In an op/ed in the Financial Times last week ("Tips from Zappos for America's broken jobs machine"), University of Toronto Professor Richard Florida noted that low-level service jobs tend to pay about half what manufacturing jobs pay, and that these low-wage positions comprised 45% of American jobs. His proposed solution was two-fold: To focus on service jobs that can't be offshored or automated, and to 'upgrade' the "entire job category" of service industry jobs so that they paid more. Florida wrote,
Mr. Obama should make upgrading service jobs the next step in repairing America's broken job machine. A national service initiative, bringing together "service innovators" -- such as Zappos (AMZN), Starbucks (SBUX), or outdoor clothing retailer REI -- would be a good start.
A few problems with Florida's proposed solutions
A few problems seem apparent with Florida's proposed solutions. The first is that even jobs that can't be offshored can be filled by immigrants willing to work more cheaply than native workers. That all things being equal, increasing the supply of labor ought to lower labor costs (i.e., wages) may seem intuitive. In fact, Harvard economist George Borjas has suggested the effect is quantifiable. In The Concise Encyclopedia of Economics Borjas wrote,
It has been estimated that the wages of native workers in a particular skill group will decline by about 3–4 percent for every 10-percent increase in the number of workers that can be attributed to immigration.
Higher entry level wages require higher margins
Another problem with Florida's second proposed solutions is that there's a limit to how much relatively low-margin retailers can afford to pay their workers, no matter how innovative they are at customer service. Zappos may add value with its unique corporate culture, but there is a limit to how much value a retalier can add by buying sneakers wholesale and selling them retail.
Consider, by contrast, a manufacturer that uses a proprietary design to assemble crucial industrial products. Coincidentally, the founder of one such manufacturer, Michael Oliver of Oliver Valves, which produces specialized valves for the oil and gas industry, was profiled in the Financial Times the same day Richard Florida's column appeared ("A bastion of British engineering"). That profile included a telling quote by Mr. Oliver, "We have one principal -- gross margin is king".
Since high margin manufacturers producing high value products can afford to pay their workers more than lower-margin retailers, you might think that Florida would suggest government find ways to facilitate the creation of more manufacturing jobs instead of trying to 'upgrade' low wage service sector jobs.
Improving education isn't a panacea
George Washington University Professor Danny Leipzigger made a similar point about the limits of low value-added jobs in a letter to the editor of the Financial Times in response to Florida's column ("Subsidizing low wage jobs will push the U.S. backwards"). However, part of Professor Leipzigger's proposed alternative, "a broader push for improved educational quality" was also flawed. Leipzigger wrote that the U.S. "ranks poorly" on the OECD's PISA tests but that the U.S. had "a better demographic outlook and a generally more immigrant-friendly regime" than Europe, Japan and Korea. Professor Leipziger failed to address the implications of U.S. immigration trends on U.S. educational performance though.
The OECD member country that ranks the lowest on the Programme for International Student Assessment (PISA) tests, Mexico, happens to be the country of origin of almost 24% of U.S. immigrants. In contrast, only about 2% of U.S. immigrants are from South Korea, the country which ranked the highest on the 2009 PISA tests (Shanghai-China ranked slightly higher than Korea, but not the country of China as whole).
Automation can replace low value-added service jobs
A third problem with Florida's approach is that it's not always clear ahead of time what jobs will be safe from automation. For example, bathing wheelchair-bound elderly people might seem like the sort of job that would be safe from automation, and yet the Japanese have invented machines to do just that. If retailers and other employers of low wage service workers raised their employees' wages too high, they'd have to pass on those costs to consumers. And if those costs got high enough, then entrepreneurs would likely offer consumers automated alternatives for less.
A look at the hedging costs of service innovators
Of the three retailers mentioned by Richard Florida as "service innovators", one, REI, is organized as a consumer cooperative, and so is not publicly traded. Another, Zappos, is owned by Amazon.com, Inc. I'm not sure if Florida considers Zappos's parent company to be a service innovator, but I have included it in the table below just in case, along with the other service innovator Florida mentioned, Starbucks Corporation. In addition, for comparison purposes, I have included the SPDR S&P 500 ETF (SPY).
The table below shows the costs, as of Friday, of hedging Amazon.com, Inc., Starbucks Corporation, and the SPDR S&P 500 ETF against greater-than-20% declines over the next several months-- using the optimal puts for that. First, a quick reminder about hedging with optimal puts.
Optimal puts are the ones that will give you the level of protection you want at the lowest possible cost. With Portfolio Armor (available in Seeking Alpha's Investor Tools store, and as an Apple iOS app) you just enter the symbol of the stock or ETF you’re looking to hedge, the number of shares you own, and the maximum decline you’re willing to accept (your threshold), and then the app uses its proprietary algorithm to scan for the optimal puts.
Cost of Protection (as % of position value)
SPDR S&P 500 ETF
*Based on optimal puts expiring in October, 2011
**Based on optimal puts expiring in December, 2011
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.