[From Understanding the Dollar Crisis (1973)]

There is today a popular idea that employers exploit the workers. This fallacy has been growing ever more popular since the days of Marx. My second lecture touched upon it briefly when I discussed the labor theory of value and Marx's idea that employers overworked employees, paying them less than the values they produced, while keeping the difference for themselves. According to this theory, the rich employers get richer and richer while the poor workers get poorer and poorer. The time would come, Marx held, when the workers would break the chains that bound them to their employers and set up a socialist utopia. According to this idea, in a market society the poor worker is helpless. He has no choice. He must take the wage that is offered to him. There is no other employer who might bid for his services.

Actually, of course, that is not so. Free market economics teaches that in the absence of any social interference, workers tend to get the full value that consumers will pay for their contribution. It is the interferences by governments and the interferences by labor unions, supported by public opinion, even without the strength of laws, that prevent all potential workers from getting those market values they could contribute to society.

If the idea that unions help all workers is popular, then we are powerless to stop them from hampering the market competition. However, in an unhampered free market economy, competition tends to allocate to every factor of production, including workers, all that they contribute. It is the values that the ultimate consumers place on each particular contribution to total production that determine what businessmen can pay for that particular contribution. We tried to show this in the last lecture in relation to prices. The same principles apply to the wages paid for labor that apply to the sums paid for raw materials or any other factor of production.

In a free market, each employer seeks to hire as many workers as he profitably can. He hires employees up to the point at which it is no longer profitable for him to hire an additional worker because he cannot sell the product of that additional worker for the wage he must pay. As he hires more workers, the wage rate tends to rise, and as more units are produced, the market price he can get per unit tends to fall. This is the market tendency we tried to illustrate in the last lecture. The more workers you hire, the higher the wage rate you will have to pay. And you must pay the higher wage to all who do similar work.

As you produce and offer more goods on the market, you can sell them only at lower prices. Eventually you reach the marginal point, where you make no profit on the last man you hire. Wage rates are ultimately set by the marginal productivity of labor, that is, the market value added to the product produced by the marginal employee, the last man hired. This is the way the free market would work, if it were allowed to work. Unfortunately, as mentioned last night, the free market is something that we have never had completely at any time and may never have. However, the nearer we get to it, the better off we shall all be.

Given the conditions the employer faces, he must pay workers pretty much the values that consumers place on their contributions. If the employer pays a higher wage, he suffers a loss. If he does not then reduce his wage rate, his number of employees, and his production to the point where he can sell all his products at a price that covers his costs, he will eventually be forced out of business. No businessman can long pay costs that he cannot get back from consumers.

In the long run it is the consumers who pay the wages. The businessman is merely a middleman. He tries to make a profit as a middleman, buying raw materials, hiring workers, and selling the products to consumers. He makes his profit, if any, by holding what he pays for the factors of production below what consumers will pay for the final product. However, once a profit appears, competitors continually bid up what must be paid for each factor of production, including labor. There is always a tendency in a free market for profits to be squeezed and disappear. This includes any profits obtained by paying workers wages lower than the market value of their contributions.

Free Competition Protects Workers

It cannot be denied that employers would always like to pay lower than market wages. In his great book, The Wealth of Nations, published in 1776, Adam Smith mentioned that whenever businessmen get together they try to set wages and hold them down. However, in the free market, they are unable to do so. It is just not possible for all employers to get together and hold wage rates down by agreement for any length of time. Once one employer finds he can profit by breaking such an agreement he will probably do so. If none breaks the agreement, and if it is a free market society wherein anybody can become an employer, new employers will soon appear to take advantage of the situation by offering workers higher wages.

If the employer pays a wage lower than the market wage, that is, less than the product of the worker can bring in the market, his profits will be such that he can expand his production and his number of employees. If he fails to do so, and fails to raise his wage rates in doing so, he will invite new competition. In either case, market competition will raise the wage rates to the value produced by the marginal employee. And there is always a marginal employee.

In most industries there are also marginal companies. These are the companies that are just breaking even. If their costs go up a little bit, they will suffer a loss. Then they will soon be out of business, because money losers cannot stay in business indefinitely.

No businessman in a free market society can long pay a worker 50 pesos an hour and sell his product for 100 pesos an hour. Why not? Because you and I and thousands of others like us would be very happy to go into that business, pay those men 60 pesos and sell their product for 100 pesos if we could. Others would soon offer to pay them 70, 80, or 90 pesos. In fact, large corporations would be very happy to make a profit of just one peso an hour for every worker they employ. They are just not able to pay them much less than the market value of their product. The last one employed would not yield them any profit, particularly in a free society where anyone who thinks he sees a chance to make a profit can come in and bid away any employee who is paid less than the market value of his contribution.

A frequent refutation is, "Yes, but most people do not have the capital to start a business." Let's remember that there are many savers eager to invest their money where they can earn more. If they can be shown a situation where they can earn more, they will be happy to make the needed capital available. All you need to do is to show them where a profit higher than current interest rates can be made.

Whenever there is a profit in a free market society, it attracts competition, and competition always reduces prices. This is constantly going on in the market. If you do not believe this, get into the stock market and learn what is happening there as the result of competition among the many investors eager for higher returns on their savings.