A Measure of Fairness (part 2)

February 26, 2015

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In A Measure of Fairness, Pollin, Brenner, Wicks-Lim and Luce report their research on two kinds of wage laws: state minimum wage laws, and municipal laws that set a living wage higher than the federal and state minimums.

In 2007, Congress mandated that the federal minimum wage rise to $7.25 an hour by 2009. Twenty-nine states and the District of Columbia have raised their minimum wages higher than that; seven states and D.C. have a minimum of at least $9.00 (see map and data)

Municipal laws that set a wage higher than both the federal and state minimums are usually narrow in scope, applying only to businesses with municipal contracts. San Francisco and Santa Fe are two cities with broader living-wage laws.

The authors identify two different ways of defining a reasonable living wage, one focusing more on benefits and the other on costs:

First, what is a wage rate that is minimally adequate in various communities, in the sense that it enables workers earning that minimum wage and the family members depending on the income produced by this worker to lead lives that are at least minimally secure in a material sense? What wage rate, correspondingly, can allow for a minimally decent level of dignity for such workers and their families?
The second, equally legitimate, question…asks, How high can a minimum wage threshold be set before it creates excessive cost burdens for businesses, such that the “law of unintended consequences” becomes operative?

High on the list of unintended consequences would be job losses if businesses chose to lay off workers or leave a city or state rather than accept higher wage costs.

The authors also identify two ways of studying these issues: prospective research that tries to anticipate the consequences of proposed laws, and retrospective research assessing the actual consequences of existing laws. Except for the last section, the findings described below are from prospective studies.

Benefits to workers and families

Who benefits from wage laws? The answer might seem to be obvious, but some critics have questioned the need for such laws on the grounds that the lowest-wage workers are rarely major breadwinners, but are often younger workers whose wages will probably go up before long anyway. The authors find that the laws primarily benefit the people they are intended to benefit: low-income workers who are “well into their long-term employment trajectories,” with a high proportion of primary breadwinners and other major contributors to family income. In addition, the laws have important ripple effects, tending to raise the wages of workers who are already a little above the legal minimum. For example, the authors estimated that 20% of the people of Arizona would receive some income benefit from a proposed minimum-wage increase, including workers and members of their families.

Several of the research reports are from studies of a proposed city-wide minimum of $10.75 for Santa Monica. It was passed by the city council in 2001 but repealed by the voters in 2002. In order to evaluate its probable effect on incomes, the authors gave careful consideration to poverty thresholds and basic economic needs. First, they drew on research by the National Research Council on more realistic poverty thresholds than those established by the federal government. “The commission’s report…presented eight separate studies using different methodologies for coming up with alternative poverty measures. If we simply calculate the average of these eight alternative poverty lines, this average is 42 percent above the official poverty line.” Considering that the cost of living in the Los Angeles area is about 25% above the national average, they decided to use 160% of the federal poverty line as the poverty threshold for their research.

By that standard, a family consisting of one adult and two children would need an income over $21,475 to escape poverty, which corresponds to a full-time hourly wage of $10.32. A family with two adults and two children would need an income of $27,030, corresponding to a full-time hourly wage of $13.00 with only one adult employed. (All figures were in 1999 dollars, so would have to be somewhat higher today.)

The authors also drew on research by the California Budget Project, which constructed a “basic needs” budget for Los Angeles and other California regions. The CBP described this as “more than a ‘bare bones’ existence, yet covers only basic expenses, allowing little room for ‘extras’ such as college savings or vacations.” By that standard, a family with one adult and two children would need an income of $37,589, or a wage of $18.07 an hour. A family with two adults and two children would need a little less, $31,298, or a wage of $15.05, if one adult stayed home and provided child care. With both adults employed full-time, however, they would need $45,683 because of child care and other costs, but each job would only have to pay $10.98 an hour to generate that income.

To assess the impact of the proposed $10.75 hourly wage, the authors construct two very specific “prototypical family types.” The first is a three-person family whose primary breadwinner earns $8.00 an hour and contributes 70% of the family income. A raise to $10.75 increases the family income from $19,430 to $24,105, an increase of 24.1%. This takes the family from 10% below the adjusted Los Angeles poverty line to 12% above it. It also takes the family from 48% below the CBP “basic needs” budget to only 36% below it.

The second prototypical family is a four-person family with a low-wage worker earning $8.30 an hour and contributing 50% of the family income. A raise to $10.75 increases the family income from $29,880 to $34,290, an increase of 14.8%. (The other adult earner is not assumed to have an hourly rate low enough to be covered by the minimum-wage increase.) This takes the family from 12% above the adjusted Los Angeles poverty line to 29% above it. It also takes the family from 35% below the CBP “basic needs” budget to only 25% below it.

However, some of the increased income from higher wages would be offset by higher taxes and lost tax credits. (It wouldn’t be offset by loss of food stamps or medical benefits, since neither prototypical family was poor enough to qualify for those in the first place.) The authors calculate that the offsets amount to 40% of the income gains for the first family and 27% of the income gains for the second family.

Costs to business

Most legally mandated wage increases are not dramatic, and their impact is limited by the number of workers whose wages are already at or near the new minimum. Typical of the research reported here is the authors’ finding that a Santa Fe living-wage ordinance would increase average costs relative to business revenue by about 1%. The impact is often two or three times greater for businesses with more low-wage workers, especially in the food service and hotel industries.

Affected businesses can handle the added labor cost in many different ways. Perhaps the most obvious is to raise prices. Although that poses some risk of lost business, the damage is limited if the price increases are small, competitors are also raising their prices, consumers are interested in quality more than price, and possibly that consumers prefer to patronize businesses that treat their employees well, as some research indicates. In addition, some businesses, especially retail businesses operating in poor neighborhoods, may gain business because better-paid workers have more money to spend.

Another way that businesses absorb higher labor costs is through increased productivity. Higher wages tend to reduce turnover, which reduces the costs incurred in recruiting, selecting, hiring and training new workers. Based on their research in Santa Fe, the authors suggest that 40% of the cost of higher wages can be recovered in higher productivity.

Businesses can also absorb higher labor costs by redistributing income within the firm. This can be done in a rather subtle fashion, simply by letting low-wage workers have a larger share of productivity gains, while holding higher incomes steadier. Perhaps that is only fair, considering that the country has been doing the opposite for some time: “The fact that the minimum wage has been falling in inflation-adjusted collars while productivity has been rising means that profit opportunities have soared while low-wage workers have gotten nothing from the country’s productivity bounty.” If paying a higher wage forces a business to accept slightly lower profits, the damage to its competitive position is limited by the fact that its competitors may be facing the same problem.

Two more drastic responses to increased costs are to lay off workers or relocate to another city or state. The businesses most likely to relocate are those with a customer base that is not tied to a specific location, and with a substantial increase in labor costs. But many of the businesses that rely on low-income labor also have strong ties to a particular place, such as many restaurants and hotels.

The authors’ summary of their New Orleans research is typical of their conclusions:

Our results suggest that the New Orleans firms should be able to absorb most, if not all, of the increased costs of the proposed minimum wage ordinance through some combination of price and productivity increases or redistribution within the firm. This result flows most basically from the main finding of our survey research–that minimum wage cost increases will amount to about 0.9 percent of operating budgets for average firms in New Orleans and no more than 2.2 percent of operating budgets for the city’s restaurant industry, which is the industry with the highest cost increase.  This also suggests that the incentive for covered firms to lay off low-wage employees or relocate outside the New Orleans city limits should be correspondingly weak.

 Retrospective studies

In a few cases, the researchers were able to evaluate the effects of wage increases that had already been in effect for some time. Mark Brenner and Stephanie Luce studied the effects of wage ordinances in Boston, Hartford and New Haven covering businesses with city contracts. Critics had predicted that fewer companies would bid on city contracts, and the reduction in competition would result in higher costs for the city. In fact, there wasn’t much difference: The number of bidders went down in New Haven, but went up in Hartford and stayed the same in Boston. Businesses did not lay off workers, but adjusted to the higher wages mainly by accepting lower profit margins.

Brenner, Wicks-Lim and Pollin did a study comparing states with and without minimum-wage laws higher than the federal minimum. They found no adverse effects of higher minimum wages on employment.

Wicks-Lim and Pollin studied the effects of Santa Fe’s citywide minimum wage on job opportunities for low-wage workers. Aaron Yelowitz had reported that unemployment rose once other factors were statistically controlled. Wicks-Lim and Pollin found that employment actually held steady, but that the rate of unemployment was higher than expected only because more people came into the labor market looking for work. They came “precisely because there were more jobs and better jobs in Santa Fe than elsewhere.” Pollin also reminds us that the United States used to have a higher minimum wage (in inflation-adjusted dollars) in the 1960s than it has today, with no apparent damage to employment or productivity.

In general, this book supports the conclusion that raising wages for low-income workers brings at least modest benefits to workers, while imposing modest costs on employers and consumers. For workers, the benefits are partly offset by higher taxes and reduced benefits for the poor. For employers, the costs are partly offset by price increases, higher productivity, and redistribution of compensation among different levels of workers. Living-wage initiatives are one effective way of addressing extreme income inequality and poverty. They are not a cure-all, however, and other measures like progressive taxation and direct public assistance remain important as well.


The Zero Marginal Cost Society

September 8, 2014

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Jeremy Rifkin. 2014. The Zero Marginal Cost Society: The Internet of Things, the Collaborative Commons, and the Eclipse of Capitalism. New York: St. Martin’s Press.

Jeremy Rifkin is the president of the Foundation on Economic Trends and a leading thinker on the transition to a more sustainable global economy based on new energy sources and infrastructure. In this latest of his many books, he predicts that capitalism will gradually decline and be largely supplanted by what he calls the “collaborative commons,” a system based on common access to cooperatively managed and shared resources. This sounds pretty utopian, but he bases his argument on some very real changes that are already occurring in how we produce and share information, obtain energy, and make things.

Rifkin’s version of the decline of capitalism is not based on its supposed failure, but on its success. The relentless quest for profit leads producers to raise productivity in order to lower unit costs and attract more buyers. Their competitors are forced to do the same. If the process is carried to its logical conclusion, productivity moves toward “the optimum point in which each additional unit introduced for sale approaches ‘near zero’ marginal cost…making the product nearly free.”

The information economy has already taken much of the profit out of some industries by making it so easy to obtain certain commodities; music and news are prime examples. Rifkin believes this is only the beginning:

The near zero marginal cost phenomenon has already wreaked havoc on the publishing, communications, and entertainment industries as more and more information is being made available nearly free to billions of people. Today, more than one-third of the human race is producing its own information on relatively cheap cellphones and computers and sharing it via video, audio, and text at near zero marginal cost in a collaborative networked world. And now the zero marginal cost revolution is beginning to affect other commercial sectors, including renewable energy, 3D printing in manufacturing, and online higher education. There are already millions of “prosumers”— consumers who have become their own producers.

In Part I, Rifkin reviews the history of capitalism, emphasizing the connections among energy sources, communication and transportation at each phase. The First Industrial Revolution depended on steam, printing and railroads; the Second Industrial Revolution relied on oil, the internal combustion engine and the telephone. In both cases, the trend was toward concentrations of economic power. “Vertically integrated corporate enterprises were the most efficient means of organizing the production and distribution of mass produced goods and services.” For a time, the only alternative to capitalism seemed to be another form of centralized power–state socialism.

Rifkin expects the Third Industrial Revolution, with its reliance on renewable energy and global electronic communications, to reverse the centralizing trend and distribute power more widely:

A new communication/energy matrix is emerging, and with it a new “smart” public infrastructure. The Internet of Things (IoT) will connect everyone and everything in a new economic paradigm that is far more complex than the First and Second Industrial Revolutions, but one whose architecture is distributed rather than centralized. Even more important, the new economy will optimize the general welfare by way of laterally integrated networks on the Collaborative Commons, rather than vertically integrated businesses in the capitalist market.

To put it simply, people will rely less on big corporations to meet their needs and more on one another.

A new infrastructure

When economists have thought about improvements in productivity, they have usually thought in terms of better machinery or better trained workers. However, economist Robert Solow found that changes in energy sources and infrastructure accounted for the greatest leaps in productivity. The Second Industrial Revolution was possible because of the electric grid, telecommunications network, interstate highway system, oil and gas pipelines, and water systems (all of which required government initiatives, by the way). Rifkin believes that the world is on the verge of a similar revolution that will take human productivity to a dramatically higher level.

First, he sees the creation of “a renewable-energy regime, loaded by buildings, partially stored in the form of hydrogen, distributed via a green electricity Internet, and connected to plug-in, zero-emission transport.” The cost of solar energy is now dropping exponentially, just as the cost of computing already has. All of the energy annually used in the global economy could be supplied by much less than one-tenth of one percent of the energy that reaches Earth from the sun. Rifkin expects 80 percent of our energy to be from renewable sources by 2040.

Another key development is the “Internet of Things,” which will connect “every machine, business, residence, and vehicle in an intelligent network,” enabling all of them to work smarter. Rifkin doesn’t provide detailed examples, but he cites studies that estimate the potential productivity gains:

Cisco systems forecasts that by 2022, the Internet of Everything will generate $ 14.4 trillion in cost savings and revenue.  A General Electric study published in November 2012 concludes that the efficiency gains and productivity advances made possible by a smart industrial Internet could resound across virtually every economic sector by 2025, impacting “approximately one half of the global economy.” It’s when we look at each industry, however, that we begin to understand the productive potential of establishing the first intelligent infrastructure in history. For example, in just the aviation industry alone, a mere 1 percent improvement in fuel efficiency, brought about by using Big Data analytics to more successfully route traffic, monitor equipment, and make repairs, would generate savings of $ 30 billion over 15 years.

Up until now, industrial manufacturing has required a lot of capital and large, vertically integrated organizations to produce goods economically. The development of 3D printing is changing that, making possible a transition “from mass production to production by the masses”:

Software— often open source— directs molten plastic, molten metal, or other feedstocks inside a printer, to build up a physical product layer by layer, creating a fully formed object , even with moveable parts, which then pops out of the printer. Like the replicator in the Star Trek television series, the printer can be programmed to produce an infinite variety of products. Printers are already producing products from jewelry and airplane parts to human prostheses. And cheap printers are being purchased by hobbyists interested in printing out their own parts and products. The consumer is beginning to give way to the prosumer as increasing numbers of people become both the producer and consumer of their own products.

The main thing one needs to be such a “prosumer” is access to the information that the printer needs to create an object, and that information is likely to be widely available in the information age. Rifkin also anticipates the expansion of low-cost education, as more learning occurs through “MOOCs”–massive open online courses.

The future of work

Rifkin acknowledges the potential of higher productivity to destroy millions of jobs by reducing the need for human labor. Jobs are disappearing because of a major structural change in the economy, not just because of a temporary recession or relocation of factories from one country to another. Although in the past, technological changes have created as many jobs as they destroyed–for example, creating factory jobs to replace farm jobs or white-collar jobs to replace blue-collar jobs–Rifkin does not see that substitution process continuing. The new information technologies are threatening white-collar and service jobs as much as manufacturing jobs.

The last book I discussed, Jaron Lanier’s Who Owns the Future?, argued that humans have to defend themselves against the smart machines by fully monetizing their own information contributions, that is, by charging for every idea, data, photo, etc., they share. Otherwise, a few owners and users of Big Data will get rich while the rest of us get poor. Rifkin’s solution is almost the opposite. He doubts that the capitalist, profit-centered model will work very well for anyone, and that all of us will end up exchanging information and things at little or no cost. Eventually, more of our time will be devoted to pursuing non-material ends, since obtaining the material necessities of life will have become so easy in a zero marginal cost world. While Lanier advocates a more thorough commodification of information, Rifkin expects less commodification and more sharing.

This will not happen overnight, and Rifkin makes an explicit distinction between time frames. “In the short and mid terms…the massive build-out of the IoT [Internet of Things] infrastructure in every locality and region of the world is going to give rise to one last surge of mass wage and salaried labor that will run 40 years.” A big part of this will be the transition to renewable energy sources and the conversion of existing buildings to use them. But in the latter half of this century, he expects most human labor to shift to nonprofit activities of one kind or another.

Continued


The Good Jobs Strategy

February 3, 2014

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Zeynep Ton. The Good Jobs Strategy: How the Smartest Companies Invest in Employees to Lower Costs and Boost Profits. Seattle: Lake Union Publishing, 2014.

Why is it so hard to find a good job? Part of the problem is matching the good jobs with workers who are qualified to do them. We hear about hi-tech companies that can’t find enough applicants with the right technical skills. But even more often these days, we hear about the disappearance of jobs with decent pay and benefits, and the proliferation of jobs with low pay, no benefits, and erratic work hours.

Globalization and technological change are often cited as factors contributing to high unemployment and low wages. Many American workers are in a poor bargaining position, vulnerable to being replaced by an industrial robot or a lower-paid foreign worker. Workers with low pay can’t afford to spend very much, giving a competitive edge to businesses that can cut costs and hold down prices. So the conventional wisdom is often that businesses cannot invest very much in their labor forces and still make a profit. Maybe this is the real “class warfare,” the attitude that regards workers as an unfortunate expense to be minimized as much as possible.

Zeynep Ton is an adjust associate professor at the Sloan School of Management. Her studies of business management have convinced her that even in today’s competitive environment, businesses have a choice. They can profit from what she calls a “bad jobs strategy,” at least in the short run. But a “good jobs strategy is also a viable option:

You can certainly succeed at the expense of your employees by offering bad jobs— jobs that pay low wages, provide scant benefits and erratic work schedules, and are designed in a way that makes it hard for employees to perform well or find meaning and dignity in their work. You can even succeed at the expense of your customers; for example, by offering shoddy service. People may not enjoy buying from you, but plenty of them will do it anyway if you keep prices low enough.

In service industries, succeeding at the expense of employees and at the expense of customers often go together. If employees can’t do their work properly, they can’t provide good customer service. That’s why our experiences with restaurants, airlines, hotels, hospitals, call centers, and retail stores are often disappointing, frustrating, and needlessly time-consuming.

Many people in the business world assume that bad jobs are necessary to keep costs down and prices low. But I give this approach a name— the bad jobs strategy— to emphasize that it is not a necessity, it is a choice.

There are companies in business today that have made a different choice, which I call the good jobs strategy. These companies provide jobs with decent pay, decent benefits, and stable work schedules. But more than that, these companies design jobs so that their employees can perform well and find meaning and dignity in their work. These companies— despite spending much more on labor than their competitors do in order to have a well-paid, well-trained, well-motivated workforce— enjoy great success. Some are even spending all that extra money on labor while competing to offer the lowest prices— and they pull it off with excellent profits and growth.

Ton’s research focuses on the retail industry, notorious for its millions of bad jobs. Its median hourly wage in 2011 was $10.88; 40% of the jobs are only part-time; and unpredictable work schedules often make it hard to care for a family, go to school, or take a second job. Ton reasons that if better jobs can be created in retail, they can be created just about anywhere.

Ton highlights four companies that are succeeding with a good jobs strategy: Costco, the wholesale buying club; Mercadona, the biggest chain of supermarkets in Spain; QuikTrip, a convenience store chain; and Trader Joes, an American supermarket chain. They manage to make good profits, offer good value in prices and service to customers, and also create good jobs. Costco pays its hourly workers 40% more than Sam’s Club. In addition to better pay, these model employers provide their workers greater “opportunity for success and growth” by giving them adequate training, time and resources to do the job well. They are places where people generally like to work.

Investing in employees

Ton describes two main ingredients for success using a good jobs strategy: investment in employees and operational choices. Both are essential. The strategy requires an adequate quantity and quality of labor, but it also requires an efficient operation to make that labor productive and justify its high cost.

One could say that the company puts itself in its employees’ hands, then does its best to make sure those hands are strong, skilled, and caring. This is not a matter of happy talk, PR, and employee-of-the-month awards. This is concrete policy, manifested not only in wages and benefits but also in recruitment, training, scheduling, equipment, in-store operations, head count, and promotion.

Ton points out that not all tasks are simple enough to be reduced to standardized routines that the least skilled and trained worker can complete. Retail operations have actually become more complex over the years, but the investment in workers has declined. (The ratio of retail wages to average U.S. wages declined from 91% to 65% between 1948 and 2011.)

Ton found that in many cases retail stores can increase profitability by adding workers rather than cutting them. The relationship between employees and profits can be described by an inverted-U-shaped curve (with employees on the horizontal axis and profits on the vertical axis). Profits are highest at a theoretical sweet spot where stores are neither understaffed nor overstaffed. But businesses often have a bias toward understaffing because they think of labor as an expense to be minimized. Whenever sales are lagging, managers may be under pressure to cut staff in order to hold payroll to a fixed percentage of sales. Businesses fail to weigh the short-term gain against the long-term harm to their operation. They have few models of companies that sustain a high commitment to their workforce.

Companies without that commitment easily fall into a “vicious downward cycle”: Low expenditure on labor leads to a low quality and/or quantity of labor, which leads to poor operational execution, which leads to low sales and profits, which leads back to low expenditure on labor.

There are many effects of failing to invest enough in one’s employees, including— but by no means limited to— phantom stockouts; promotions that are executed incorrectly or not executed at all; data corruption that undermines inventory and strategic planning; and loss of products due to theft, spoilage, and faulty paperwork. [Phantom stockouts are situations where what the customer wants is actually in stock, but nobody can find it.]

Investing in employees can create a more virtuous cycle in which higher expenditures on labor justify and sustain themselves by supporting better operational execution and higher sales and profits.

The operational choices that support the good jobs strategy will be the topic of the next post.


Getting Back to Full Employment (part 2)

December 4, 2013

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In the first part of their book, Dean Baker and Jared Bernstein argue for placing a higher priority on reducing unemployment, as opposed to the current policy preoccupations of holding down inflation and reducing the federal deficit. The later chapters discuss different ways of increasing labor demand and boosting employment.

Before the recent recession, the economy was creating more jobs, but growth was driven mainly by a housing bubble that both created a boom in construction and made homeowners feel wealthy enough to spend more. The problem now is to replace the economic demand that was lost when the bubble burst. That requires some combination of increases in consumption, investment, government spending or net exports.

The authors do not expect consumption to return to its former level by itself, since consumers no longer feel very wealthy, and “tens of millions of baby boomers stand at the end of retirement with little or no savings.” They also reject the view that “investment will surge if we reduce the tax and regulatory burdens on business.” Over the last fifty years investment has averaged less than 9% of GDP, and so it would take an enormous increase to make up for much of the lost demand. And I might add, why invest in more production until one is confident that potential customers are willing and able to consume more?

Increasing net exports by reducing the trade deficit has the potential to create millions of jobs. The authors estimate that balancing exports with imports could increase GDP by 5.4% and lower the unemployment rate from over 7% to under 5%. Investments in infrastructure and education may make American products more competitive, but that is a long-term project. Letting the dollar fall in value against foreign currencies would have more immediate benefits by making our products cheaper, although it would also hurt big importers of cheap foreign products, such as Wal-Mart.

In Chapter 6, Baker and Bernstein make their case for public spending to create more jobs. Their reasoning is solidly in the Keynesian tradition:

Downturns are characterized by a drop-off in demand that the private sector is unable to fill. The government, with its capacity to borrow on favorable terms, can afford to spend when everyone else is hunkered down. Some forms of spending are better than others in terms of reinvigorating demand, and one of the best forms is public infrastructure investment, which can employ hundreds of thousands of workers in projects that yield long-term, continuing returns on the dollar.

They also recommend public investments in areas where the United States lags behind other developed countries, such as rail systems, energy-efficient construction and high-speed internet access.

But won’t additional public spending make the federal deficit even worse? The authors reject the popular but simplistic argument that debt is just as bad for a government as for an individual. How much an individual can ever repay is limited by the human lifespan. The government never dies [unless Grover Norquist succeeds in drowning it in that bathtub!], and can draw on revenue from a growing economy to finance its debts. Public investments that stimulate growth pay off in additional tax revenues, while “austerity measures that would cut spending in order to generate growth have the counterproductive effect of hurting growth, and they typically fail to reduce deficits because slower growth lowers tax revenues and requires more spending on economic stabilizers” like public assistance and unemployment benefits.

The best way to measure the burden of debt on government is to consider the interest paid as a percentage of GDP. That percentage rose steeply in the 1980s but declined steeply in the 1990s. It has remained relatively low since 2000, as interest rates have come down. The ratio of the deficit itself to GDP has declined from 10% in 2009 to 4% in 2013. “The bottom line is that the government is nowhere near the limit of its ability to take on additional debt.”

The United States does have a longer-term problem of containing health care costs, which impact government through spending on Medicare and Medicaid. “The United States spends more than twice as much per person on health care than do other wealthy countries, with too little to show for it in the way of outcomes relative to these other advanced economies.” But that is a problem for the country whether we finance it with tax dollars or consumer dollars, and the best solution is to reduce health care costs, not reduce other economically and socially beneficial public spending.

Baker and Bernstein have an excellent response to the common argument that government borrowing is hurting the next generation:

One of the most peculiar arguments about deficits is that we must save our children from the phantom menace of future debt tomorrow by severely underinvesting in them today. We must defund Head Start, public schools, universities, libraries – not to mention our own employment opportunities. This absurdity is accepted wisdom in today’s fiscal debates, even though the extraordinarily low interest rates at which the government can borrow money would be taken as a signal by any private investor that now is a good time to borrow. If government were run like a business, it would be taking advantage of low interest rates to finance a wide variety of public investments. Franklin Roosevelt did that during the New Deal, undertaking infrastructure projects that still support the economy today.

The authors also recommend “a flexible program of publicly funded jobs that can ramp up and down as needed.” The jobs themselves can be in the private sector, with public subsidies to promote additional hiring, as long as regulations are in place to make sure that the new jobs are truly new, not just replacements for existing jobs.

Finally, they recommend policies to promote shorter work hours, more paid vacation days and more generous family leave policies. These would spread the available work among more people and reduce the number without jobs altogether. It would also save money on unemployment compensation and keep workers attached to the workforce so that their skills don’t deteriorate. Germany’s average work year is only 1,400 hours, compared to 1,800 hours in the United States. Germany also uses public money to supplement the wages of workers whose hours are cut during economic downturns.

Baker and Bernstein believe that a high rate of unemployment is unnecessary, and that it can be ameliorated with the right policies. Although the economic demand for labor is too low, the ultimate need for labor is not a problem. True, new technologies and higher productivity are reducing the need for labor in many traditional industries, but that’s been going on for a long time. In the twentieth century, new technologies like the assembly line also boosted productivity, but the country was ultimately richer for it. Workers whose productivity went up eventually received a share of the benefits in the form of higher wages, and the money they spent created new jobs in expanding industries. Workers also got some of the benefits in the form of a shorter work week, when the 40-hour week became standard with the Fair Labor Standards Act of 1938. So what’s not to like? Pay went up, hours went down, massive unemployment was avoided, and living standards improved dramatically from the 1940s until the 1970s.

The point here is simple: We need never worry that a reduced need for labor will lead to massive unemployment. If workers are sharing in the gains of productivity growth, and they take a portion of these gains in the form of more leisure time, then the supply of labor will to some extent adjust to any reduction in need due to improved productivity. When productivity growth is translated directly into shorter work years, the sense in which these gains are a source of wealth rather than impoverishment is more clearly visible. If workers can have the same living standard by working fewer hours, then they are obviously better off.

What is stopping us from making the same kind of progress again? In Baker and Bernstein’s view, the policies that tolerate high unemployment and stagnating wages derive from the mistaken belief that any measures to stimulate economic demand can only bring back inflation. That in turn depends on the assumption that the productive labor is already employed, and that the rest just aren’t worth being paid a wage they could live on because they can’t produce enough to justify it. The weak demand for labor hurts the bargaining power of all workers, helping to hold wages down even when their productivity is rising. So we try to keep the economy expanding and profits growing while refusing to place a higher value on human labor. Except, of course, for executive labor, since executives, after all, are the “job creators”(!)

I would also suggest that an underlying problem here is a zero-sum mentality, a fear that nothing can be done for the unemployed, or for low-wage workers, without taking something away from someone else, either in higher taxes or higher prices. Anyone who speaks up for workers is quickly accused of engaging in “class warfare,” which is another way of calling someone a communist. How did we lose our confidence in our nation’s ability to prosper and to create opportunity for all?


Getting Back to Full Employment

December 2, 2013

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Dean Baker and Jared Bernstein. Getting Back to Full Employment: A Better Bargain for Working People. Washington, DC: Center for Economic and Policy Research, 2013.

In this short but cogent book, Baker and Bernstein make their case for focusing public policy more on the goal of achieving full employment. That goal seems strangely out of fashion, considering how high unemployment has been since the financial crisis of 2008. Reducing the federal deficit and holding down inflation are the goals that preoccupy policymakers, but the authors see that as economically counterproductive.

As economists use the term, “full employment” doesn’t mean that everyone who would like a job is actually working. The labor force always includes some people who are currently between jobs (the “frictionally” unemployed) and some who lack the ability or skill for the existing jobs (the “structurally” unemployed). An economy does not have to employ those groups to be considered at full employment, but it does have to have enough jobs to eliminate “cyclical unemployment,” unemployment resulting from a weak demand for labor in general. While structural unemployment is a problem of labor supply, requiring improvements in the qualifications of workers, cyclical unemployment is a problem of labor demand, potentially responsive to stimulatory fiscal and monetary policy. To the degree that government can stimulate demand through such measures as cutting interest rates or increasing public spending, it can reduce cyclical unemployment and move the economy toward full employment.

If, however, the economy is already near full employment, and most of the remaining unemployment is structural, then policies intended to promote additional employment could mainly generate inflation instead. If the job-seekers are mostly underqualified for existing jobs, then employers who wish to hire must either bid up the price of the qualified workers or pay the unqualified more than the value of what they can actually produce. Either puts upward pressure on wages and/or prices. Theoretically, there is a rate of unemployment at which cyclical–but not structural–unemployment is absent, and below which unemployment cannot go without increasing the rate of inflation. Economists call that the “non-accelerating inflation rate of unemployment,” or NAIRU. It is the theoretical sweet spot of “full employment and stable inflation.”

In practice, economists have trouble agreeing on the NAIRU rate, or on the inflationary cost of trying to get unemployment even lower once that rate has been reached. Baker and Bernstein are concerned that an excessive fear of hitting an inflation threshold makes policymakers too timid about fighting today’s high unemployment, unemployment at a rate they consider well above NAIRU.

To acknowledge this relationship between low unemployment and price pressure is common sense. But there is a huge difference between acknowledging the relationship and believing that public policy must avoid full employment because it will cause inflation, or that it must tolerate a cruelly high level of unemployment simply to avoid a slight risk of inflation.

In the early 1990s, most economists thought that unemployment couldn’t go below 6% without triggering more inflation, but it actually came down to 4% by the end of the decade, while wages remained stable. Today, the Congressional Budget Office estimates NAIRU at 5.5%, and a few economists regard unemployment rates over 7% as mostly structural rather than cyclical. That view blames unemployment primarily on the poor qualifications of the workers and discourages efforts to stimulate economic demand by warning of inflationary consequences.

Baker and Bernstein disagree. They reason that if employers generally were having trouble finding qualified workers, they would be offering higher pay or lengthening the workweek for existing workers. That’s true for a few jobs, but not for the economy generally. The authors also point out that unemployment that appears structural could actually be cyclical, since employers are much more likely to upgrade worker qualifications through training when the demand for labor is high.

I would add that a lack of high-paying jobs has a structural dimension, since it is at least partly due to a lack of education or skills in a particular population. But as Arne Kalleberg argues in Good Jobs, Bad Jobs, it also reflects how employers choose to organize work. Some companies deliberately create jobs that can be performed by cheap, low-skill labor, and such jobs have proliferated in our “post-industrial” economy, especially in service industries. When labor demand is high, skill requirements are not as significant an obstacle to employment as all the talk about hi-tech industries would suggest.

Believing as they do that today’s very high unemployment is mostly cyclical, Baker and Bernstein argue that the benefits of reducing it far outweigh any inflationary costs of doing so. “If the unemployment rate could in fact fall to 4.0 percent, and possibly lower, without leading to accelerating inflation, then the result of a policy that kept it higher would be the needless unemployment of millions of workers and lower wages for tens of millions.”

When the demand for labor is low, as it has been since the financial crisis, that creates unemployment for some and low wages for many more. Workers are in a much stronger bargaining position when labor markets are tight. Long-term unemployment has negative effects on earnings that last for many years beyond the actual period of unemployment. Since these effects are greatest for workers at the low end of the income scale to begin with, slack labor markets tend to widen the income gap between rich and poor.

Moreover, the damage of job loss extends beyond earnings and hours worked, as job losers have been found more likely to experience a number of noneconomic negative impacts, including increased rates of stroke and heart attack, higher rates of divorce, lower rates of home ownership, and even lower life expectancy. Generational effects have also been found as the children of parents facing long-term unemployment are more likely to have lower test scores and reduced earnings as adults than similarly placed children whose parents avoid long jobless spells.

Beyond the effects on workers and their families, economic downturns that drag on needlessly have huge costs for the entire country through lost productivity. Since 2008, United States has produced $6 trillion less than the CBO projected it would before the recession. “This is a large cost that dwarfs the estimates of the losses associated with modestly higher rates of inflation.” Unemployment also affects the federal budget deficit, since it reduces tax revenue and increases the number of people qualifying for government assistance. For example, workers with chronic health problems who could find jobs when labor demand is high have been applying for disability benefits since demand declined.

Baker and Bernstein see the costs of inflation as much smaller than all that. Even if stimulatory economic policies were to push the unemployment rate a full percentage point below NAIRU–and they believe that it is well above that point now–the research indicates that the rise in inflation would only be in the range of 0.3 to 0.5 percent. The costs in terms of economic growth would be less than those of persistently high unemployment. Although some studies have found a negative impact of inflation on economic growth, “the size of the estimated impact of inflation on growth in the studies that found an effect is certainly well within the range that could be explained by measurement error.” (Here they discuss a particular type of measurement error that plagues these studies. If, as many economists believe, conventional measures often overstate inflation, such overstatements would both increase measured inflation and decrease measured GDP growth, since real growth is nominal growth minus inflation. Such cases could skew the results so that the same countries appeared to have both higher inflation and lower real growth.)

A modest amount of inflation can even help with some policy issues. Suppose the Federal Reserve reduces the federal funds rate to 2%, in order to stimulate the economy by making borrowing more affordable. If inflation is 1%, the real federal funds rate (nominal rate minus inflation) also becomes 1%. But a higher inflation rate can bring the real rate down to 0% or even below zero, making borrowing really pay.

The authors are especially critical of central bankers who make low inflation their overriding policy objective, especially when the central bank has a legal mandate to pursue both price stability and high employment, as it does in the United States. They summarize:

The evidence used to support inflation-targeting policy is dubious. If the general public and even most politicians fully understood the costs and risks associated with the inflation policy pursued by central banks, few would agree that it is appropriate to keep millions out of work and deny wage growth to tens of millions simply to reduce the risk of modestly higher inflation.

While Baker and Bernstein focus on the economics rather than the politics of unemployment, one may observe how easily full employment gets relegated to the back burner. Although high unemployment hurts the entire economy, the costs fall disproportionately on the have-nots, the workers whose labor is in least demand. Inflation, on the other hand, erodes the value of whatever wealth and income people already have. In a society with extreme inequality and minimal restrictions on political spending, the haves can use their influence to create a systemic bias toward fighting inflation instead of unemployment. Prevailing policies may not be optimal for economic growth, but they help perpetuate the unequal distribution of the benefits that flow from whatever growth occurs. Much of the resulting unemployment may not be structural in the economic sense, that is, resulting from the workers’ inability to do today’s jobs. But it could be structural in a more political sense, resulting from the weak position in the power structure of workers in general and unemployed workers in particular. That would explain how unemployment could be technically cyclical as Baker and Bernstein argue, and yet so persistent.

Continued