Era of contractual relations

Lee Young-hee, Professor emeritus at Inha University, passed away last week. He served as labor minister in the Lee Myung-bak administration from February 2008 to September 2009. Strikes took place frequently at the industrial sites of major manufacturers during his term. The companies and unions waged a tense tug-of-war during the early stage of the new administration with a backdrop of a global economy struggling to survive a major financial meltdown. The strikes in 2008 translated into a loss of 89,000 working days, the highest in a decade. Since then, working days lost through labor disputes decreased by 20 percent, thanks largely to the late Lee’s efforts.

The former professor of labor law worried that the gap between large and smaller companies would widen if left unattended. After he retired, he told me that there was a bigger universal labor right than the rights to organize, collective negotiate, and strike. He said it was a right that is taken for granted. He was talking about the right of every worker to work. He said the hardest part of his job was getting this simple common rule to work as the right to work was often undermined and disregarded.

A society could be healthy if the rights of both employees and management were well protected and the duties were dutifully followed in accordance with joint agreements, he used to say. The priority of public labor policy should be to ensure the agreements are respected and administered. There won’t be disputes if people are allowed to work and paid rightfully, he claimed. But in reality, irregularities are common and force can be exerted, leading to a disregarding of the agreed upon terms. Those with power tend to change agreements to their favor. Such practices snowball and irregularities spread.

The term contract sounds cold and inhuman. It does not have a warm connotation. This year’s Noble Prize in economics went to Oliver Hart, a British economist teaching at Harvard University, and Bengt Holmstrom, a Finnish economist teaching at the Massachusetts Institute of Technology, for their contributions to building contract theory to explain the functioning of modern societies. They theorized how poor and imperfect designed contracts can lead to moral hazard and innovation-lacking enterprises. Optimization of contractual arrangements by ensuring the control rights of concerning parties can prevent breakdowns in relationships and companies. Good contract design can make a happier society, Hart argued.

Contract theory has big implications for a labor market unsettled our the fast evolution toward the so-called fourth industrial revolution. In a new age, conventional concepts of an enterprise and workers become blurry. A company outsources work and technology for inspiration or to save costs. It consigns work to outside members and rewards them instead of relying on its inner resources. The employees can feel isolated and redundant. Online transportation network company Uber is a good example of how an independent contract driver becomes both an employer and employee depending on his or her resourcing capacity.

Contracts can guarantee fairness in such an ambiguous industrial age. In a contract, the output is prioritized over input. The traditional reward system where labor is paid according to the working hours would no longer stand. The age when the amount of invested labor and capital mattered is no more. What comes out would count more. The more innovative the outcome, the bigger the reward. The income of a company and worker, therefore, would hinge entirely on the output. It is why a pay system where salaries are given out based on an annual output and achievements instead of mechanical increases according to the working years is being preferred.

We are entering an era of contractual relations instead of industrial relations. In traditional industrial relations, the raised fist overruled. The union enjoyed mighty power backed by its physical and vested power. Contracts are weakened by the use of force. When the powerful has a say in contracts, they won’t be designed for productivity and ensure execution.

Jobs will become the most valuable issue in the future, according to Hart. And transparent contracts would strengthen the sense of commitment and deliver greater returns to all economic parties. Contracts are based on faith. There is no need for the use of force. No one has to feel unfairly treated in the name of customs. That is why Hart argues people could become happier through contracts. The key to contract theory is incentive.

People would become happier if contracts incentivize employees to work in the interest of their employer through just payment and other compensations. How both the employer and employees can become happier in a new unsettling industrial age may have been the reason this year’s Nobel Prize highlighted the work of contract theory.

JoongAng Ilbo, Oct. 24, Page 28

*The author is an editorial writer of the JoongAng Ilbo.

Kim Ki-chan