Thursday, August 11, 2011

Price of Labor

Tobold is writing about riots and mistakes made by businesses and notes that a business exists to create added value, the profit from which is then given to investors, instead of both investors and workers. Earlier in the same article he laments the high youth unemployment rate. I respect Tobold, but he clearly doesn't understand how the price of labor works.

First of all, businesses are not about adding value, for the benefit of society or whatever. Businesses are about chasing a higher yield, a higher return on investment. If I had a few hundred thousand lying around, and my goal is to get more money, I have a few options. I can put my money in a bank savings account, getting a 1% return. I can buy treasury bonds for a 2% return. I can put money in a balanced investment portfolio and get a 4-6% return. Or, I can start or invest directly in a business and hope for a higher return. Tobold's suggestion is that the profits from a business should be re-balanced, with a reduction for investors and an increase for labor salaries. That's a minor thing if you're company is already generating a 20% return and would shift to an 18% return. But if implemented across all businesses, it would mean that those businesses only making a 7% return, which now are still a better investment than stocks, would only make a 5% return, and so there'd be no reason to have that business at all. If Tobold's advice were followed, it would lead to factories and small businesses closing and fewer new ones being created, causing more unemployment.

It always frustrates me when I hear people bitching about how unfair it is that a company ceo earns 10 million  a year while some of his employees only earn 22k a year. What people don't understand is that the ceo is going to earn 8 million anyway, even if he didn't bother to run the company, just from taking the money he would have invested in the company and instead investing it elsewhere. Instead, he chased a higher yield, getting an extra 2 million and in the process employing hundreds of people and creating added value.

But all of that is completely ignoring the other side of the equation, the price of labor. What those salaries 'should' be. Like it or not, people have different talents and abilities, and some skill sets are more in demand by society than others. A doctor doesn't make a couple hundred thousand a year because doctors deserve a higher salary, rather it's because people demand healthcare, doctors provide healthcare, and not many people have the skill set to become doctors. If magically 90% of the population had a doctor's knowledge and experience, while also becoming weak and frail, then the salaries of doctors would drop to 30k and people who can carry boxes would jump to a 200k salary. Salary is determined by 1) how much society values what a job produces, and by 2) how many other people can also do that job.

Unemployment is caused by two things, they're not both required, either one will cause unemployment.

1. Job creators (businesses) failing to attain high enough yields, leading to a reduction in new capital investment and the closing of businesses on the margin. This can be caused by rising costs due to labor (minimum wage, work eligibility, etc), higher raw material or production costs (such as the oil price rising), taxation (of both business yields and again as income/capital gains), a reduction in how much society wants your added value (watch consumer confidence), or a shift in how other investment options perform relative to  businesses (watch the fed's interest rates).

2. Government intervention pricing people out of the labor market. There are people whose skill sets do not give them the option to earn a high paying job, or who have limitations on their productivity from medical problems, time availability, travel difficulties, etc. The marginal value of their labor ends up very low. If the government puts price controls on labor, for example by saying you can't hire people for less than a certain amount, then those people whose labor value is below that amount will never be able to find jobs. If there are requirements regarding providing health care or pensions or other benefits, the same thing occurs. It's an interesting side note, but the point of those programs is to make things better for workers. Is it justice to remove 2% of the labor force to cause better work conditions for 5% of the labor force? For 10%? Removing 10% for 50%? How much suffering should the gov cause in a small group to improve the average of the total group?

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