WHY GOOD BUSINESS CAN BE BAD ECONOMICS
Though we’re past the #100 mark, there’s a string of topics crying out to be discussed. Future articles might look at what the market economy really is – and what it isn’t – and perhaps take in the “gig” or “sharing” economy as well. I’m also thinking about doing something rather outside normal parameters, looking at where businesses should (and shouldn’t) seek to invest.
Here, though, we look at a critical paradox. It’s critical, because it goes a long way towards explaining why countries like Germany prosper whilst countries like Britain don’t.
Economics is full of paradoxes. Perhaps the most famous is the “paradox of thrift”. If you save or I save, that’s prudent and commendable. But if we all save, and do too much of it, that’s bad, because demand will slump, to the detriment of the economy. Actually, what this really means is that we want a “Goldilocks” amount of saving. If there’s too much of it, we’re stifling demand – but if there’s too little, we’re not investing enough.
Here’s another paradox, less widely recognized (indeed, seemingly hardly recognized at all), but actually much more important. Let’s call it “the paradox of pay”. This is important, and certainly merits discussion, because it’s a major factor depressing performance in a number of Western economies.
The pay paradox
Here’s how it works. If you’re running a business, keeping down pay can be a good thing. As a business, wages are likely to be one of your biggest costs, indeed very probably the biggest of the lot. So, if you keep your wage bill as low as you possibly can, your profits will increase.
That sounds good.
If all employers do this, however, business, and the economy, are the losers. Small pay packets mean weak consumer spending, and the consumer typically accounts for 60-70% of the GDP of a Western developed economy. If you undermine wages, then, you undermine sales.
No so good.
Henry Ford famously understood this. That’s why he paid his workers more than the bare minimum. If he didn’t, reasoned Mr Ford, how would they ever be able to buy his cars?
There’s a revealing story about this, in a different car plant in a different era. A manager proudly unveils the first production robot, and says to a trades union leader: “try to persuade that to join your union!”
To which, of course, the union man replies: “try persuading it to buy a car!”
The truism, of course, is that workers and consumers are the same people.
Micro and macro
Actually, the “paradox of pay” really amounts to the difference between microeconomics (the economics of the firm) and macroeconomics (the study of the whole economy). Low pay can be good microeconomics, but is always bad macroeconomics.
It can make sense for a company to minimise its wage bill. But it is idiotic for a country to do the same.
There are, however, simpletons who think that an economy should be run like a business. So, if it’s good for businesses to minimise wages, it must be good for a country to do the same. The theory – a pretty half-baked one – is that, if we can keep down the wages of people making (say) cars in our country, we keep those cars cheap, thereby increasing our ability to sell them on the world market.
Actually, this theory is worse than half-baked. Observation reveals that low wages don’t make for national competitiveness or prosperity. If they did, Ghana would be richer than Germany, and Swaziland more prosperous than Switzerland.
In reality, there are perfectly good reasons why a high-wage economy like Germany is more prosperous than a low-wage country like Ghana. For a start, demand is stronger. The German worker has more money in his or her pocket than his Ghanaian counterpart, increasing his ability to buy goods and services produced by other German firms. Moreover, the higher the average level of pay, the higher both quality and productivity are likely to be.
From this, an obvious truism follows. A company like Mercedes or BMW can never turn out cars cheaper than a plant in a, say, Vietnam. If Germany’s car-makers (or any other German sector) tried to compete on price, they’d fail.
So, being sensible people, they don’t. They compete, instead, on quality. This is the obvious (indeed, the only rational) course of action for a developed economy. Competing on quality makes sense.
Trying to compete on price is, frankly, pretty crazy.
The price of a fallacy
Some countries – the obvious examples being America and Britain – don’t seem to grasp what, to a German, seems perfectly obvious. Instead, they assume that getting wages down must be a good thing. Pursuing this policy involves maximising the supposed “openness” of your economy, and backing “globalization” to the hilt. By all means ship out skilled jobs from Derby to Delhi, if profits increase. Go ahead and outsource work from Cleveland to Calcutta for a short-term boost to the bottom line. “What’s good for American (or British) business”, the slogan runs, “is good for America (or Britain!)”
It’s a persuasive slogan.
It’s also, in economic terms, drivel.
The point, you see, is that running a country isn’t the same as running a business. Businesses can benefit from low wages. A country can’t.
This said, a lot of businesses are too smart to succumb to the low-wage mantra. Many enlightened firms recognize that getting good staff – skilled, innovative, productive, dedicated and committed employees – can’t be done on the cheap. The pay-off in terms of quality and productivity can far outweigh the cost of paying good wages to attract and retain the best.
A fool’s paradise
If a country follows the low-wage route, a string of adverse consequences quickly follows. It’s a chain-reaction process.
For starters, outsourcing skilled jobs undermines consumption. One seductively-easy way of countering this is to fill the consumption gap with credit. Countries that follow the low-wage mantra tend to succumb pretty soon to a policy of making credit both cheap and easy to obtain. This involves both low interest rates and “deregulation” of the lending industry. This in turn results in soaring indebtedness and escalating risk.
It also depresses tax revenues, and undermines productivity, whilst skewing the economy away from activities at the high end of the value-added spectrum. You end up with very little manufacturing, but plenty of pedicurists and pizza-deliverers.
What results is an economy with low skills, feeble productivity, and too much debt (does that remind you of anywhere?). You find yourself in a position where each incremental unit of GDP comes at a high cost in additional borrowing (say, getting on for £6 of new debt for each £1 of growth). Tax revenue weakens, resulting in big fiscal deficits and escalating debt.
You can try to offset the deficit by cutting public spending, of course, but even a passing familiarity with Keynes should convince you that voluntary “austerity”, by depressing demand, is likely to be counter-productive. Some of the weaker Eurozone countries have had austerity imposed on them by their inability to devalue. Other countries have embraced austerity voluntarily, out of sheer folly or desperation.
As well as depressing the economy, too much austerity is likely to depress voters, the end result being that you’re out on your ear. Frankly, if you’ve been following the fool’s mantra of a low wage strategy, that’s nothing more than you deserve.
At some point, meanwhile, someone notices that people are struggling to cope with servicing their bloated debts, so you cut rates even further, now to levels that are a long way below inflation. Doing this might be unavoidable, but it’s still akin to handing a bottle of gin to an alcoholic.
One consequence is that, whilst asset prices balloon, returns collapse. This opens up huge chasms in pension and other provision, which can be impossible to bridge even with a high savings ratio, let alone with a savings ratio that has crumbled under the onslaught of impoverishment.
At this point, with foreigners wondering whether to go on bailing you out with capital infusions, and the locals beginning to wonder whether inflated house prices don’t amount to realizable riches after all, hopefully some nice people turn up with a waistcoat that laces up at the back.
Wisdom and folly
So there you have it. Paying low wages might, at the micro level, help you to make cheaper washing-machines (though whether it’ll help you to make high quality ones that people actually want to buy might be a different question).
At the macro level, though, low wages have a string of adverse effects. They undermine quality and productivity. They’re likely to push debt up sharply, inflate asset prices and depress returns. They’ll certainly undermine demand, stifle growth and undercut tax revenues, and they’re highly likely to degrade the value-adding profile of the economy.
The Germans, amongst others, clearly understand this. The British authorities, equally clearly, don’t. It will be interesting to find out whether Mr Trump and M. Macron understand it, too.