Lessons from the Labor Markets

By Epstein, Richard A. | Chief Executive (U.S.), July/August 2007 | Go to article overview

Lessons from the Labor Markets


Epstein, Richard A., Chief Executive (U.S.)


What to do about class actions and employment discrimination. BY RICHARD A. EPSTEIN

In general, most CEOs accept the basic proposition that free competition in both capital and labor markets is the surest road to social prosperity and business success. Speaking in the most general terms, U.S. capital markets (with the notable exception of Sarbanes-Oxley) are freer now than they were 50 years ago. Labor markets are not. Without question, labor markets were severely compromised by two major 1960s legislative reforms, seemingly unrelated at the time. The first is the expansion of the class action, both in federal and state courts. The second is the ever-greater regulation of the employment relationship, particularly through the modern antidiscrimination law, which has carved a huge hole in the principle of freedom of contract.

Let's start with the substance and then turn to the procedure. The great engine of U.S. economic productivity rests on the ability of employers and workers to set mutually agreeable terms on wages and conditions, largely without state intervention. Freedom of contract in labor markets creates a win-win situation. The employer values the worker's services more than the salary it pays; the worker values the salary and the opportunity more than the demands of the job.

The parties are the sole judges of their own interests, and they are protected against exploitation by being able to quit or fire without explanation-on what is commonly termed a "contract at will." The contract at will has many vocal critics today. Their central complaint is that this arrangement is the outgrowth of unequal bargaining power that leaves the worker with little or no job security. That bargaining power conception is largely incoherent, however, because it cannot explain how supply and demand come into equilibrium, or why wages rise when supply is tight.

Unfortunately, catchy phrases often lead to unwise proposals, in this instance a legal rule that allows firms to fire workers only "for cause," a term which sounds a lot clearer on paper than it turns out to be in practice. Unfortunately, this proposal would create a de facto civil service that would make it impossible to reconfigure work forces to meet the challenges of a fast moving marketplace. Nor does this proposal help workers as a class. In my view, their best protection against employer abuse lies in their ability to switch jobs.

Ideally, all protections for both the firm and the worker should depend on a fair reading of the labor contract in its social setting, not on external state commands that impose non-waivable obligations on the parties. That older, largely judge-made system is easy to understand and cheap to operate, and it avoids the greatest peril that managers have to face: being second-guessed in court years after any disputed personnel decision is made.

In general, that view has not prevailed in the U.S. Yet, ironically, our labor markets are less regulated than those, say, of Europe- where employees in France work a maximum 35-hour workweek- that have led to civil-service-like rigidities in private firms, coupled with management versus labor strife, both leading to the endemic levels of high unemployment.

Employment Discrimination Laws

Nonetheless, outdoing the Europeans hardly amounts to a clean bill of health. Let's look at the key development of the 1960s: The antidiscrimination laws based on race and sex joined shortly thereafter by prohibitions based on age and disability. On their face, the protection these laws extend to "any individual" seems to limit the ability of firms to adopt voluntary affirmative action. Indeed, most CEOs have consistently supported carving an exception for these programs into the civil rights laws, and for good reason: They amount to a partial repeal of the 1964 Act that increases a firm's control over its own hiring.

Yet other developments under the 1964 Civil Rights Act and its progeny should, and do, send shivers down the spine of any responsible CEO. …

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