The Global Labor Shock: Consequences and Future Options

by: Dirk McCoy

For all the talk of cronyism and peak oil, the single biggest factor driving economic activity has been the massive labor shock brought on by technology and the addition of a billion new workers to the global labor pool. After the fall of the Soviet bloc and opening of China, it took a decade of development before workers in Eastern Europe, China, and India could participate in providing labor to a global market, but they are providing it en masse now. This has had a few effects:

  1. The promise of lower-cost workers who could receive better pay and emerge as new customers created massive support for NAFTA and WTO; These low cost workers allowed massive, integrated production facilities in Low Cost Countries (integration is much easier when you're so sure of your labor cost advantage that you know your factory will be competitive).
  2. These large production facilities became attractive to major companies that had previously manufactured complex products in the US, especially electronics companies.
  3. This rush to low cost countries cratered US manufacturing jobs in the last recession, with over 25% of jobs being permanently lost;
  4. The availability of lower-cost workers enabled lower-cost goods to be manufactured by smaller companies, and a boom for big box retailers and Wal-Mart (NYSE:WMT).
  5. Lower cost goods and services translated into a consumption boom and repositioning of the US economy to focus on more protectable industries such as homebuilding, banking, healthcare, financial services, and the like.
  6. The ability of other nations to pay off debt with production grew, while US costs remained high relative to global competitors, thus causing the dollar to fall 33%.
  7. Political winds of change between 2006 and 2008 brought higher Fed funds rates (to slow "out of control" growth), higher minimum wages, and the prospects of more protectionism and regulation.
  8. Credit destruction of historical proportions created a serious recession.

So, what now? There are a couple extreme choices:

  • Go with the flow- continue to exploit low cost country labor, continue to focus on protectable industries, continue to see dollar devaluation, reduce labor cost controls so more American workers are competitive, continue to expand global trade, continue to market low cost foreign goods and services, continue to lead the spread of capitalist principles; or
  • Fight the tide- establish protectionist policies, centrally plan economic activity, attempt to prop up the dollar, attempt to increase wages, attempt to regulate foreign industrial activity, and let the market determine which economic principles it wishes to accept.

While the first course of action yields ongoing negative labor wage pressures, which will continue to expand as low cost countries move up the value chain into medical services, travel services, financial services, and product design and marketing, it ultimately will yield an economy creating the greatest amount of goods and services, and apportioning them to the owners, risk-takers, and producers.

The second course of action is more likely to reduce global economic activity, yield local disruptions and shortages, create under and un-employment, and apportioin goods and services to those designated by the political regulating class.

It should be helpful at this point to consider what has happened in previous labor shocks. The industrial revolution reduced wages for those manufacturing shoes, clothing, and similar items, creating a backlash that led to better labor conditions (if still lower than average pay). The agricultural revolution reduced wages for farm workers. The percentage of GDP going to these industries, and percentage of workers, was vastly reduced. Yet, these workers were eventually re-adsorbed into other industries as new industries were created. And the cost of these goods dropped precipitously while the quality increased.

While there is work required to improve the quality of goods and services (not just pet food from China, but healthcare in the US), technology and labor exist to make progress on this score. And while we may be worried about the share of GDP that goes into healthcare or financial services, we should be thankful that the share of GDP required for food and clothing is near an all-time low. So for those wondering if more workers producing lower cost goods and services is a good or bad thing, ask yourselves this- who likely lives better, a farmer in the Sudan or a bellboy in New York City?

Consequently, I believe the US will generally continue along the first path of globalization, the dollar will continue to fall, and companies that focus on competing globally and developing new markets in low cost countries will do very well going forward for decades.

Disclosure: No positions