Preface
Work
and daily occupation is a cornerstone of society, as well as a key
component of our political economy. In order to share in the social
surplus, one must earn his piece by working. Work and labor is
undoubtedly an economic input. Labor is a required ingredient to
many productive processes which create the commodities and services
modern consumers demand. Somewhat strangely however, workers are
rarely paid based on productivity or output, and labor unions have
often resisted piece-work schemes or performance based pay. Firms
are often reluctant to lay-off surplus workers when times are good
and profits are relatively stable.
Therefore,
modern work is as much a political and social construct as an
economic phenomenon. This reality helps to explain why firms don't
lay off in mass, even when doing so might maximize profits. It also
explains things such as vacation pay and severance packages, and
employer-based healthcare. Furthermore, it might also explain while
socially pleasant but incompetent workers often not only retain their
jobs, but receive promotions.
A
Permanent Shortage of Aggregate Demand
Centuries
of capital investments and savings have given us an economy which can
produce many times what it can consume. This supply and demand
mismatch would normally lead to divestment and contraction, and in
particular industries this has certainly been the case. The
overbuilding of houses caused a bust in the construction industry in
recent years, and forecasters have seen recent upticks in
construction employment as a sign that the economy is healing.
However, in the broader economy, the reality is that the difference
between supply and demand is absorbed by debt and waste.
This
is somewhat true on the household level, as families racked up credit
card and housing debt during the the last business cycle, only to
aggressively pay down this debt after the collapse. However,
consumers, by their very nature are fickle, and households have
trouble maintaining spending during lean times. Therefore, the most
important borrower and spender has been the US government.
Agricultural
subsidies, much bemoaned by many on the left and right, continue to
provide nearly 20 percent of income for farms. Decades of farm
subsidies have created incentives for tremendous increases in
efficiencies in farming. The result is that the US is one of the
worlds largest per capita food exporters with a relatively small
number of workers in the farm sector. The European Union, which
also heavily subsidizes agricultural also posts similarly impressive
figures.
While
on the surface it appears that the government is simply paying
farmers to produce crop surpluses, these subsidies (financed via
government debt) are really investments which have produced and
sustained a large and highly efficient food system capable of feeding
the world with relatively few workers. In a world where hunger is
still a problem, this system is an invaluable asset both in terms of
easing human suffering and raising general living standards.
Similar
stories have played out not just in farming, but also high-tech
industries like aviation. For fiscal year 2014, the government will
spend nearly 40 billion dollars on new aircraft. Even though this
figure represents a 12 percent year on year reduction since 2013, it
still accounts for nearly 25 percent of all new aircraft orders for
2014. Although policy makers at the Defense Department say that many
of these procurements are unnecessary, Congress has forced Defense to
go through with these slated orders anyway. The political
explanation is that many Congressman have corporate and natural
person constituents highly dependent on government contracts and
orders. However, economically, these orders, again financed largely
through debt, have built up a huge high tech industry which has
revolutionized life for the average American. Let us not forget that
the internet comes to us courtesy of investments made by the US
military.
Recessions
Drive Restructurings via “Shock Therapy.”
These
high levels of capital investments are also in line with massive
exodus of labor from capital intensive industries into the service
sector. The following figures show the amazing reality that while
manufacturing jobs have been lost in the US, manufacturing output has
soared. As evidence in Figure 1, it's almost as if the more people manufacturers lay off (and
replace them with machines) the higher output rises.
Figure 1: Indices
of manufacturing output(red), employment(blue), and investment in
machines and software(green). Employment has tends to stay steady
but roughly fall during recessions, never to recover. Output rises
sharply during boom times, falls during recessions, only to robustly
recover. Fixed investment rises steadily, regardless of the business
cycle.
Another
interesting feature is that firms only tend to lay off during
recessions, or as a last resort in order to survive. From 1992 to
2000, manufacturers added few jobs while output soared. Then the
2001 recession resulted in huge layoffs and a drop in output.
However, output quickly recovered while layoffs continued through the
2000s. Technology advances rapidly, however, such a marked change in
business model over a single year can hardly be accounted for by
technological progress. The fact that men could be replaced by
machines was probably largely true several years earlier in the 1998,
during the internet boom. It is also worth noting that investments
in equipment (green line) did not break their upward trends during
the past few recessions. Finally, some sudden technological
innovation would entail a spike in capital spending as manufacturers
rushed to bring the newest most efficient machines online. Instead
we see a steady rise in capital spending, which occurs regardless of
cuts in labor costs.
Conclusions
we can draw from this data are that manufacturers tend to lay off
only as a last resort, not to maximize profits. Recessions act as
'shocks' which force firms to lay off in mass, after which
manufacturers quickly realize that most of the labor let go during
the layoffs can be replaced by machines and retained employees.
Indeed, investment in equipment has risen steadily even through
recessions. Unit labor costs, or the labor costs per unit of output,
also tend to fall during recessions, reflecting that retained
employees tend to raise their productivity after layoffs.
In
sum, the unwillingness of firms to gradually adjust to changing
fundamentals adds instability to the economy and probably prolongs
downturns. Rather than waiting to be forced to layoff workers in
mass, firms should replace workers with fixed capital as it becomes
more profitable. This would avoid the mass flood of workers onto the
labor market during downturns as firms layoff workers as a last
resort. It would also allow the broader economy more flexibility in
absorbing excess workers, a theme we will explore in the next
section.
Ironically,
at least in the manufacturing sector, data suggests that hiring and
firing decisions during boom years are not based on profit
maximization. Other factors, such as loyalty, social cohesion, and
satisfaction with being an employer may cause firms to retain many
otherwise unnecessary employees.
The
Service Sector Absorbs Excess Labor, For Now
Thanks
to the dynamism of the US economy, labor formerly employed in the
manufacturing sector has largely been absorbed by the service sector.
In recent years, this has been reflected by the strong growth in
food service and healthcare jobs. Furthermore, as shown in figure 2, the losses of jobs in
manufacturing have been a continuation of the post-war trend,
beginning around 1950.
Figure 2: The
relative composition of the total workforce by sector.
Services(red), manufacturing(blue), government(green)
So
largely, losses in the manufacturing sector have be off-set by gains
in the service sector. Modest gains in the public sector, on the
order of about 5 percent as a relative share of the total workforce,
have also eased the transition. Furthermore, there is little
evidence that machines will replace workers in the broader, service
oriented economy. Thus, the service sector has acted as a safety
valve to redirect displaced manufacturing labor. Indeed, unlike
manufacturing, in the broader economy, investment in human labor
(wage growth) continues to outstrip investment in fixed capital.
(office computers and software, buildings, ect.) Figure 3 illustrates.
Figure 3: Labor
and capital investments in the broader economy. Wages (red) continue
to outpace growth in capital investments (blue). Unlike in
manufacturing, capital investment moves with the business cycle.
This suggests that service industries are not as easily able to save
labor costs through up front capital purchases.
It
therefore is evident that the broader economy is much more dependent
on hiring to increase output. So long as this remains the case,
labor can continue to shift from manufacturing into to service,
albeit with great disruption to many households.
Modern employment trends started nearly 60 years ago. The same post-war mechanisms of recession induced layoffs
in manufacturing, and job growth recovery coming in the service
sector, are at work today. Fixed capital investment in manufacturing
has remained robust and surprising strong even in business
contractions. This is consistent with the steady replacement of man
with machine in the manufacturing sector. The service sector remains
the key absorber of excess labor unemployed in manufacturing.
Furthermore, service sector wage growth continues to outpace capital
investments in service oriented industries. This suggests that
machines will not replace humans any time soon in the service sector.
Advancement in technology may someday cause the service sector to go
through the same revolution that manufacturing has undergone in the
past 60 years. This would clog the key safety valve which has
historically soaked up excess labor. The result of such a “service
sector revolution” would be foreshadowed by large capital
investments in service industries, followed by layoffs during
recessions. These workers would not be rehired, but replaced by
further capital investments. Some futurists envision much service
work being done by intelligent machines. This would result in
permanently high structural unemployment, because at this moment,
unlike the times of industrial mechanization, no obvious absorber of
excess workers exists. The economic and sociological implications of
this hypothetical are profound. But that is a subject for another
book.
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