CHAPTER SEVENTEEN
The Danger of Excessive Labor Income
IT IS RAPIDLY BECOMING CLEAR that both productivity and capital formation depend heavily on the labor-income ratio—the proportion of value added that goes to wages and fringe benefits—and that this is true whether we are talking about a company, an industry, or a national economy. If the ratio goes above a certain threshold, apparently between 80 percent and 85 percent, productivity declines and capital formation falls too low to maintain present jobs, let alone create new ones.
Consider the U.S. auto and steel industries. It is common today to bemoan the decline of American industrial competitiveness and to wonder what has become of American management. In truth, however, the “American disease” is by and large confined to autos and steel.
The bulk of U.S. manufacturing industry—from fashion goods to airplanes, from textiles to computers—has been enjoying an extraordinary export boom these last four years, almost as vigorous as the export boom immediately after World War II when the industrial plants of our potential competitors lay in ruins. The export performance of most American industry explains why the much-heralded 1979–80 “recession” was so much shorter and milder than anticipated—despite oil-price jumps and the near collapse of the auto and steel industries. Indeed, our export surplus with the Common Market will most likely be one of the major problems of foreign economic relations for the Reagan Administration.
Autos and steel, thought to be the rule, are thus truly the exception. And they are the exception principally because they spend too much, relatively, on wages and fringe benefits. In most American manufacturing the labor-income ratio is probably still below 80 percent (though reliable data are hard to come by). But in autos and steel the ratio is well above 85 percent and may approach 90 percent.
Labor costs in the U.S. auto and steel industries—whether measured per employee, per hour actually worked, or per unit of output—are 50 percent to 100 percent higher than the prevailing labor costs of other American manufacturing industries. At Ford Motor Company, the hourly labor cost per employee, including all fringes and the costs of not working, e.g., absenteeism, is close to $25, compared with about $15 even in high-paying industries such as chemical manufacturing. Since the labor costs of Japanese and German auto- and steel-makers are roughly on a par with prevailing American labor costs in other manufacturing industries, it’s no wonder that the U.S. auto and steel industries have had so much trouble competing against imports—and that so many auto and steelworkers are out of a job.
Apart from worsening import competition, a labor-income ratio of 85 to 90 percent makes capital formation impossible and thus endangers the jobs of tomorrow. Even General Motors is barely able to generate or raise the sums needed to modernize its plants and convert them to the production of fuel-efficient cars.
In Europe, Ford has already done a superb job producing and marketing competitive, fuel-efficient small cars. But in this country it cannot generate the capital fast enough to change its plants to producing cars it already makes, cars that have been proven in the market. The steel companies are in the same boat, and in such circumstances it makes little difference how good management is, how well it is planning, and how well it can design and market.
On the economy-wide level, too, countries where labor income accounts for more than 85 percent of gross national product—Britain, the Netherlands, Belgium, and Scandinavia—are in the deepest trouble. By contrast, the Germans and Japanese operate on labor-income ratios of 70 to 75 percent, or at most 80 percent.
Indeed, the labor-income ratio seems to be more important for the ability of a country to perform than is the proportion of GNP that goes through the transfer mechanism of government. In Germany the transfer proportion is high, in Japan it is quite low. Yet both economies perform somewhat alike, and far better than countries such as the United States, where the transfer proportion is comparatively low but where key industries have a high labor-income ratio.
Economists and economic policy-makers have traditionally paid little attention to the labor-income ratio, for the simple reason that it never was a problem before. The relationship between “wage fund” and “capital fund” has been studied and argued about for almost two hundred years, since David Ricardo’s first theoretical papers. But right down to John Maynard Keynes, the central question was always how to prevent the “capital fund” from becoming “excessive.” But now, with a labor-income ratio of 80 to 85 percent, even convinced Keynesians accept the idea that economic theory and economic policy have to concern themselves with restoring productivity and capital formation.
High labor-income ratios also pose a life-or-death crisis for the labor union and for traditional wage setting through collective bargaining. It is no coincidence that the two U.S. industries—autos and steel—in so much trouble, with so much unemployment, are the two industries where there is a virtual labor union monopoly, with practically no nonunion plants.
What’s more, a labor-income ratio of 80 to 85 percent invalidates all the fundamental tenets of the labor movement—e.g., the axiom that the labor share of GNP can never be excessive. When the labor movement started, well over one hundred years ago, labor’s share of GNP was at most 40 percent or so. Hence, Samuel Gompers, the pioneering leader of American labor, defined the aim of labor as “More.”
But can this aim still be maintained when labor income is 85 percent of national product and there is no more “more”? Or does one then have to ask what limits have to be set on labor income as a share of gross product to enable a company, an industry, or a country to form enough capital for the jobs of tomorrow?
It has similarly been a tenet of the labor movement that a union monopoly—unlike a business monopoly—can never do damage. A business monopoly, Adam Smith pointed out, reduces aggregate demand and thereby creates unemployment. By contrast, labor economists have been arguing for a century that a union monopoly can only create demand, i.e., purchasing power, and therefore will not promote unemployment. Even most pro-business economists have accepted this, excepting only a few American heretics, such as George Stigler and the late Henry Simons, both at the University of Chicago. But surely in the U.S. auto and steel industries, union monopoly has helped create massive unemployment.
Unions, finally, have argued since well before Marx that the worker’s propensity to save would go up at least as fast as his income. Capital formation in a society of low surplus—that is, little income other than labor income—would be no lower and, the argument ran, probably higher than in a society where capital formation is in the hands of capitalists or of business. In postulating the multiplier effect of consumption demand on investment, Keynes gave only an elegant theoretical formulation to what had long been an axiom among socialists and labor economists.
But can any of these axioms still be maintained? Or will we have to replace them by totally different postulates? One might be that labor income has to be kept below a certain point, say 80 to 85 percent, if a company, an industry, or a country is to be sure of adequate capital formation. Perhaps we should limit union monopoly powers to enable industries dominated by unions to maintain their competitive position as well as their ability to create future jobs.
We might also have to balance every increase in the share of labor income with measures to stimulate capital formation, especially in businesses—whether that means a shift from taxes on higher incomes to sales taxes, for instance, or the removal of taxes on savings, capital gains, and business profits. Maybe we will even have to make acceptance of a rise in the labor-income ratio dependent on the capital formation rate—or link the two in some way which does not, as Keynesians and Friedmanites both do, rely entirely on the invisible hand of a multiplier which automatically turns consumer demand or money supply into investment.
The union crisis is the most difficult of all challenges: a crisis of success. The labor union has attained its objectives—and when that happens, institutions tend to become reactionary and then degenerate and atrophy.
As events in Poland in 1980 have shown again, a modern society needs the labor union. There has to be a countervailing power against the power of the bosses—even in a free economy where the market sets severe limits to the power of the bosses. But counter-vailing power is still power. And to be legitimate, power requires what the union so far lacks: clear responsibility, accountability, and pre-set limitations.
(1981)