Parker, an employee of the Inland Revenue Department, who having successfully appealed against a less qualified man being promoted ahead of her, had her salary cut. (Mrs Parker was then the sole earner for the household, her husband being a student.)

There is no evidence that the 1960 pay hike for women in the public sector flowed into the private sector. As a consequence an Equal Pay Act for the private sector had to be passed in 1972.

The economist’s explanation is called ‘balkanisation of the labour market’. which observes that labour markets are segmented and that people do not readily switch from one to another (thus there will not be too many railway workers – or university teachers – who are going to become residential care workers). That means that wage differentials between markets do not rapidly disappear by people moving between them.

Damn, there goes another neoliberal assumption. Actually the whole of this column is about labour markets being far more complex than we pretend. And that we certainly should not confuse a person’s value to society with how much they are paid.