A labour market reform that would improve productivity growth

Roger Partridge
NZ Herald
22 June, 2021

Readers of this column will be only too well aware why the Government’s proposals to return to compulsory, occupation-wide collective bargaining (misleadingly dubbed “Fair Pay Agreements”) will damage New Zealand’s already fragile productivity growth.

The evidence is set out in black and white in The New Zealand Initiative’s 2019 report, Work in Progress: Why Fair Pay Agreements would be bad for labour.

But that does not mean New Zealand’s labour market settings are as productivity enhancing as they could be. Indeed, there are good reasons for believing the breadth of the unjustified dismissal provisions in the Employment Relations Act 2000 (ERA) is acting as a handbrake on productivity growth.

Unjustified dismissal laws first emerged in New Zealand in the 1970s. The premise was that the common law of contract lacked sufficient safeguards for vulnerable workers against capricious or arbitrary conduct by management.

The Bolger Government’s Employment Contracts Act 1991 (the ERA’s predecessor) extended unjustified dismissal protections to all employees, even highly paid senior management. Previously, an employer could terminate a job by giving the employee contractual notice without having to provide a reason.

But statutory unjustified dismissal provisions create difficulties for businesses when applied to highly paid managers and executives. As countless boards and business owners will attest, the difference between C-grade and A-grade managers may very well be the difference between business success or failure. Between preserving the jobs of ordinary workers or losing them. Yet mediocrity is no longer enough to justify a dismissal.

Consequently – and paradoxically – laws introduced to protect the jobs of ordinary workers may be placing those jobs at risk.

Evidence for the harmful effects of overly restrictive employment protection laws may also explain a Productivity Commission finding in its report, An International Perspective on New Zealand’s Productivity Paradox. Published in 2014, the Commission singled out the low quality of managerial capabilities as a cause of the country’s poor productivity growth record.

High-income earning managers are also adversely affected by statutory unjustified dismissal procedures. Because employment protection laws make it costlier to fire an employee, employers are more cautious about hiring new staff. This makes it harder for the marginal manager to gain employment. And firms pay staff less because firms carry the burden of the employment arrangement going wrong – with the associated costs of complying with the statutory dismissal procedures.

Society also suffers from excessive employment protections. Because stringent job dismissal regulations adversely affect productivity growth, they hamper both prosperity and overall wellbeing.

An Australian solution

Across the Tasman, Australia deals with the unjustified dismissal paradox by excluding employees earning above a specified “high-income threshold” from the protection of its unfair dismissal laws.

In New Zealand, a 2016 private members’ Bill proposed to allow firms and high-income employees to contract out of the unjustified dismissal regime.

However, the contracting out mechanisms proposed in the Bill were cumbersome. The Bill also had no mechanism for the high-income threshold to adjust in line with increases in median incomes. And those opposing the Bill considered the proposed $150,000 threshold for determining who was a “high-income earner” to be too low. This despite it mirroring the current A$150,000 threshold in Australia. The Bill was voted down following the change in government in 2017.

This week, The New Zealand Initiative published a research note making the case for the government to reconsider the issue. Nothing costs nothing: Why unjustified dismissal laws should not apply to the highly paid sets out the economic arguments for New Zealand introducing an Australian-style carve-out for high-income earners from unjustified dismissal protections.

To avoid the criticisms of the earlier Bill, the Government should raise the high-income threshold from approximately $150,000, to $250,000. This is more-or-less the starting salary for Ministers of the Crown. Unlike other senior roles, Ministers serve at the Prime Minister’s pleasure and can be dismissed without justification.

The $250,000 threshold would catch less than the top 1% of income earners. Yet it would capture the CEOs and senior management whose roles have the most significant impact on productivity.

In place of the cumbersome contracting out mechanisms in the 2016 Bill, the Government should seemly exclude employees who earn over the high-income threshold from relying on the unjustified dismissal provisions. Regulations should permit the threshold to be adjusted annually to track movements in median incomes. To compensate for employees’ inability to bring personal grievances alleging unjustified dismissal, the contractual right to bring actions for wrongful dismissal should be reinstated.

Unjustified dismissal protections are a fundamental aspect of New Zealand’s industrial relations landscape. And for obvious reasons. No one wants vulnerable workers being unjustifiably dismissed.

But nothing costs nothing. Unjustified dismissal protection comes at a cost. Employees receive lower incomes. Work is put at risk. And society is poorer due to the adverse effects of unjustified dismissal laws on productivity.

Economic theory suggests these latter costs are higher for high-income earning employees. Following  Australia’s lead and exempting high-income earners from the protection of unjustified dismissal laws would be a win: win for firms and workers.

And with one fewer handbrake on New Zealand’s tepid productivity growth, overall wellbeing would be a winner too.

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