Why Fair Pay Agreements were never going to work

Roger Partridge
NZ Herald
14 December, 2023

The demise of the last Government’s Fair Pay Agreement legislation is a cautionary tale for policymakers. Death and taxes are sometimes called the only certainties.

But so, too, are the iron laws
 of economics. Governments ignore them at their peril.

As I wrote last year in this column, the FPA policy has always been a lemon. It was born of wishful thinking. Labour's idea was that the government could improve the country's productivity and prosperity by introducing compulsory collective bargaining to increase wages above market rates.

However, there is no economic evidence that regulating for higher wages will make a country more prosperous. Conversely, there is plenty of evidence to the contrary.

Litany of problems

The New Zealand Initiative's 2019 report, Work in Progress: Why Fair Pay Agreements would be bad for labour, chronicled a litany of problems with the FPA policy.

Setting terms and conditions of employment across entire industries or occupations under a system of FPAs would reduce labour market flexibility. It would lock in practices that are unsuitable or inefficient for specific workplaces. It would also add cost and complexity. Productivity would suffer as a result.

It is little wonder that the OECD has cautioned that centralised bargaining systems like FPAs are associated with lower productivity growth if coverage is high. Rather than advancing the former government's laudable vision of a high-wage, high-productivity economy, FPAs risked undermining it.

Workers also faced harm from FPAs. If FPAs successfully force up wages beyond market rates, that might be good news for workers who remain employed. However, higher labour costs from FPAs would lead to job losses in those firms unable to recoup those costs from consumers. Worse still, the burden of job losses usually falls disproportionately on the young.

Higher wage rates also raise the hurdle for the unemployed, particularly inexperienced and unskilled workers, looking to enter the labour market.

FPAs also risk harm to consumers from firms increasing prices for goods and services to recoup their increased labour costs. In the midst of a cost-of-living crisis, this is another reason why FPAs were a bad idea.

Official advice against FPAs

Over the past fortnight, some commentators have focused on language cherry-picked from a leaked Cabinet Paper about possible downsides of repealing FPAs. But Government officials have hated the idea of FPAs from the outset.

Advice from Treasury in 2019 to then Workplace Relations and Safety Minister Ian Lees-Galloway, questioned the rationale for introducing FPAs. Treasury pointed to the absence of evidence for the wage and productivity concerns the Minister claimed FPAs were intended to address. Even if those problems existed, Treasury said it could not see a "strong case" that FPAs were the most appropriate policy response.

The Regulatory Impact Statement on the FPA Bill from the Minister's own department, the Ministry of Business, Innovation and Employment, was similarly sceptical.  MBIE said that the Minister's proposed FPA system was not its "preferred" approach.

Instead, MBIE favoured strengthening the existing system and, only where justified, setting targeted sector-based standards.

While saying the case for FPAs was "weakly positive", MBIE also said "the approach has significant downside risks" and that "it is unclear the system would always have net benefits".

The regulatory impact assessment catalogued multiple risks with the government's proposals: FPAs were "not well targeted" and "may create significant labour market inflexibility". When used in sectors without demonstrable labour market issues, "costs for employers and displaced workers…could outweigh benefits".

Officials also warned that "the compulsory nature of FPA bargaining and the bar on industrial action may not comply with New Zealand's international labour obligations."

Though, noting the FPAs could lead to increased wages, MBIE warned that the higher costs may be passed on to consumers. Higher costs may also hurt employees "if employers reduce hours of work, reduce the size of their workforce or do not hire as many workers to remain competitive." MBIE's assessment also warned that FPAs would likely reduce productivity growth, with "potential impacts on innovation, productivity, and competition".

In case these warnings were not clear enough, MBIE's assessment recorded that "the OECD Economics Department structural reform quantification simulator suggests that the reforms would reduce GDP per capita in the long run, the more so, the greater the extent of the agreements".

As I have said in this column before, it is hard to conceive of a more damning conclusion from public servants.

Unfortunately, these complexities were glossed over in the past fortnight's commentary on the leaked Cabinet Paper proposing to repeal the FPA laws from the new Government's Workplace Relations and Safety Minister Brooke van Velden.

Instead, commentators highlighted the Cabinet Paper's observation about the workers who might benefit from potential higher wage rates resulting from FPAs. Because FPAs target industries with workers on low incomes, they disproportionately affect marginalised workers.

Yet, this is only a small part of the FPA story. Officials' repeated reservations about the downsides of FPAs were simply ignored.

Good news

So, where does the demise of FPAs leave the New Zealand labour markets? Happily, the short answer is well-placed.

Judged by their results over the last three decades, our labour markets have been working very well. Our unemployment rate has been low compared with our OECD peers. Our rate of job creation is the third highest in the OECD. Labour market participation rates have consistently been amongst the highest in the world. And at a time when wages for low-income earners have been stagnating in some OECD countries, the OECD has singled out New Zealand (along with Denmark) as counties where real median wage growth has closely tracked productivity growth.

Against this background, perhaps the best that can be said about Labour's FPA legislation is that it barely outlived the terms in office of the two Labour Ministers who championed its introduction, Iain Lees-Galloway and Michael Wood.

If only poorly thought-through regulations always faced such a speedy demise. But then, it is rare that new laws fly in the face of such overwhelming economic evidence.

Perhaps that is the moral of the FPA story.

Workplace Relations and Safety Minister Brooke van Velden is the only member of the New Zealand Parliament with a degree in economics. She, more than anyone, understands the importance of realigning New Zealand's labour market settings with the laws of economics. We should wish her a more assured future than her predecessors.

With her Bill to abolish FPAs, she has got off to a good start.

To read the article on the NZ Herald website, click here.

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