Capital in the Twenty-First Century

May 15, 2014

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Thomas Piketty. 2014. Capital in the Twenty-First Century. Translated by Arthur Goldhammer. Cambridge, MA: The Belknap Press of Harvard University Press.

As John Maynard Keynes was the economist of economic depression and government stimulus, Thomas Piketty may be the economist of sluggish growth and growing economic inequality. This is the strongest argument I’ve seen against the notion that the rising tide of economic growth lifts all the boats, the yachts and the little rowboats alike. That notion has the most truth to it when the economy is growing at an exceptionally high rate. Piketty explains why it can’t work when the growth rate is reverting to a lower level. Then the income going to investors increases faster than the income going to wage earners. If the growth rate remains persistently low, the share of national income received by investors may eventually stabilize, but it will stabilize at a very high level. If left to its own devices, a capitalist economy will then tend to create a capitalist class living off of large inherited fortunes, a situation not conducive to political equality and democracy.

Piketty reaches his conclusions by studying the fundamental relationships among several economic variables: the rate of economic growth (g), the rate of return on capital (r), the savings rate (s), the share of national income going to capital (alpha), and the ratio of capital to national income (beta). At the heart of the argument is the observation that r is usually greater than g. This difference explains why people who live off of investments get a disproportionate share of national income, and also how that share will grow whenever r increases or g falls.

Some commentators have oversimplified the economics by saying that inequality automatically gets worse just because r > g, and Piketty himself makes statements that contribute to that impression. That would be true if capital always grew at the rate of return r. But as any investor should know, an investment doesn’t actually compound at the rate of return unless all returns are reinvested. If you save only some returns and spend the rest, as many investors do, then your capital actually grows less than r.  For the economy as a whole, the rate of capital expansion is not r, but a lower value that takes the national savings rate into account, and that actually approaches g if the relevant rates remain stable for a long time. The following example should clarify these dynamics.

Imagine a two-class society consisting of capitalists and workers. The capitalists get their income primarily from investments, and the workers get their income primarily from wages. Imagine that national output and income are growing at a real sustained rate of 2%, but the average rate of return on investments is 5%. Capital has the potential to grow over twice as fast as average income, but that potential isn’t normally realized because some income from capital is spent rather than reinvested. Suppose that the national savings rate is 10% of income, a rate that is five times the growth rate of national income. The growth in capital will reach a limit when amount of capital is also five times as much as annual income. At that point the savings rate of 10% of income can only add 2% to capital, since capital is 5 times income. So the growth rate of capital stabilizes at g, not r. Multiply the 5% rate of return by 5, the ratio of capital to income, and you get the share of income derived from capital (25%). But the savings rate is only 10%, so the savings added to capital each year are only 40% of the income from capital. So it makes sense that capital will actually grow at g (2%), instead of r (5%). A household living entirely from investment income needs to invest only 40% of its income to increase both its capital and its income by 2% a year.

These relationships can be summarized by two equations given by Piketty:

Capital-to-income ratio Beta = s/g = 10%/2% = 5

Capital’s share of income Alpha = r x Beta  = 5% x 5 = 25%

Now we are in a better position to see why r is normally greater than g. This difference enables some people to derive their income from capital, save and invest a portion of that income while spending the rest, and still see their income grow as fast as the general growth rate of the economy. It’s hard to see how capitalism could work if r weren’t greater than g, because then it wouldn’t pay to be a capitalist.

This example also illustrates that as long as the rates are stable and the difference between r and g is not too large, capital’s share of income is not extreme, although it is usually disproportionate to the size of the group that gets most of it. And although a superficial reading of Piketty might lead one to conclude that general inequality will keep increasing as long as r > g, the math says that capital’s share of income does approach stability as long as r, g and s are constant. What may not approach stability is the size of large inherited fortunes, since their owners can live off a small portion of the income and maintain a savings rate much higher than the national average. Their capital can grow as fast as r, or even more than that if they receive superior investment advice.

But now let’s get to the heart of Piketty’s argument by looking at what happens when the growth rate falls. Suppose that the growth rate slows from 2% to a sustained 1%. One might expect the return on capital to be cut in half as well, but that has not been the the historical experience. The rate of return r has fluctuated in a narrow range of about 4 to 5% whether economic growth g is high or low. (Maybe that’s why it’s called capitalism: the capitalists get richer more consistently than the workers!) So let’s suppose that the return on capital remains 5%, allowing capital to grow faster than income and output. If growth remains 1% for some time, the ratio of capital to income will grow from 5 to 10, and capital’s share of income will grow from 25% to 50%:

Beta = s/g = 10%/1% = 10

Alpha = r x Beta = 5% x 10 = 50%

Just a 1% decline in the growth rate has produced a huge transfer of income from labor to capital.

What Piketty establishes is that the difference between the return on capital and the growth rate is the crucial determinant of the division of income between capital and labor. The fact that r is greater than g is what makes it pay to be a capitalist. And the greater the gap between r and g, the more it pays to be a capitalist. Since r has usually varied within a narrower range than g, variations in g are more crucial. With a return on capital of 5% and a savings rate of 10%, it takes a sustained growth rate of at least 1% to keep capital from receiving over 50% of the national income. With a high growth rate, getting ahead through labor compares favorably with getting ahead through investment, but with a low growth rate, it becomes much more important to have capital to invest. With sustained growth at 0.7%, capital gets 71% of the income, and with growth of only 0.5%, capital theoretically takes all the income! (With growth below that, no equilibrium point can be calculated.)

Piketty drives the point home:

In a society where output per capita grows tenfold every generation, it is better to count on what one can earn and save from one’s own labor: the income of previous generations is so small compared with current income that the wealth accumulated by one’s parents and grandparents doesn’t amount to much….

When the rate of return on capital significantly exceeds the growth rate of the economy (as it did through much of history until the nineteenth century and as is likely to be the case again in the twenty-first century), then it logically follows that inherited wealth grows faster than output and income. People with inherited wealth need save only a portion of their income from capital to see that capital grow more quickly than the economy as a whole. Under such conditions, it is almost inevitable that inherited wealth will dominate wealth amassed from a lifetime’s labor by a wide margin, and the concentration of capital will attain extremely high levels— levels potentially incompatible with the meritocratic values and principles of social justice fundamental to modern democratic societies.

Are there any natural economic limits on the gap between r and g, or can it increase until the lion’s share of the national income goes to capital? One limit could be that as capital accumulation becomes too extreme, the rate of return on capital has to come down a bit. It becomes too hard to invest all that capital productively in a slow-growth economy, and imprudent investments just produce asset bubbles that eventually burst (sound familiar?). Decline in g may be offset partly by decline in r, so that capital’s share of income doesn’t increase as much as if r were constant. In the previous example, if the return on capital falls to 4% (with g = 1%), capital’s share of income becomes 40% instead of 50%. But in practice, fluctuations in r are not usually enough to keep fluctuations in g from producing substantial redistributions of income.

Piketty believes that limits on economic inequality have to come primarily from noneconomic factors, either through unwanted “shocks” to capital like war, or deliberate public policies like progressive taxation. For most of capitalism’s history, the growth rate has not been high enough to prevent capitalists from hogging a large share of the income and accumulating vast fortunes. The biggest exception was during the postwar economic boom, fueled both by recovery from a period of depression and war and by a baby boom. Piketty expects economic growth in the twenty-first century to be much lower. His projection is for 1.2% per-capita growth in the richest countries (with population growth providing a small but declining boost to output in some countries). Capital’s share of income, which was in the range of 15-25% for rich countries in 1970, has already increased to 25-30%, and would be expected to rise to at least 40% if growth remains this low. To make matters worse, disparities in pay between top managers and ordinary workers have risen to unprecedented levels, and taxes have declined on high incomes and estates, with the US leading both these trends. Welcome to the twenty-first century!

Piketty’s book has already started a global conversation, and may well frame the debate over economics and public policy for years to come.

Continued

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Made in the USA

April 25, 2014

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Vacliv Smil. 2013. Made in the USA: The Rise and Retreat of American Manufacturing. Cambridge, MA: The MIT Press.

In 1950, manufacturing’s share of US GDP was 27%. By 2010, that had declined to 13.5%. After peaking in 1979, US manufacturing jobs declined from 19.5 million to 11.5 million by 2010, enough jobs for only 8.2% of workers. In the first decade of this century alone, “Michigan lost nearly 47% of its manufacturing jobs (mostly in the auto industry) and North Carolina lost almost 44% (mostly in textiles).”

Vacliv Smil is an interdisciplinary scientist on the Environment faculty at the University of Manitoba. He does not believe that the United States should give up its manufacturing industries without a struggle. He say he is “convinced that no advanced modern economy can truly prosper without a strong, diverse, and innovating manufacturing sector whose aim is not only affordable, high-quality output but also to provide jobs for more than a minuscule share of the working population….”

Many observers accept or even welcome the decline of American manufacturing. One line of reasoning is that manufacturing growth is unsustainable because of its impact on environmental resources. A quite different argument is that manufacturing should go the way of farming, becoming so productive that it needn’t employ a very large segment of the labor force. The future of the economy lies in the growth of service industries.

With regard to the environmental argument, Smil seems a little ambivalent. On the one hand, he acknowledges that “the notion of a successful modern life has become overly defined by the possession of manufactures.” On the other hand, he is skeptical about scaling back consumption of manufactured goods very much, especially since so much of the world has yet to participate in mass consumption. He is even more critical of the second argument, rejecting the notion that services alone can create a strong domestic economy and generate enough exports to pay for imported manufacturing goods.

Smil’s belief in the continuing importance of manufacturing rests on three main points:

  1. “Manufacturing has been the principal driver of technical innovation, and technical innovation in turn has been the most important source of economic growth in modern societies.”
  2. Although job losses in manufacturing have been very large, the sector’s absolute output continues to be large and growing. Reversing that trend would damage overall economic growth and make it even harder to address domestic problems such as poverty.
  3. The United States needs to increase its manufacturing exports to reduce its trade deficit and stop accumulating unsustainable debt, since it probably cannot export enough services to do so.

Dominance and decline

The book goes into some detail on the rise in American manufacturing to a position of world dominance in the mid-twentieth century. I will pass over the details, since that story has so often been told. Smil summarizes:

During the quarter century of postwar economic expansion between 1948 and 1973, America’s manufacturing progress made it possible to create, for better or for worse, the world’s first true mass consumption society, to reach new peaks of industrial production, and to start diffusing the powers of electronic computing. These accomplishments were made easier by abundant and inexpensive supplies of natural resources, the absence of any foreign economic competition that could seriously weaken US primacy, and, as has become clear in retrospect, a relative strategic stability of the bipolar superpower contest during the decades of the Cold War.

In 1970, the US had less than 6% of the world population, but 30% of the world’s economic activity.

The very strength of the US economy sowed the seeds of its later decline. Smil writes of two great advantages that eventually became disadvantages–the producer’s market in manufactured goods and the availability of cheap energy:

The first reality was created by rising disposable incomes, a relatively high rate of saving, a population shift to the suburbs, and the high fertility of the baby boom era. This combination generated an enormous demand for durable goods, and US manufacturers could sell almost anything they made. Product durability, functionality, and design quality were of secondary (and sometimes, it seems, of hardly any) importance compared to the quest for quantity, a quick profit, and built-in obsolescence. Some designs were completely devoid of any functionality or any design sensibility: we need only think of those massive chrome ornaments and risible fins of large automobiles of the day.

The ready availability of inexpensive energy and other resources meant that “durable goods could be, and were, designed as if material and energy did not matter.” In particular, automobile manufacturers made cars that were “progressively larger, heavier, and more powerful.” As other countries recovered from World War II and began competing for resources, and as developing nations drove a harder bargain in selling their resources, manufacturers faced growing pressures for increased quality and energy efficiency.

Some of the decline in the US share of global manufacturing was inevitable, as a result of developments in other countries. But Smil does not believe that the decline had to be as bad as it has been, or that it had to be accompanied by large trade deficits, indebtedness to other countries, a low savings rate, government budget deficits, poor educational performance, deteriorating infrastructure, and rising economic inequality.

What went wrong?

US manufacturing has not adapted very well to the new global environment. Smil says that American manufacturers had been able to prosper for a long time by focusing on the domestic market. “For more than a century the world’s largest manufacturing economy was an efficient mass-maker of industrial products for its huge domestic market, but in relative terms, the United States has been always a rather inferior exporter.” That was okay as long as imports were modest, but as American consumers were increasingly drawn to foreign goods because of their low cost or high quality, US exports didn’t increase enough to compensate. Americans wanted foreign cars much more than foreign consumers wanted American cars.

Relatively high wages and health benefits made it hard for American manufacturing to compete with a country like China. “China’s ruling party…attracts foreign companies and enormous direct investment by guaranteeing the stability of a police state and by supplying a docile workforce that labors with minimum rights, commonly for extended hours under severe discipline, and is housed in substandard conditions.” Walmart went from importing 5% of its products in the mid-1980s to importing over 80% from China alone more recently. But what is especially disturbing is that the US became a net importer even of advanced technology products that American companies had originally developed. Smil is very critical of high-tech companies like Apple that could have done very well competing on the basis of quality, but chose to make additional profits by outsourcing much of their operations to China.

Smil concludes that most of the manufacturing decline “has not been an inevitable outcome of either unstoppable economic forces or an equally unstoppable mechanization and robotization of modern manufacturing but a matter of deliberate choices, the self-inflicted weakening of America’s productive capacities resulting from companies’ dubious quest to maximize profits and individuals’ and households’ desire to maximize the consumption of cheap goods.”

Smil’s suggestions for trying to remedy the situation are relatively familiar. Among them:

  • Improve the educational system to provide more students with the skills most relevant to advanced manufacturing, especially science and engineering skills
  • Control the health care costs that have become a burden on US employers and workers
  • Increase spending on infrastructure
  • Reduce taxes on corporate income and increase them on consumption
  • Encourage countries with trade surpluses to increase domestic consumption

Smil is not at all sure that the United States can recover from the deterioration of its manufacturing base and the advantages that other countries have gained over us in key industries, such as aerospace. He concludes:

I believe that in the affairs of large nations, no situation is ever completely hopeless— and as a lifelong critical observer of American society I am well aware how it has repeatedly demonstrated its impressive capacity for renewal. And yet I am not sure whether it can demonstrate it again as I have not seen, so far, enough commitment and resolve even to acknowledge fully the severity of the accumulated challenges . Even odds of success are thus the best bet I can offer— hoping that I will be wrong, fearing that I am expecting too much.

 

 

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Who Votes Now? (part 2)

February 21, 2014

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Leighley and Nagler argue that voter turnout matters in the United States because of increasing income inequality and a persistent income bias in voting. Higher-income voters vote more, and political leaders are more responsive to their interests.

Perceived policy choices

The poor may vote less for many reasons, such as being too busy trying to make ends meet to think very much about politics. But one reason might be that they don’t perceive much difference between candidates on the issues that concern them, or that they don’t see either candidate’s position as very close to their own. Leighley and Nagler test these hypotheses by measuring two variables they call Perceived Policy Difference and Perceived Policy Alienation.

The data for this part of their study come from the American National Election Study covering elections from 1972 to 2008. They analyze the responses to two items:

  1. A seven-point political ideology scale from “extremely liberal” to “extremely conservative”
  2. A seven-point jobs question, with the endpoints “Some people feel that the government in Washington should see to it that every person has a job and a good standard of living” and “Others think that the government should just let each person get ahead on his/her own.”

Respondents were asked about the candidates’ positions as well as their own.

Perceived Policy Difference turned out to be a better predictor of voting than Perceived Policy Alienation. For both of the above items, voters who perceived a difference between candidates were more likely to vote. Each item had an independent effect, suggesting that the more differences voters perceive between candidates, the more likely they are to vote. Low-income respondents perceived less difference in candidates than high-income respondents, which is one reason they didn’t vote as much.

Differences between voters and nonvoters

For voter turnout to matter, voters must differ from nonvoters in their positions on issues. More specifically, the authors argue that the income bias in who votes matters because voters differ from nonvoters on economic issues. This is true, for example, for the jobs question: “In 2008, there is a 10.2 percentage-point difference between nonvoters and voters believing that it is the government’s responsibility to guarantee jobs, and a 12.5 percentage-point difference between voters and nonvoters believing that people should ‘get by on their own.'” Voters also differ from nonvoters in political affiliation. In 2008, Republicans were a much larger percentage of voters than of nonvoters (42.7% vs. 26.9%), while Democrats were a slightly smaller percentage (51.7% vs. 54.1%), and Independents were a much smaller percentage (5.6% vs. 18.9%). Independents are a rather disparate bunch, by the way, since the term includes many people who just aren’t interested in politics, as well as a few with specific positions outside the political mainstream.

The authors also report on the 2004 National Annenberg Election Study, which compared the percentages of voters and nonvoters favoring certain economic policies. For each of the following policies, voters were less in favor than nonvoters:

Government health insurance for workers (68.1% vs. 82.1%)
Government health insurance for children (76.6% vs. 88.1%
Making union organizing easier (53.5% vs. 65.9%)
More federal assistance for schools (66.9% vs. 78.6%)
Increasing the minimum wage (80.5% vs. 88.3%)

Leighley and Nagler summarize their findings:

Voters are significantly more conservative than nonvoters on redistributive issues, and they have been in every election since 1972. If we had to point to our most important empirical finding of the many that we report, this is it. Voters may be more liberal than nonvoters on social issues, but on redistributive issues they are not. These redistributive issues define a fundamental relationship between citizens and the state in a modern industrialized democracy and are central to ongoing conflicts about the scope of government. It is on these issues that voters offer a biased view of the preferences of the electorate.

International studies find that the United States stands out among democracies both for its low voter turnout and the income bias in its turnout. The authors charge that our political parties are “failing to convince lower-income voters that they are offering distinctive choices on these issues. Whether perception or reality, this perceived lack of choices undermines the extent to which elections function as a linkage mechanism between citizen preferences and government policies.” Although legislative changes to make voting easier do increase general turnout a little, the authors do not find that they boost turnout very much for the lowest income quintile. What would help more, the authors believe, is giving low-income voters something more substantial to vote for.

Clearly the focus of this study on income bias in voting reflects the authors’ values. They are obviously concerned about the impact of economic inequality on democracy. Critics may fault them for looking so hard for evidence to support their theory. On the other hand, by focusing on this issue, Leighley and Nagler are able to correct some conventional wisdom in their field that turnout doesn’t matter very much. Studies that include a large smorgasbord of issues may find that it often doesn’t. But who participates in the democratic act of voting may matter a great deal in deciding how our democracy addresses a specific issue of great importance–the response of democratic government to the economic inequalities generated by the market economy. (For an interesting discussion of this very old problem, see Benjamin Radcliff’s The Political Economy of Human Happiness.) The question of who votes is inseparable from the question of whose economic interests does government serve. Does it protect the winnings of the more successful or create more opportunity for the less successful? Bill de Blasio ran away with the New York mayor’s race by attacking economic inequality specifically. Is that an antidote for voter disengagement, and a portent of things to come?

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Who Votes Now?

February 20, 2014

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Jan E. Leighley and Jonathan Nagler. Who Votes Now? Demographics, Issues, Inequality, and Turnout in the United States. Princeton and Oxford: Princeton University Press, 2014

In 1980, Ray Wolfinger and Steve Rosenstone published Who Votes?, a classic text on voter turnout in the United States. They found that although turnout in presidential elections is low–often less than 60% of eligible voters–that doesn’t effect election outcomes as much as one might think. They didn’t find that voters and nonvoters were different enough in political preferences to make turnout a very large factor. Adding in the nonvoters would not change the outcomes of most elections.

Leighley and Nagler believe that new research is warranted, especially in light of increasing income inequality and the persistent income bias in voter turnout. “The share of income going to the bottom fifth of the distribution decreased from 4.1 percent in 1972 to 3.4 percent of income by 2008. During that same time the share of income going to the wealthiest fifth of the population increased from 43.9 percent of income to 50% of income.” During this period voting rates varied from about 50% for the poorest quintile to 80% for the richest quintile.

Leighley and Nagler set out to show that voters are not representative of the general population when it comes to certain policy issues, especially issues of taxing and spending that affect the distribution of wealth. Nonvoters are more likely to be low-income people who would support redistributive policies if they had an opportunity to do so. The qualification is important, since the authors believe that “the impact of increased economic inequality on turnout will be conditioned by the nature of the political choices offered by the political parties. Individuals may not be given the option by either party to substantially redistribute income from those above the median income level to those below it.” If not, they may have little incentive to vote. And since politicians are more responsive to those who vote than those who don’t, the income bias in voting perpetuates an income bias in policy. By this logic, low turnout is much more detrimental to democracy than earlier studies acknowledged.

Demographics of voting

In addition to the persistent income bias in voting, Leighley and Nagler report a large educational effect–individuals with more formal education are more likely to vote. Multivariate analysis shows that income and education each have an independent effect on voting.

The Anglo (non-Hispanic white) portion of the population declined from 83.2% to 65.6% over the election period studied, 1972-2008. Hispanics are less likely to vote, however, even after controlling for ethnic differences in income and education. African Americans are also less likely to vote, but that difference disappears after controlling for income and education. Blacks actually vote at higher rates than whites of similar socioeconomic status, and black turnout was already increasing before Barack Obama ran for president.

The old vote more than the young, with a noticeable recent increase among those over 75. While age gaps persist, voting rates for the young have been gaining on those of the middle-aged. Single people vote less than married people, even after controlling for age, but the single portion of the population has been growing as people marry later and experience more divorce.

Women used to vote less than men, but since 1984 they’ve been voting more than men.

The authors do not discuss in any detail how these changing demographics affect political party affiliation or voting preferences. The turnout of higher-income voters is no doubt crucial to Republican candidates, but Democrats might take comfort in the fact that some groups with Democratic inclinations are either growing as a share of the population (Hispanics, single people) or voting at a higher rate (women, African Americans).

Legal measures to increase turnout

The authors observe that “the United States is unique among modern democracies in the burden it puts on citizens seeking to exercise their right to vote.” Voter registration usually requires a special application process well in advance of an election. Voting often takes place within a short window of time scheduled for a workday. One approach to increasing turnout is making it easier to register or cast a ballot.

Between 1972 and 2008, most states adopted one or more innovations to make voting easier. The number of states allowing voter registration through motor vehicle departments increased from 2 to 50, as required by a new federal law; the number with “no-fault” absentee voting (voting absentee for whatever reason), went from 2 to 27; the number with in-person early voting went from 2 to 27; and the number with election-day registration went from 0 to 9.

Leighley and Nagler find small but significant effects for many of these reforms. Their quantitative model estimates that no-fault absentee voting increases turnout by 3.2%, and election-day voting increases it by 2.8%. Early voting has little effect unless the voting period is unusually long. The authors did not study the effects of rolling back any of these reforms, as Republicans in some states are now trying to do. One wonders if increases in turnout are easily reversible, or if most of the newer voters continue to participate once they get over the initial hurdle. Also not studied were new legal requirements such as voter ID.

Having reported the modest effects of legislative changes on turnout, the authors turn to their main interest, demonstrating that the income bias in turnout leaves certain economic policy positions underrepresented in our democracy. That will be the topic of my next post.

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The Good Jobs Strategy (part 2)

February 5, 2014

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The first part of Zeynep Ton’s book made a case for investing more in workers, even in the retail industry where bad jobs proliferate. The later chapters deal mostly with operational choices that support a good jobs strategy. These two sides of the problem are interdependent. On the one hand, investing in better paid, better trained and more highly motivated workers can improve operations. On the other hand, smooth operations not only make work more enjoyable, but they can reduce costs, improve productivity, and justify the investment being made in workers. Good operations are essential to maintaining the good jobs strategy.

Ton describes four operational choices that companies pursuing a good jobs strategy usually make: Offer less, standardize and empower, cross-train, and operate with slack. All of them are departures from what retail businesses usually do.

Offer less

Ton’s model companies tend to offer fewer products and run fewer sales promotions than their competitors. Trader Joe’s carries around 4,000 products, while the typical supermarket carries almost 40,000! Trying to give customers anything they might want makes it more costly and complicated to run a store. It means trying to have the right number of all those items in inventory, and putting a greater burden on employees to locate them and stock them as needed. It makes it harder to cut costs by buying and shipping in bulk, which requires ordering more items of the same kind. It confuses customers, who can never be sure they made a good choice among all the alternatives.

By concentrating on a smaller number of products, Trader Joe’s gives more attention to selecting them carefully with a view to customer satisfaction. It conducts extensive taste tests and sets high standards–“no artificial flavors, no MSG, no synthetic colors, no partially hydrogenated oils, and always at a low price.” Employees are able to discuss the merits of the product with the customers, making the job more enjoyable, and the customer-friendly policies generate the revenue that justifies high wages as well.

Standardize and empower

Standardizing operations and empowering workers are usually seen as mutually exclusive. Theodore Levitt wrote in the Harvard Business Review that “discretion is the enemy of order, standardization, and quality.” Tell the worker exactly what to do if you want a reliable, high-quality result.

Ton’s view is more nuanced. Some forms of variation are undesirable, such as stocking variations that create problems for customers trying to find a product. But some variations are normal, such as variations in customer wants. “It is almost impossible to anticipate precisely what every customer will want, how each will behave, and what will make each one happy, and to create a script or rule book to achieve that.” Service industries have to strike a balance between standardizing their operations and empowering workers to respond sensibly to situations as they arise. “When employees are asked to follow tasks mindlessly, they are not engaged in their work, and that shows up in how well they do their jobs and satisfy customers.” Some tasks can be highly standardized, especially “tasks that do not depend on local business conditions or on individual customers’ needs,” but others cannot.

Cross-train

Many retailers try to achieve a “just-in-time” scheduling of workers to match fluctuations in customer traffic, analogous to the “just-in-time” scheduling of inventory to meet customer demand for products. This attempt to treat people the same as commodities can be a mistake. It makes the job worse for employees by limiting them to short hours, temporary schedules, and last-minute changes, resulting in higher turnover, absenteeism and tardiness.

Retailers with a good jobs strategy deal with variations in customer traffic less by varying staffing and more by varying the tasks to which staff are assigned. Managers find other things for workers to do besides serving customers, and they train them to do those things. “During off-peak hours…they perform all their other tasks that do not directly involve customers. They conduct inventory checks, bring products from back rooms, arrange their shelves, look for problems and improvement opportunities, and order more stock.” That makes the worker more of a person with a steady job, not a temporary functionary.

Operate with slack

Ton considers adequate staffing the “ultimate expression of putting employees at the center of a company’s success.” As I mentioned in Part 1, retailers are tempted to understaff their stores because the costs of additional employees are obvious, while the costs of understaffing are more subtle and harder to measure. Ton quotes Marshall Fisher of the Wharton school, warning about “business-school thinking gone wrong”:

We teach our students to be rigorous and manage by the numbers. Not a bad idea, except that it leads to over-weighting the measurable and under-weighting what’s hard to measure. In a store, what’s measurable is the payroll checks a retailer writes every week to its stores’ staffs. What’s hard to measure is the impact that stores’ staffs have on revenue.

Having a little slack in staffing insures that customers will be adequately served even in times of unexpectedly high traffic. It also allows workers–in conjunction with cross-training–to devote themselves to store improvements when they are not directly engaged with customers.

We have seen that committed, empowered, well-trained employees who aren’t rushing desperately from task to task make higher performance standards possible because they like having high standards they can actually achieve. One can feel so much more proud of oneself when one does a really good job, especially for customers. We have seen that committed, empowered, well-trained employees who aren’t rushing desperately from task to task are a huge source of ideas about improvement and are often the means by which those ideas can be implemented.

Strategic opportunities

Ton discusses two additional benefits of the good jobs strategy that contribute to economic competitiveness. The first is being better able to adapt to changes in the competitive environment, such as changing customer tasks or new technologies. Here she uses a negative example from her own dissertation research, in which she documented the failure of Borders to adapt to changes in the book business. Borders tried to add an online sales operation, but gave up because it couldn’t integrate it with its physical stores. Borders wanted customers to be able to order online and pick up locally, but customers couldn’t be assured of being able to get the book in the store, even if it was supposed to be in inventory. “Employee turnover, understaffed stores, lack of training, operational complexity, and poorly defined processes all contributed. Borders lacked what other companies that follow the bad jobs strategy lack–the ability to execute operationally.”

The other benefit is being able to make the business special in the eyes of customers. Companies with the good jobs strategy “have a better shot at keeping their customer base loyal by giving them a reason to shop there rather than at other physical stores or online.”

Values

Companies that maintain a good jobs strategy place a high value on taking care of their workers and their customers, and setting a high standard of excellence. This is explicit in Costco’s mission statement, for example. Strong values enable a company to resist short-term pressures to put quarterly earnings above investment in workers. Unlike other airlines, Southwest refused to lay off workers during the industry slump that followed September 11, and yet it continued to outperform its competitors.

Values impose constraints on businesses, discouraging them from adapting in worker-unfriendly ways and forcing companies to innovate in alternative ways. If they understand that, and they enlist their workers in contributing to those innovations, they can do well.

I found this discussion of values refreshing. It implies that companies have a “freedom to choose” in a more meaningful sense than promulgated by “free market” advocates such as Milton Friedman. The freedom they describe isn’t all it’s cracked up to be, since it often turns out to be illusory when real questions of value are raised. If you suggest that businesses might choose to raise wages or choose to improve working conditions, you will probably hear that they are not really free to do so, since the market constrains them by punishing such actions. Economic decision-makers are nominally free, but they are really regarded as cogs in a competitive economic machine. That’s okay, we are told, because the machine works great. It’s as if the market is good, so people don’t need to be. Individual values are irrelevant because people must conform to the laws of the marketplace, and this conformity is paradoxically referred to as liberty.

Three cheers for Ton, for reminding us that we all have choices, and that we don’t have to settle for a vicious cycle of bad jobs and poor service. The idea that a prosperous and productive society needs better jobs is an idea whose time has come. What strange philosophy ever made us think otherwise?

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Posted by Ed Steffes

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