wages

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Wages. Just For Fun.

This is just for fun.  It’s nearly the holiday season after all.

Let’s tell a story: a friend of ours here in southern Vermont was looking for a job.  She saw an advertisement posted by a local business.  Or, perhaps, she heard something about a job from a friend.  In any case she applied and got the job.

Well done.

Her wage is, naturally, determined by her marginal productivity.  We all know that.  All wages are determined by individual worker marginal productivity.

Right?

Our friends’ new employer has an education in economics and remembers what Mankiw says:

“Economic theory says that the wage a worker earns, measured in units of output, equals the amount of output the worker can produce. Otherwise, competitive firms would have an incentive to alter the number of workers they hire, and these adjustments would bring wages and productivity in line. If the wage were below productivity, firms would find it profitable to hire more workers. This would put upward pressure on wages and, because of diminishing returns, downward pressure on productivity. Conversely, if the wage were above productivity, firms would find it profitable to shed labor, putting downward pressure on wages and upward pressure on productivity. The equilibrium requires the wage of a worker equaling what that worker can produce.”

That’s pretty clear.  Open and shut.

Our friend’s wage is determined by her output.  Measured in units.  

That’s interesting.  Our friend is an accountant.  Her output is reports and so on.  

Nevertheless her wage matches her output in numbers of reports.  Or so the story goes.  And, naturally, her new employer has that information close to hand.  As they do for every single one of the several hundred positions they have to fill.  All employers have all that data to hand when they hire people.  Employers are, as we all know, all knowing. 

Aren’t they?

Of course they are!

Back to the story:  our friend —Jane — is happily producing marginally.  Meanwhile her employer — Anne — hears that a local factory has just been re-organized and its accounting function has been moved to the headquarters in another state.  There are a few accountants looking for work.  One of whom is well known to Anne — they play tennis together.  During a conversation after a game Anne learns that this other accountant, who has more experience than Jane, is willing to work for less.  Anne has a predicament.  Jane’s wage matches her output perfectly, but that output could be produced for less.  

Now what?

The local labor market has been flooded with unemployed accountants.  The supply curve has moved.  The market is telling Anne that she should be paying less.  

Now Anne has a quandary.  What to do?

Did she misunderstand Jane’s marginal productivity?  Surely not.  She has perfect information.  Not understanding is not possible.  She breathes a sigh of relief.  It would not do not to have perfect information.  Just the other day she was discussing interest rates in 2054 and found the conversation totally boring — everyone knows the same thing!  There was no discussion to be had.  But this marginal productivity thing vexes her.

What to do indeed!

Anne feels ignorant.  She is overpaying.  The market says so.  But her perfect information of marginal productivity also says she is paying the correct wage.  She needs to square this circle.

She gets annoyed.  How could the market and her perfect information of Jane’s marginal productivity not align?  How can Anne combat the laws of economics?

She rummages around her attic to find her copy of Mankiw’s textbook to refresh her memory.  The resolution to her dilemma will surely be there.  After all this cannot be a unique circumstance.  Economists have thought of everything.

No?

Phew.

She discovers that Mankiw goes on:

“Why don’t real wages and productivity always line up in the data? There are a several reasons”…

She reads on to explanation number three:

“3. There is heterogeneity among workers. Productivity is most easily calculated for the average worker in the economy: total output divided by total hours worked. Not every type of worker, however, will experience the same productivity change as the average. Average productivity is best compared with average real wages. If you see average productivity compared with median wages or with the wages of only production workers, you should be concerned that the comparison is, from the standpoint of economic theory, the wrong one.”

Oh my!  Workers may differ in various ways.  Anne is stunned.  This had never occurred to her.  She should have paid more attention in her economics classes.  She would have known more about business.

Perhaps she can resolve her dilemma by calculating average productivity.  The average of what, she wonders.  The average of her accountants?  But she only has two.  The average of all her workers, including Bill the office janitor?  His output is the number of mop strokes per hour.  How does that average with Jane’s reports per hour?  Mopping and accounting seem so different.  But not in economics.  They are “units”.  They are the same thing when you think about it long enough.

Then Anne begins to get confused.  

Mankiw says that “productivity is most easily calculated for the average worker in the economy”.  Anne wonders just who this average worker is.  Does she employ this person?  Is it Jane?  Is it Bill?  She hopes that it isn’t that Susan in marketing whose output is perfectly known but seems never quite to achieve the sales goals Anne sets.

Then Anne recalls why her economics textbook is in the attic and not at the office.  It has no relevance.  She pours herself a congratulatory drink.

The telltale is in the way Mankiw words his explanation.

He leads off by saying that “economic theory tells us…”. Anne should have stopped there.  Its economic theory!  It isn’t the reality she lives in.  Mankiw drives the message home when he says “… the equilibrium requires he wage of a worker equaling what that worker can produce.”.  

The equilibrium requires.  How can an equilibrium require something?  Who, or what, is it that is actually doing the requiring?  Perhaps economists trying to fit things together?  Surely not!

Anne wonders where this equilibrium is.  Possibly near the average worker?  Does Bill have something to do with it?  Anne notes to herself that she will ask Bill if he has seen an equilibrium in the hallway next time she sees him.

After a second drink Anne realizes that Mankiw has not helped her at all.  But she still feels upset that she’s paying Jane more than she might pay her tennis partner.  Where in economic theory can she find help?

All this talk of averages and an equilibrium don’t have much relevance to Jane.  Or Anne.  How can it be that the average has so little to say about an individual experience?  How can economics be so blind to those individual experiences?  After all, Anne vaguely recalls,  Mankiw and the others were always running on about individuals in their lectures.  The individual was everything.  Wasn’t it?  Or did she forget?  So why does Mankiw retreat to “averages”?  

What, exactly, is an average in this context?  Who is it?  And is this why, Anne wonders, why so many people today feel rotten despite all those upbeat numbers on the economy she reads about?  Are they averages too?  Are the people average, or is it the data? 

Even more confused, Anne listens to the economic news.  The labor market is running hot apparently.  The Fed might have to raise interest rates to cool it off.  Oh dear, Anne thinks.  Is that another average?  Who is running hot?  Does that mean the local supply of accountants is part of that average?  Maybe.  Maybe not.  Did the Fed forget about the local accountants?  Should she tell someone?

In frustration Anne gives up.  She switches channels to get the latest weather report.  At least those people give more accurate forecasts.  But she is haunted by the idea of averages.  When she steps out tomorrow morning will the weather be the average?  Or will it be what she actually experiences?

Who knows?

Meanwhile Jane goes to sleep happy with the knowledge that she beat the market.  Not that that’s possible.  

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Addendum:

I took some liberty with my Mankiw quotes.  They are not from a textbook.  They are from a blog post he wrote a few years back.  Nonetheless, learning, as I always try to do, I decided to abstract to get at the essence of the problem.  Call it poetic license.  

And yes.  Economists can square this circle.  They have a lot of square circles in their inventory.  

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State of Play at Year End

Is it just me?

Or is the realm of punditry in a state of confusion?

There seems to be an emerging consensus that something big is happening.  It’s just that we don’t quite know what.  The problem is that the template we are all applying is frayed if not shattered.  Consequently we are searching for the safety of explanations but finding that our questions do not elicit comfortable answers.  This is not a place we like to inhabit.  What are we to do?

Let’s speculate.

Stagflation?  Growth seems to have slowed dramatically over the last decade if not longer.  There’s talk of malaise.  There’s talk of a post-growth economy.  Some folks even applaud the idea that the days of vertiginous growth are behind us.  Now, we are told, we can focus on the environment and pivot to a less material way of life.  We can manage with less stuff after all.  How many homes, cars, and trinkets do we really need?

Lots.  Lots say the pro-growth crowd.  Just look at the cornucopia we call contemporary America.  It is stashed full of goodies.  Our poor ancestors would be green with envy at all the gadgets, the health care, the cozy homes, and the relative lack of physical exertion needed to provide it all.  Why would we not want more?

Ah.  Some others say.  We might be knee deep in goodies overall, but there appears to a problem with the distribution of those goodies.  Too many end up in too few hands.  That’s not good.  It eats away at social cohesion.  It isn’t, as the elitists inevitably say, that the poor are envious.  Not at all.  It’s that the concentration of goodies leaks into a concentration of power.  And the elitists use that power to preserve what they have.  They reject the very nostrums of the liberalism they espouse.  They abhor competition.  And they absolutely don’t want to partake of anything social.  Except for the exotic parties and trips they enjoy.  They prefer their society over our society. 

Inflation?  The curse is back.  Some of us thought it was transitory.  But we didn’t define what we meant.  We did not mean, as the denizens of Wall Street suggest in error, that the transition would take a few weeks or even months.  We simply didn’t know.  What we did mean, however, was that transitory implied that the curse was not permanent and ought not be treated as such.  There was no need to impoverish workers by hammering them and their wage demands.  There are other things we could do.  How about controlling prices whilst the folks who screwed up their supply chains get themselves sorted out?  After all their shareholders benefited from those tenuous supply chains.  Why not make them pay for fixing them?  Why smash workers who had nothing to do with the decisions?  

Because monetary policy is one dimensional.  And we need to protect the creditor class from the debasement of their assets.  You know, the assets that appreciated in value during the long run of ultra low interest rates.  Asset inflation is, apparently, a positive thing.  Wage inflation not so much.  That bias is hidden in the words we use.  Do we talk of wage appreciation?  No.  Of course not.  But we do talk of asset appreciation.  Maybe that’s because we appreciate assets more than wages.

This bias means we just keep politics out of monetary policy.  No. No.  There are no politics in monetary policy.  Or so we are told.  It sits beyond the greedy grasp of the democratic mob.  It is protected within the technocratic walls of the central banks.  Independent central banks.  Unaccountable central banks.  Unaccountable that is, to the mob.  Phew.  Wall Street can breath easily.  The mob is being punished for its wage demands and having the temerity to criticize the wise heads who know what’s good for the economy.  Extra unemployment.  That’s good for the economy.  Apparently.

Except those wise heads are now all a-muddle.

Stagflation!

Having constructed an economy to their liking the wise heads are now rumbling in discontent.  Their creation isn’t behaving.

And the natives are restless.  It’s that mob again.  This time, though, the mob is not alone.  The wheels came off the rigged game back in 2008.  So we had to double down on the rigging.  Efforts to squeeze more from the workforce were re-doubled.  Those longer and less predictable work hours, fewer benefits, cuts to the safety net, the outsourcing of jobs, cuts to training, and all the siphoning off of profit to shareholders has produced … well not much.  We’ve run the place dry.  We are aground.

Aground because the middle class has been stripped bare.  Where once there were deep waters there are now only shallows.

And in such waters ugly rocks protrude.  We begrudge the poor.  After all we know they are poor because they don’t work hard.  Nor do they try to improve themselves.  They mooch.  They want entitlements.  Freebies.  We can’t afford that.  So we cut it back.  Good.

But the middle class?  Isn’t that the engine of consumption?  Why are they complaining?  Haven’t we showered them with stuff through the years?  What’s wrong?

Health care costs.  Education costs.  The threat of unemployment.  Housing costs.  Long commutes.  Cluttered suburbs.  Financial insecurity.  Reduced health and longevity.  Poor retirement prospects.  The list of complaints is long.  Perhaps worst of all is the sense of disillusionment.  The opportunity is gone.  Mobility isn’t what it used to be.  The kids will not be as well off as the parents were.  That’s not supposed to happen.

The ossification necessary to preserve the goodies for the elite has stopped the conveyor belt at last.  The mob is left looking up at a distant elite that has little to no empathy for the mess below.  A new Gilded Age is upon us.  

And no one seems to understand how this happened.

Didn’t the pundits realize that sending our capital and intellectual property to China in order to exploit low wages was, in effect, reducing wages here?  What is difficult about that?  Did they not realize that globalization implied the reduction of investment here?  Did they not see that reduced government investment in speculative research would cut off the supply of ideas for the private sector to profit from?  Or that lower taxes means eroding infrastructure?  Did they not realize that the transition to a service economy inevitably means lower productivity — unless we invest, which we didn’t? Did they not realize that concentration within industries opened the door to poor service and higher prices? Didn’t they realize that cutting investment in training and education would produce a workforce less capable?  Or that cutting research to favor short term profit is self-destructive?

When we privilege asset holders, and shareholders in particular, over all else — all else — then the place will inevitably get a bit threadbare.  

And threadbare isn’t a healthy place to be.  It certainly isn’t good for growth. 

So: stagflation.

The part that flummoxes me most is that the pundits and their clientele amongst the elite didn’t see this coming.  They didn’t read the statistics.  I wonder what they really thought about decades of flat wages?  Good for profits is what they thought.  A what’s good for profit is good for America.  It’s worse than this: they hired people in their captive think tanks to provide them with comfortable articles saying that stagnant wages were an illusion.  No, the elite was told, stories of poor wage growth and rising inequality were untrue.  Relax.  Go back to your second or third house and feel good.  Block out those complaints.  They are the lazy words of the envious.

No.  I am wrong.  The part that flummoxes me most is the lack of alternatives.  The punditry class has run out of ideas.  They simply recycle the same stuff more intensively in the hope that, somehow, the world will revert back to one in which those safe, tried and true ideas work once more.  They yearn for the Reagan years.  The good old days.  When the market was — in their minds — truly free.

When the facts defy your theory there is always a temptation to ignore those facts.  Creating a new theory is such hard work.  Besides a new theory might threaten the status quo.  There are too many reputations and livelihoods at stake.  So we repeat the old stories in the hope that the facts change.  It’s the more comfortable thing to do.  It’s what elites have always done.  Especially once the energy that brought them to their power and prestige has dissipated.  Now they are the lazy class.  Bereft of ideas.  Fearful of change.  Stuck.  But wealthy. 

Meanwhile, let’s impoverish a few more workers.  Keep them in line.  That’ll do the trick.  Won’t it?

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Economics as Myth Making

Well that was an interesting summer.  At least I managed to reduce my pile of unread books slightly.  Only one or two to go.  And now it’s back to … what exactly?  So little seems to change.  There are just so many times I can read sentences beginning with “Neoclassical theory does not explain …”.  I get quite jaded from all the attempts contemporary economists make to separate themselves from past failed theories even if those theories still dominate what is taught to unsuspecting youngsters.  And even if politicians still cling to those failures as intellectual underpinnings for whatever crazy ideological purpose they want to believe in or promulgate.

The current dodge seems to be to pin an arbitrary, but distant, date to neoclassical theory in an effort to bury it, in the minds of the reader, in history.  Phillipe Aghion is an example of this when he says: “Up to the late 1980s, the dominant theory of economic growth, known as the neoclassical model …”  You see what he did there?  He cast poor old Solow et al as ancient history whilst creating the illusion that the neoclassical model is, obviously, an antique of interest only to those who study the history of economics.

Aghion is a major proponent of what is known as modern growth theory.  Which seems to be a brushed up version of Schumpeter and “creative destruction”.   But more on that another time.  What makes my eyes glaze over is the appeal to intuition that passes as insight so often in economics.  Solow is famous, and earned respect within the profession, for hitting on the previously ignored fact that technical progress may have something to do with economic growth.  Ignored, that is, in model making.   In Aghion’s words: “As Robert Solow explained very clearly, generating sustained growth necessitates technical progress that makes it possible to improve the quality of machines — in other words, their productivity.”

Yes.  You can win a Nobel prize for realizing and explaining clearly what the business world had been doing for the better part of two hundred years.

Talk to any self-respecting thoughtful business person and/or worker at most any time since the 1800s and they would have been able to tell you that machines matter, that they are getting progressively smarter and more powerful, and that, in consequence, we can make more with the same or less than we once did.  Those Victorian era chest-beating displays of industry were hardly so subtle that they passed without notice.  Except, I realize, in academic economics where capital and labor remained, and remain, the critical components of production.  Technical progress had to be discovered by economics a hundred or so years later.

Even then it was set aside within a “residual” known rather opaquely as total factor productivity [TFP] which has become both a dead end and a commonly used get-out-of-jail card when an author wants to discuss economic growth.  Solow set the tone for this dodge.  Again, in Aghion’s words: “But Solow did not describe the factors that determine technical progress and in particular the factors that stimulate or inhibit innovation.”  So Solow stopped short.  Very short as it turns out.  But he launched one of economics more absurd artifacts.  TFP gets tossed about in most descriptions of growth.  It has become a plug for economists to use to cover their ignorance of what really matters in growth.  They often admit as much.  TFP is a measure of ignorance. Or, rather, it is a recognition of the inadequacy of economics which falls short of being a comprehensive description of an economy because it fails to delve into all those factors that Solow didn’t explore.

Now I don’t know Solow, but I doubt he had no interest in what causes growth.  After all he spent a great deal of his time and prestige on building models to get at those causes.  His problem is that when he arrived at the boundary of what economic formality allows he stopped.  He peered over the edge and refused to go further.  He could have expanded economics into a more interesting subject matter.  He could have delved into the social, cultural, and political milieu within which technical progress occurs.  Plenty of economic historians have.  But the theorists haven’t.  Solow could have unraveled those production function factors that still bedevil us and dug into more interesting realms.  Energy?  Information? Both capital and labor are simply combinations of those more fundamental elements.  Machines are entirely comprised of them expressed within a physical substrate.  Economics could have hewed more closely to other disciplines.  It could have, for instance, become the study of work throughout time.

Who does work?  Why?  What is work for? How do machines fit into the evolution of work? and so on.  An economy is simply a lot of work being done.  Economics as the study of work would have been able to explore those cultural elements that get hidden in the oddity of TFP.  It could have taken a look at power in the arrangement and organization of work.  And it would have had to encompass the explosion of technical know-how over the past two hundred years or so.  Instead it gave us the mythological monster known as TFP that lurks like a dinosaur on the discipline’s landscape reminding us all of it limitations.

Perhaps Aghion and then others working on new growth theory can get us beyond this limitations.

After which they can deal with another of my mythological favorites.  Marginal productivity is such a joke.

In just two days the Financial Times has displayed the dilemma that economics creates when it finds a shiny intellectual object and stops thinking about something.

Day one [yesterday] has an article talking about the way in which businesses, and big-tech businesses in particular, are struggling  with the remote working phenomenon unleashed by the pandemic.  Oh horrors!  Apparently a goodly number of workers like working remotely and have made the smart decision to maximize their incomes by moving to a home in a lower cost of living area.  How dare they!

Now the paragons of modernity we know as the big-tech companies are wailing about being taken advantage of by their own employees.  They are planning revenge.  They are announcing, many of them, that they will cut the wages of such enterprising employees.  After all, doesn’t it make sense for an employer to pay wages calibrated against the cost of living in various areas?

No.  It doesn’t.

You see, there’s this small artifact of economic theory called marginal productivity.  It argues that an employee gets paid the equivalent of their contribution on the margin.  The location of the employee and the costs that employee face in life are nowhere to be found in that calculation.  Nowhere.

The existence  of marginal productivity is simply a matter of convenience for economists.  It allows them to play with formal models without getting into the messy world of reality.  It allows them to create a myth to launch into the wider world and sound really clever.  That it has no bearing on how wages are actually set is neither here nor there.  It sounds and looks good.  Employees get paid what they contribute.  Simple.  That the big-tech companies defy the myth with their effort to tie wages to cost of living and not productivity is an empirical point we are supposed to ignore.

Day two [today] brings us class war.  It is always thus when workers get uppity and try to get paid more.  The financial types get excited about class war whenever workers get, or seem to get, the upper hand in the wage setting arena.  The pandemic appears to have altered the conditions in which employers operate.  There appear to be worker shortages.  When there are enough workers they seem to want to be paid more.  And they also appear to spurn rotten low paid jobs.  This just won’t do.  It’s a return to what the article calls an outmoded idea: that the relative power of economic classes alters macroeconomic outcomes and that macroeconomic policy tilts relative power.

Well I never.

Let’s just set aside the hand wringing.  Macroeconomic classes exist.  They have relative power.  Policy affects that relative power.  None of this is outmoded.  It is a perpetual reality.  That we choose to ignore that reality is more to do with which side we are on and whether our side is winning than with “outmodedness”.  The financial world is trying hard to get to grips with a shift in power.  More to the point, that shift is away from its chosen center and towards what it regards as hostile territory.  Workers.

The key to the need to raise this shift as ominous comes in the article’s next paragraph which launches the marginal productivity myth in all its glory as being the proper way to set wages.  The implication is that letting power relationships enter the fray is to introduce a distortion.  Never mind that power relationships are the foundation for the social construction of wages. Or that the marginal productivity myth is an artifice of convenience for economists to make their modeling more easy.   Here is the myth being thrown into a discussion of current events as if it had any analytical efficacy.  Its doesn’t.  It was always, like TFP, a plug to cover a gaping hole in economist’s understanding of reality.  Yet here is a journalist using it as a counterweight to the new conditions in the labor market that appear to be tilting in favor of workers.

You can guess where all this distortion will lead.  Inflation.  It is amazing that after four decades or so of wage suppression in the name of shareholder value, when an opportunity to turn the tables occurs, economic myths get wheeled out to be used as weapons against workers.  Had workers been paid according to their marginal productivity the yawning gap between productivity and wages that is one of the most obvious features of the entire post 1980 economy would not be so pronounced.  It would have been reduced if not eliminated.  Yet there it is.  And now there seems to be a window of time in which workers can address the insufficiency of their wages during that period.  The financial world is atwitter with the affront.  It moans about the new class war.  As it hadn’t;t been waging its own class are all those years.

Oh.  And the extent of inflation induced by wage claims is, in a broad sense, a measure of the injustice wrought during the decades of suppression.  I suspect it could be quite a bit.

Meanwhile those myths will be trotted out and presented as shiny analytical objects.  Just don’t breath too hard.  They might turn to dust.

 

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Remote Working Pay Cut?

When a large corporation goes on the hunt for a lower cost base of operations I doubt whether it thinks it will be penalized for what is a rational and frequently made decision.  After all if you can make the same revenue and reduce your costs your profit goes up. Yeah.  Capitalism 101.  If we all go about life in this way, and if we believe Adam Smith, all this pursuit of self-interest will shower society with the glories of social benefits previously unheard of.

I know, that’s twisting things a bit.  But self-interest in a corporation is most often expressed in the endless search for that extra little bit of profit.  So re-locating to a low cost base is a classic move in the well-read CEO playbook.  And who cares if your employees have to uproot themselves and take their families to a less desirable part of the country?  Tough on them.  They need to suck it up and take one for the shareholders.  Or that can quit.

Loyalty, though, is a one way street in corporate life.  Beware the foolish soul who settles in and falls for the human resource department jargon.

The halting departure from the pandemic is showing just how one-way that loyalty is.

I read recently that Facebook is quite happy for its employees to stay and work remotely, although it is trying to limit just how much time people stay away from those expensive offices.  The popular word — presumably more consulting-world jargon — is “guidance”.  Corporations nowadays are issuing guidance.  This seems to be a velvet gloved-yet-firm policy much like herding sheep.  There’s room for some individual expression, but just be sure to end up in the right place.  Zuckerberg doesn’t want to be seen as the dictator he really is, so he issues guidance rather than instructions.  The message is clear though.  Going full-on remote is not acceptable.

Especially, it turns out, if you decide to take your high Silicon Valley wage and re-locate to a low cost of living area.  How dastardly can an employee get?  The outrage!  Moving to a low cost area just to eke out a little extra income.  How gauche.

Yes, it’s true.  Facebook has warned its employees that their pay might get reduced if they have the temerity to move, along with their high-cost area pay, to a low cost area.  Poor Facebook doesn’t want its employees playing fancy life-style games or gaming the system.  Can you imagine the terrible example that would set?  Whatever next?

Facebook, naturally, is not alone.  Apparently there is an epidemic of rational employees.  So many of them have discovered the pleasantries of living away from the cramped and overly expensive districts in which their employers park them, that they have decamped and taken their big wages with them.  They are spreading the wealth into cheaper neighborhoods, living quiet lives, enjoying being home, and generally performing exactly how any sensible person would.

Obviously this won’t do.

Facebook doesn’t want sensible or happy employees.  So all those employees who pursue this horrible strategy of maximizing their income need to be punished.  It’s Zuckerberg’s income they should be maximizing not their own!

Those extra bits of profit rightfully belong to to corporation so it can pay big CEO bonuses and reward its ever-suffering shareholders.  The CEO of Morgan Stanley is quoted in today’s Financial Times as agreeing.  He’s clear: maximize your income at Morgan’s expense and you can expect a pay cut.  There is a rash of impoverished Silicon Valley corporations lining up to do the same thing.  The problem with employees nowadays is that they seem to have paid attention too much to what the big people do.  Only the wealthy and the corporations are allowed to cheat, squeeze, and connive.  Employees are employees for a reason: they are the squeezees not the squeezers.  They are a cost to be managed down wherever possible.  This idea that they might get a real wage increase simply by re-locating is plainly wrong.  It sounds almost socialist.  And that’s as bad as it gets.

Really.  This pandemic just can’t be over soon enough.  Employees moving to maximize income?

You can’t get good help anymore.  You just can’t.

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Power Shifts, or Not?

Power can flummox even the best economist.  A typical explanation of events in an economy makes scant reference to the way in which power distorts the wondrous smooth motions that so obsess the discipline.  It’s almost as if human relationships don’t exist in those wonderful models they are all so proud of.  For the rest of us, power is central.  It takes little time to realize that establishing an imbalance can have all sorts of advantages.  They most notable being that it defeats or undermines the consequences of the classic impersonal marketplace.  Fair is out.  Asymmetry is in.

Not that the existence of asymmetry ought surprise anyone.  The real world is an awfully lumpy place.  Resources, information, people, and everything else exist in clumps.  Without those clumps there would be no exchange.  There would be no trade.  There would be no markets.  But the world is lumpy, hence all of the above.  This paradox, that economists study idealized worlds whose features eliminate the very phenomena that are the supposed object of study, is one of the more endearing aspects of economics.  Building theories about made up worlds is a whole lot more fun and easier than inventing them to explain the real world.  But, hey, let’s be fair: as long as we all know that we are theorizing about our fantasies in order to extract useful nuggets about the real world, we should go for it.  Unfortunately, and I think this is fair criticism, the way in which economics is taught often elides this.

One of the odd things about our emergence from the pandemic and the sudden prospect before us of a robust economy is that the more conventional analysts are all bleating about inflation.  Something terrible is about to happen, they argue, unless we correct for all that money sloshing about as a consequence of governments trying to bail out their respective economies.  The ghosts of the 1970s are everywhere.  Strange things are afoot.  Are massive purchases of government debts by central banks properly called monetary policy?  Or are they a sort of fiscal policy?  Are we in an era of well-anchored inflation expectations?  Or are we adrift about to take on water?  And the difference between forecast and outcome based policy setting is keeping some analysts awake at night.

It’s enough to confuse even the most adroit of us.

There are so many puzzle pieces on the table it’s difficult to send the outline of the picture we need to paint.  So let’s look for a straight edge.

That’s where power comes in.

It might be passing, but at the moment workers here in the U.S. have the upper hand.  For the first time in decades they are able to extract higher wages from prospective employers.  And the employers aren’t liking it.  Nor are the financial media types and analysts brought up in an era of shareholder value dominated business strategies.  All those consultants whose existence is to give intellectual cover to the suppression of the workforce despite all their screeds on employee “engagement” and “human capital” are perplexed.  What is a cost-cutter to do when the source of the largest single cost in most businesses gets less supine?  Heck management might even have to pay the workforce more.  Hell is freezing over.

Power is shifting.  At least temporarily.

How temporarily will be affected by the ability of business to re-assert its oligopolistic hold on the economy.  This is why a new book by Jan Eeckhout is so timely.  It is called “The Profit Paradox”, although the subtitle “How Thriving Firms Threaten the Future of Work” is far more telling.  It is somewhat disappointing to find a book in 2021 whose main thesis is the shift in the balance of power away from labor to capital.  Surely we all knew about this a long time ago.  Has it really taken this long for someone to take a good look at why?  Of course not.  Others have ventured here before.  What I find interesting about Eeckhout’s ideas though is that he ties the individual firm’s pursuit of self-interest — via the infamous shareholder value proposition — to the general decline of economic performance.  It’s an inversion of the famous Smithian view that the result of self-interest is to produce a socially beneficial result.  Clearly when we examine firms rather than individuals that is no longer true.

Rather than belabor the point let me quote from page 75 of his book:

“This is the central thesis of the book.  We tend to accept that when firms do well, the economy does well.  Competing firms that make profits create jobs and work benefits.  Alas, currently dominant firms exert market power and do the opposite.  They generate excess profits because they face too few competitors and make consumers pay too high a price for a bottle of beer or for their grandmother’s prosthetic hip.  Therefore they sell fewer units, as fewer people can afford to buy.  Market power is now so widespread, from tech to textiles, that it lowers production and the demand for labor.  Instead of creating jobs, profitability due to market power lowers wages and destroys work.  That is the profit paradox.  Only a competitive marketplace where firms sell at low prices brings benefits for workers and restores a healthy economy.”

The entire book is an explanation of how market power is created and protected.  The consequences are lower economic growth, lower wages, and fewer jobs.  It is an interesting thesis and well worth getting to know.

Okay: I cheated a little.  Eeckhout doesn’t actually mention shareholder value.  I assume that’s because it has become such an institutional piece of management technology that it is subsumed into the reality we deal with.  No one appears to question it much.  So I thought I would add it into my narrative to remind us that the rise in market power Eeckhout describes so well is a consequence of the strategic decision-making of firms driven by the perceived need to maximize shareholder value.  That “need” is, of course, not a need at all.  It is a choice.  It is ideological.  It has deep roots in neoclassical economic thought.  But let me give Eeckhout credit.  He touches briefly on the issue when he talks about cost-cutting in his chapter on technological change.  One of the great technological innovations in management is the development of supply chains that stretch around the globe.  The objective is to cut costs.  They could not exist without the enablement of the digital information flows and the development of super-sized carriers to make transport cheap.  The words “supply-chain” and “logistics” were hardly used a few decades back.  Now they are talked about obsessively in management circles.  In this context, Eeckhout even hints at what he seems too think of a business school education:

“That is possibly the success of a business school education.  MBAs have learned finance, how to act strategically, and how to minimize expenses.  This cost-cutting cult achieves lower costs for the firm, higher profits for the shareholders, and lower prices for the customer … [but] Cost cutting that results in such market power is not entirely beneficial to the customer because the dominant firm does not pass the entire cost reduction to the customer, and keeps part of those savings in their own accounts as profit.”

Business school education is exactly about how to create excess profits.  It is about how to undermine all the standard economic arguments for a free market.  Firms seek power to undermine the market.  That us what Eeckhout points to as a major, if not the main, cause of our recent stagnation both in the economy at large and in wages in particular.  Reducing his entire thesis to one short sentence: business strategy [and therefore all MBA education] is an attempt to suppress the workforce in favor of shareholders.  It is about power.

And here we are.  It has taken a pandemic to create the space within which workers can challenge that power.  Given that our economy is now so riddled through with oligopoly it seems hard to see how workers can maintain this space for themselves.  As an aside: Eeckhout reminds us to use the word oligopsony rather than monopsony when we discuss the wage suppression big business espouses.

Perhaps all the inflation hawks out there haven’t been paying too much attention.  They appear to have missed the role of power in wage rate setting.  Instead they all seem hell-bent on providing intellectual cover for the continuation of wage stagnation.  After all we can’t have those pesky workers getting too much of a pay raise.  Even after decades of near flat wages a significant pay raise would rock the establishment boat too much.  Look at the inflation it all would cause!   We can’t have that.  Who ever heard of workers having power?

Oh, as an an addendum: let me say I was surprised to learn, via Larry Summers, that savings could be a cause of inflation.  I had no idea.  None.  I thought the detrimental effect of excess savings was through its reduction of demand.  Larry, though, added the existence of the “excess” savings created by all those government support payments as one of his potential causes of inflation.  Anyway, I assume he means that once those savings are no longer savings but turn up as demand they then become pernicious.  That would imply he thinks we would have demand in excess of supply.  Which, kind of, gets us back to market power and Eeckhout’s argument: one of the major effects of oligopolistic market power is in the under-supply of product.  It pays dominant firms to reduce supply in order to build excess profits.

As I said: power can flummox any economist.  Even someone as smart as Larry Summers.  Maybe he needs to go to business school to get an understanding of how the economy is actually run?  No!  That’s not our answer.  We need to re-think the MBA, not advocate it!

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