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So all right, we’ve now seen how the market dictates how much sellers can charge for their products, via forces like competition and demand elasticity (i.e. customers’ willingness to stop buying a product if it gets more expensive). But consumer prices are just one of the aspects of the economy that people care about; another concern that they often care about even more is their own paychecks. So how does the market mechanism work in this area, where the “seller” in question isn’t a company selling a product, but is instead an individual worker selling their labor? How do market forces determine how much money a worker is able to command when they go to work for a company?

Well, as it turns out, it’s basically exactly the same story – because in the broadest sense, a worker selling their labor to an employer isn’t all that different from any other kind of seller selling a good or service to a buyer. When a worker goes to work at (say) a hair salon for eight hours a day, they’re essentially selling eight hours’ worth of their hair-cutting services to the owners of the salon for a particular price (i.e. their wage), in just the same way that the company then goes on to resell those hair-cutting services to customers. Naturally, the salon is able to charge the customers more than the worker is able to charge the salon, because the salon has added extra value to the worker’s labor – they’ve supplied the worker with specialized equipment (clippers, curling irons, hairspray, etc.) to improve the quality of the haircuts, a safe and comfortable venue in an easy-to-find location to attract more customers, a reputable brand name to reassure those customers that the person cutting their hair has been well-vetted and trained up to a particular standard, and so on. All of these things enable the worker to attract more customers, offer better haircuts, and thereby earn more money than if they were operating independently, cutting people’s hair out of their garage with an ordinary pair of scissors and nothing else – so in exchange for all this, the worker willingly agrees to let the salon take a cut of the revenue they produce cutting hair. From the worker’s perspective, then, it’s as if they’re still operating as a kind of independent firm unto themselves, and are simply “renting” all the extra accoutrements from the salon on a day-to-day basis, as just another tool for more effectively (and profitably) supplying haircuts to their customers. The company’s function, in other words, is simply to act as a “productivity multiplier” for the worker. And as a result of this enhanced productivity, the worker ultimately comes out well ahead of where they’d be without the employer, while the employer likewise comes out ahead of where they’d be without the worker – so it’s ultimately a win-win for both sides.

(You can apply the same basic model to other kinds of labor as well – like a worker taking a job at a bicycle factory because its advanced machinery allows the worker to build bicycles far more productively than if they were trying to build them by hand, or a worker taking a job in the kitchen of a restaurant because its ability to buy ingredients in bulk and utilize multiple co-workers for a more efficient division of labor allows the worker to cook meals far more productively than if they were trying to do so all by themselves in their own kitchen, etc. In these examples (unlike in the hair-cutting example), we’ve introduced the additional element of raw materials, supplied by the employer, which the worker then converts into a finished product – but this doesn’t really change the fundamental nature of the employment contract. Essentially, all that’s happening is that the employer is temporarily selling those raw materials to the worker at the start of each shift, letting the worker apply their labor to the raw materials in such a way as to increase their value by turning them into a finished product, and then buying that finished product back from the worker at a slightly higher price before reselling it to customers – with that difference in price (between when the employer first sold the raw materials to the worker and when they bought the finished product back from them) being the worker’s wage.)

Now, we could imagine a world in which workers refused to ever enter into employment contracts with larger employers in this way, and always tried to go it completely alone instead. Rather than going to work at an established workplace, they’d have to find a place of their own to do their business; rather than using the equipment provided by an employer, they’d have to buy all their own equipment; and so on. All of this would require capital – which would mean, in most cases, going to a bank or some other lender and taking out a loan. But just being a random unknown person, the typical worker would probably have a much harder time getting favorable terms on that loan than they would if they were a large, well-known company. The lender would perceive them as a greater risk, and would therefore charge a higher rate of interest in order to compensate for it. Consequently, the worker would probably find that it would be more expensive (and just less desirable all around) to take out this loan and buy all their own productivity-enhancing accoutrements for themselves than it would be to simply “rent” them on a day-to-day basis from a traditional employer by going to work for them. In the latter case, the employer would still be lending the worker what they needed to do their job and earn a living, just like a more traditional lender would be; but unlike a traditional lender, they’d have the added advantage of being able to specify how exactly they’d want the worker to do the job, and would be able to more directly monitor their performance, and so on – which would mean that the “loan” would constitute less of a risk in their eyes, and so they’d be able to comfortably “charge” the worker less for it than what a traditional lender might want to charge. Again, compared to the alternatives, it’d be a win-win arrangement for both the employer and the worker.

(Of course, I should emphasize that this isn’t necessarily true in every case, obviously, as some individuals are in fact able to get past this issue of capital and successfully launch their own startups, leading them to prosper more than if they’d chosen to work at an already-existing company. In fact, it seems like such exceptions are becoming increasingly common in this digital age where huge up-front investments in physical assets like machines and real estate aren’t as necessary anymore. But even so, the general rule still seems true for the majority of workers who do their work in more normal contexts.)

Critics of the free market will often argue that the relationship between businesses and their employees in a market economy, like the relationship between businesses and their customers, can only ever be exploitative. And I do think it’s fair to say that in some cases, they’re right; exploitation certainly can exist in some contexts (which we’ll discuss later). But the idea that the employer-employee relationship is always necessarily exploitative is, I think, based on the same kind of misunderstanding as the idea that the relationship between sellers and buyers is always necessarily exploitative – because again, these two kinds of market transactions are basically just different versions of the same thing; and they can be positive-sum for the same reasons. Alexander phrases the pro-market argument (for both producer-consumer transactions and employer-employee transactions) in this way:

In a free market, all trade has to be voluntary, so you will never agree to a trade unless it benefits you.

Further, you won’t make a trade unless you think it’s the best possible trade you can make. If you knew you could make a better one, you’d hold out for that. So trades in a free market are not only better than nothing, they’re also the best possible transaction you could make at that time.

Labor is no different from any other commercial transaction in this respect. You won’t agree to a job unless it benefits you more than anything else you can do with your time, and your employer won’t hire you unless it benefits her more than anything else she can do with her money. So a voluntarily agreed labor contract must benefit both parties, and must do so more than any other alternative.

Now of course, this version of the argument oversimplifies things quite a bit, as Alexander goes on to explain in the rest of his post. It’s not quite as simple as “Anything that two parties agree to must automatically be good by definition.” But even so, it does reflect some basic ideas that are fundamentally true: If you’re charging more for your services than what a buyer values them at, they won’t buy your services at all. If you’re charging less than that, but still more than what someone else who’s also selling the same thing is charging, the buyer will buy from that other person instead of you. If you want to sell something at all, then (whether it be a physical product or your services as a worker), you’re probably going to have to sell it for close to the minimum amount that would make it a better option for you than any of your other available alternatives. Either that, or what you’re selling will have to be unique or scarce enough that the buyer can’t easily buy it from someone else – which, in the case of working a job, means either acquiring a skill set that not many other people have, or else being willing to do an unpleasant job that not many other people are willing to do.

Within this framing, we can start to see the basic mechanisms through which the market determines how much workers can charge employers for their services (i.e. how high a wage they can command). Ultimately, as with any other market transaction, it all comes back to supply and demand. Let’s dig a little deeper into these forces, then, starting with the supply side of the equation.

Continued on next page →