TCS Daily


Productivity: The Labor of Love

By Tim Worstall - April 7, 2006 12:00 AM

Is globalization a race to the bottom or a race to the top? Will living standards for the average American inevitably fall as all those foreigners make everything for us while being paid spit-and-a-packet-of-peanuts? Or, as most economists point out, will foreigners getting richer make us richer still?

After all, if the Chinese (for example) can do everything cheaper than we can, what on earth will we produce? If shoes, cars, clothes, steel and everything else will be made in China, what on earth is there going to be left for the American worker to make?

A fair question.

In the shorter term, the answer lies in David Ricardo's thoughts on "comparative advantage." We should make whatever we're least bad at and sell it to the Chinese in return for whatever it is they are least bad at making. But even if they are, in fact, better than we at everything -- such a trading rationale still holds true. Everyone benefits from the trades.

If you prefer your analyses with a dash of Marxism, however, try this from The Guardian:

"A piece of conventional wisdom about the world dear to economists is that the share of national income going to workers stays pretty stable. Karl Marx disagreed; he argued that labour-saving capital investment would limit demand for labour, while also bankrupting small-scale producers, in agriculture for example. They would swell the labour supply, creating a permanent "reserve army of labour" that would prevent real wages growing as fast as labour productivity. Workers would thus spend an increasing proportion of working time producing profits for capitalists -- a falling share for labour or a rising rate of exploitation, in Marx's terminology.

[...]

China (and India) ... [have] vast labour reserves. Total employment in China is estimated at around 750 million, or about one and a half times that of all the rich economies, and nearly 10 times the combined employment of Japan and Korea. About one half of China's employment is still in agriculture; together with tens of millions of urban underemployed, they constitute a reserve army of labour of quite unprecedented magnitude."

The Chinese (or whomever) are not better than we at producing everything, nor are they more productive. In the economy as a whole they're just as productive as us per dollar paid for their labor. But as you may have noticed, they're paid a lot less per hour than American workers are. The lower wages and lower productivity cancel each other out. For a basic concept is that when the Chinese are just as productive as Americans they'll be paid just as much as Americans. That may be why people started thinking that US wages will fall to Chinese ones and globalization will indeed be a race to the bottom.

But average wages in an economy are set by the average productivity in that economy. They are not set at the level of a factory or a firm, but at that of the surrounding economy and there's no reason that has to be as a country either. This is how we can get some Chinese factories or companies that are, say, 50 percent as productive as a US one while they pay only 25 percent of the wages (the difference between this 25 percent and the 3 percent quoted in the Guardian is that I have made up this latter number just as an example. They have also grossly miscalculated their percentage for a number of boring technical reasons, which none of us really wants me explain right now.)

What's more, wages will rise where productivity rises, not fall in the other places to match the lower wages. There's a temptation to simply say that is just the way it's going to be and that's the way it's always worked in the past. As labor has become more productive at the economy-wide level, wages paid to that labor have always risen.

This week, we're rather privileged to be able to point to something beyond theory, from the front page of the New York Times, no less.

"SHENZHEN, China -- Persistent labor shortages at hundreds of Chinese factories have led experts to conclude that the economy is undergoing a profound change that will ripple through the global market for manufactured goods.

"The shortage of workers is pushing up wages and swelling the ranks of the country's middle class, and it could make Chinese-made products less of a bargain worldwide. International manufacturers are already talking about moving factories to lower-cost countries like Vietnam.

"At the Well Brain factory here in one of China's special economic zones, the changes are clear. Over the last year, Well Brain, a midsize producer of small electric appliances like hair rollers, coffee makers and hot plates, has raised salaries, improved benefits and even dispatched a team of recruiters to find workers in the countryside."

Things are, indeed, working out as expected. As the Chinese economy becomes more productive, in general, wages are going up. Tim Harford explains the mechanism is his book The Undercover Economist (yes, I know, that was out months ago in the US. We get it next week in the UK.)

"As more multinational companies have set up factories, they have competed with each other for the workers with the best skills. Wages have risen, not because the companies are generous but because they have no choice if they want to attract good workers. Local firms learn the latest production techniques and become big employers too. It becomes more and more attractive for people to work in a factory and to acquire the necessary skills: education improves. People move away from the countryside, raising rural earnings for those who remain to a more tolerable level."

That's exactly what that NYT piece is reporting on. Factories both need and want more labor and are willing to pay more to get it. This pushes up incomes across the entire economy. The end result will be just as predicted: when the entire Chinese economy is as productive as the American one, then Chinese workers will be paid the same as American ones. (And it'll be the higher American wage rate, not the currently low Chinese one.)

Such is also the answer to that Marxist analysis from The Guardian. If we say that there is something called "capital" which hires all the workers, their dystopia is indeed possible. That is, that we have one buyer of labor, a monopoly buyer if you wish (to use the jargon, a monopsonist). But that isn't what we have; we have capitalists (entrepreneurs or companies) and the important thing to note is that the word is plural. There are many of them and they are not in direct competition with labor. They are in competition with each other for access to that labor. So if the productivity of labor rises, then so will the amount paid to the workers as the plutocratic bosses compete with each other to get hold of the good workers.

With this analysis we don't even have to stop and think about what it's going to be like for American workers and companies to have 1 billion people to sell to and trade with, 1 billion just as rich as the average American -- vast though those opportunities are going to be.

We can see that globalization is a race to the top, one in which we all win... Or, if you prefer: Marx 0, Capitalism 1. (Again.)

Tim Worstall is a TCS contributing writer.

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19 Comments

Productivity parity?
Some of this material is a little teuous. Worstall says "The Chinese (or whomever) are not better than we at producing everything, nor are they more productive. In the economy as a whole they're just as productive as us per dollar paid for their labor. But as you may have noticed, they're paid a lot less per hour than American workers are. The lower wages and lower productivity cancel each other out."

Hmm. I guess that's why the price of cheap consumer goods has fallen back to what it was in the 1950's. The price of a hammer at the dollar store is one dollar. Or, you can pick up a perfectly good American hammer for $18. I find it hard to believe there is productivity parity measured in dollars.

No, the Chinese will continue to sell us everything we need in exchange for our pictures of dead presidents. The only other thing we give them they could possibly use is work orders, and a few SUV's to drive around in.

China's one billion not-yet-employed are far more of a problem to the Chinese than they are to us. We'd better hope the Chinese find a productive use to put them to-- because if they don't, there problem may well become everyone's problem. A stable and prospering China is essential to a happy world.

Productivity
Perhaps that part on productivity is slightly clumsily worded. Apologies.

There’s a difference between the economy wide productivity levels (which are low in China as are the ages) and certain sectors (where they are higher). Average wages are set by that economy wide level. That’s how come you get the $1 hammer. There could be a factory worker at, say, 50% of US productivity levels but he’s still being paid Chinese wages.

Our two tiered economy
Thanks for the clarification, Tim. I've always been struck by the disconnects, where since the 1980's prices for foreign-made "stuff" keep coming down further and further, while costs for services (requiring the recovery of incredibly high American wages) keep skyrocketing.

Where are consumers losing ground? Health care and professional services. On the other hand we're hip deep in cheap consumer crap. It's quality crap, too.

Yup
Sure, that’s something called the Baumol Effect. search here at TCS for "worstall baumol" and you’ll find a piece on exactly that.

international economy
The international economy is a race to the bottom and a race to the top. Post WW2 conditions with the USofA being the only world power are over. We are reverting to pre WW1 conditions with 50% poverty class, 30% with decent jobs, 15% managerial, small business owners, and professional people an 5% millionaires.

However, the nature of poverty has changed thanks to increased productivity. Poor people have accessto most of the sorts of consumer products as the rich people but of a lower quality and poor people have to stand in line to get them.

The labour of love or complusion?
Why multinational corporation opening factries in Channa and outsourcing in India, because here labour is very cheap.Both countriea are really cooli of westren countries. real benifit is getting to westrencountries. Chanies and Indians labour doing this job not for love but this one is complusion on them, they have no tradition of science so they are very poor in origanal productivity. both countries are rich only in man power.Future of gobaliztin will run same way main profit will go to westren countries and both countries will get only pure labour,

one child policy
I'll be curious to see how China's one child policy will affect their overall productivity in the future. Without knowing for sure I have to assume their current workforce is on the "mature" side. Assuming that, will they be forced to import workers from poorer nation-neighbors, or will they "export" lower end manufacturing to them instead; and in the process become a service-oriented economy like the USA is becoming? Stay tuned...

Interesting as you say
The one child policiy hasn’t made an impact just yet. Another decade or two and they’ll have one of the fastest ageing populations on the planet. (Well, one year at a time, like everyone else, but you know what I mean.)
It’s one of hte reasons they have such a high savings rate, all those people trying to save for retirement.

Good to see!
By the way, it's nice to see the author of a particular article on the thread interacting with the readers. I don't see that too often, so thanks!

Aww, shucks
I write here at TCS because I enjoy doing so (and yes, I do also get paid). Part of the enjoyment comes from at times being corrected, being led to further details, learning more about the subject. I’ve at least once used something I was pointed to in the comments as the basis for a further article (with a name check, of course) simply because what I was pointed to was both interesting and relevant.

There’s a little bit of it that comes from my writing having grown out of blogging. I’m both used to the interactivity and enjoy it, have almost come to expect it. When I write for the newspapers (which I do occasionally) I very much miss knowing what the readers thought about it.

Most of it though is of course because I have an ego the size of the planet. I simply can’t resist reading what people are saying about anything I’ve done. :-)

industrialization
In your opinion, would China and India be better off if the West did not buy their products?

As to India, I would dispute your claim that they have tradition of science. Indian science was not advancing as fast as western science, but it did exist.
Secondly, so what. India is rapidly becoming a powerhouse in computer engineering.

Both China and India have many, many smart people. What's holding them back is, and was, their respective governments. Now that India's govt has abandoned many of it's failed socialist baggage, the Indian business community is in the process of creating great amounts of wealth, for the entire country. Not just western businessmen.

Race to the middle
The China/India are racing upwards, and the west is racing downwards. We'll meet somewhere in the middle. Some of the things postponing this are the US going further and further into debt to try to hold on to an older richer way of life, and China increasing savings and currency manipulation to try to keep costs as cheap as they used to be. Both sides are building up more and more pressure that will eventually be released as the 2 sides snap towards each other.

Decline of the West
Unfortunately, the author of the article does not inspire much confidence. To begin with, he has trouble with the English language, mistaking the accusative for the nominative case (as when he uses “whomever” when he should use “whoever” and “us” when he should use “we”). Perhaps he takes his grammar lessons from President Bush.

The mother tongue aside, the truly gross error of the article is the fantasy that “we're all the same” and therefore will produce equally in our respective lands, a condition resulting in parity and wonderfulness for all.

Reality is quite different. As northern Mongoloids, the Chinese - for so long frozen in the past, then convulsed with the absurdities of the Communist slaughterhouse - actually have IQs on average superior to those of Caucasians, except for Ashkenazi Jews. They also could not care less about touchy-feely methods of education; either the student works like a demon and comprehends the material or he becomes a coolie at the level of a beast of burden. The same, by the way, is going on in a number of other Asian countries. The result: by 2010 90% of ALL scientists and engineers in the world will be Asians living in Asia, according to recent projections.

Moreover, the United States achieved its great power and status due to a number of extraordinary and unrepeatable historical circumstances. The discovery of a complete, new continent rich in resources inhabited only by Stone-Age cultures was one of those circumstances. The rise of science and technology was another. And very significant is a third: the discovery and availability of cheap petroleum of excellent quality. The advantages afforded by all of these conditions and others are now ending. And with it, the American way of life.

Within a few decades, it will again be the way it always used to be: a struggle for survival, and survival of the fittest.

Immigration and Productivity
Great article as usual, Mr. Worstall. I would also like to second the sentiments of an earlier poster, I really appreciate your participation in the discussion forum.

The fundamental truth that average standard of living is set by average productivity can never be repeated too often.

It is especially applicable in the current immigration debate. If the ranters and ravers clamoring to "send them home" ever took the time to analyze what that would do to their own standard of living, maybe they would calm down and realize that welcoming their brown or other skinned brothers to work beside them is actually a really good idea.

Consider the productivity implications of deporting illegal immigrants.

On average, all of those immigrants are more productive here than they were in their country of origin. If they weren't, they wouldn't have bothered to emigrate.

Forcing them into less productive jobs or unemployment in their home countries will make a substantial cut in the productivity of the closed economic system that is our planet. Their loss is our loss.

Meanwhile, their living costs do not go away just because they step over a magic line designated "border". Their families still demand similar resources- food, shelter, education, and health care.

People have to eat every day, but they don't have to produce every day. The lost productivity is gone forever. Even a half-hearted attempt to deport illegal immigrants whose only crime is to come here and attempt to stay here will have the effect of making a large deduction from the global asset pool.

The global asset pool is the accummulated surplus of the planet since time began. It includes both tangibles and intangibles. It is the fuel for the fire of economic growth. It has a critical mass.

When the global asset pool is smaller then necessary to support the global population, people die for lack of basic necessities and this loss of human assets shrinks the asset pool geometrically. When it is large enough to
support the global population, the pool expands geometrically.

We are blessed to live in a time when the global asset pool has grown geometrically for over 60 years. World War II destroyed an enormous portion of the pool. Peace and prosperity is not just a popular idiom because of the alliteration. Peace brings prosperity and prosperity brings peace. Peace allows the global asset pool to grow as assets are not being destroyed or consumed due to conflict.

Totalitarian regimes around the world have limited but not stopped the growth of the pool. Forcing productive workers to relocate to a less productive locale would simply be our own totalitarian regimen. And it would have the same predictable results, reducing the growth of the global asset pool, cooling the fire of economic growth.

Thanks again for your clear thinking and persuasive writing on the primacy of productivity.




One child --> One boy
I'm more interested in how the one child has become in some areas of China nearly a one boy policy. Normally nature gives us about 105 live boy births for every 100 girls. In the interior of China it's now upwards of 135 boys to 100 girls. An unintended consequence of medical advances like ultrasounds and cheap, safe abortions.

Socializing boys is one of society's most difficult tasks, but one that has to be done. The job gets harder when the likelihood of finding a mate goes down.

Interesting article in March/April issue of Foreign Policy that touches on this.

Link to "Everyone Benefits" - Sweet
I followed the link "Everyone benefits from the trades". That was cool. You can talk till you are blue in the face sometimes, trying to explain how market forces actually do maximize overall productivity, thereby benefiting ALL trading partners (although not EQUALLY) and some people just dont see it. So this game is a good demo.

My uncle is a union auto worker, and no amount of reason will convince him. Even if he played this game, he would probably still complain that the gains were not FAIR. To him, the only way rich people get rich (excluding himself, of course) is by exploiting others. This game clearly demonstrates otherwise.

health care
The biggest reason why health care is so expensive is because govt keeps it that way.

Europe
I would agree that Europe is poised to race downwards, but here in the US, we are still racing upwards. Just not as fast as China and India.

struggles
America's one true advantage was the ability to make a clean break from Europe.
Our national resources had nothing to do with our wealth. It was our people and our system that created that wealth.

HongKong has no natural resources, yet it became the richest country in the world, until China took it back.

In the mid 1800's, the standard of living in Mexico was virtually the same as in the US.

In the 1930's Cuba had a standard of living nearly equal to the US, and Argentina had one that was slightly higher.

It wasn't cheap oil that made the US wealthy. Every other country in the world had equal access to that same cheap oil.

What made America wealthy was that we let people alone to find their own way, and we didn't punish them when they had the temerity to make themselves wealthy.

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