Laboring Productivity and Free Trade

Labor and capital have battled perpetually since the dawn of humanity. This struggle usually resolved itself through the barrel of a club, sword, or gun. Those who wanted more capital took it through the application of their labor in various militaristic means. Moving from serfdom to the industrial revolution the battle became less a direct application of force to a more nuanced form of subjugation through the trading of labor for wages. This exchange permitted a person to enrich themselves by working more or increasing productivity. With time a finite resource, the worker's incentive was to increase productivity to their own and capital's benefit. Labor won the battle over the past 200 years; however, the outcome reversed for US labor during the last few decades. Reversing this secular trend is difficult: the President's proposed trade policies may be labor's requiem.

Leaping Forward. As most of the Western World foraged headlong into the industrial revolution, major regions of the world wallowed in self-inflicted seclusion and exploitation that lessened the benefits of industrialization and global trade. After World War II, there is no starker contrast than the capitalism of the United States establishing a world money order to promote trade and China's isolationist Communism. One led the economic world for decades, while the other leaped down a path to famine.

As the US enjoyed world hegemony in the last few decades of the 20th century, other leading economies commenced their reentry into the economic world order. China began its long path to economic re-engagement with the world, Communism collapsed in the USSR, and India liberalized its economy. A new period of global trade commenced, and the developed world welcomed billions of new customers and new competition for developed world labor.

Producing Gains. Productivity increases came from the application of new manufacturing techniques, open global trade, and the efficient management of information. The world economy now encompasses a global supply chain that is managed in real time and seeks to deploy efficiently capital irrespective of the market. Productivity, however, is self-limiting. After a certain level of development the gains slow, and more modest growth expectations arrive.

The story is different when a mature economy is joined with an economy that possesses significantly more labor and inferior productivity. Adam Smith long ago provided the insight into trade that stands to this day: produce the good where it is more efficient, and thus an economy can “import” productivity growth from abroad. The secular change that is occurring in the world today is a combination of the constant application of technology to a supremely efficient global manufacturing process and an open global trading system.

Substituting Labor. The watershed moment for global trade was the entry of China into the World Trade Organization in 2001. With a dramatically lower cost of labor and an efficient global transportation system, the productivity gains are self-evident for global business. US companies availed themselves to the new source of cheap labor, but at a cost. While the gains to trade are numerous, the implication on domestic labor was long forgotten.

In a time before floating currencies and global trade, two insightful economists reasoned that trade could reduce local employment and wages as jobs left for the lower cost country. The US and China provided validation decades later: a free market will seek the lowest cost of production in tradable goods. Since 2001, the service sector has continued its ascent in the US, but the goods-producing sector succumbed to economic forces and reduced in number.

Herein is the paradox of productivity: capital is insensitive to the social contract. Freely traded global capital and goods markets but a domestically constrained labor market ensure that labor bears the burden. The bifurcation is abundantly clear: if the good or service is tradable it will be produced in the most efficient location in the world, while services that involve geographic proximity are, for the most part, insensitive. Thus, we may revel in the decreasing prices of tradable goods, but find our employ exported to more capital friendly environs.

Trading People. The US exported low-value labor jobs over the last 20-years with growth in goods-producing employment coming from the non-tradable goods sector and little contribution from the tradable goods sector. Over the same period, the composition of services-related employment growth evolved as education, health services, and leisure dominated. The impact of China on US labor helped accelerate job changes that demographics and technology initiated.

The global labor market reflects the bifurcation of the US labor market: the low-value service sector serves the high-value-added service sector. The redundant labor in the manufacturing sector is transitioning into high-touch, low-value service. While the aristocracy may no longer have an in-house maid, butler, and chauffeur, they are increasingly receiving service similar in effect when they dine, dry clean, taxi, and relax: someone is serving them.

Hooked up. The US and China are effectively one economic engine linked via trade. Growth economics dictates that an economy will seek the optimal level of consumption based on the ratio of capital to labor. As global US firms exploited the dual engines of trade and technology, they delivered higher returns to capital by increasing productivity, but at the expense of increasing labor redundancy in the domestic US market.

China is investing capital at a rate in excess required for its domestic consumption requirements, while its excess capital flows to the US and helps the US consumer avail themselves to cheap imports. This action was fortuitous during a period when global trade was accelerating, however, over investment increases the depreciation of capital and labor stocks as they quickly become redundant.

Capital Risk. A plan by the US to focus on exports at the expense of imports would break this delicate balance with China. While value-added taxes exist in most of the developed world, this outcome for the US would be a first. Critically, the policies would most likely hurt US exports as the US dollar appreciates and their labor production becomes noncompetitive. Further, the policy would maintain the current level of imports and thus ensure achievement of none of its objectives.

The most damaging outcome may not be the dead-weight loss on the US export orientated sector, but the response from its competitors. They may no longer feel the need to follow the rules of global trade and place their needs first as well. Their actions may include further devaluing of their currencies, import tax on US exports, and support for their export sectors. All these measures would further erode the competitiveness of US labor. The death knell can certainly be heard; it is yet to be determined whether it rings for US labor or current US politics.