Differentiating wage rate from labor cost

BACKBENCHER
Rod Kapunan
4/30-5/1/2011



Some economists would like to differentiate wage rate from labor cost to debunk the notion that high wage rate is the principal cause of the migration of factories from the United States to China and to other countries offering lower rates. This is often the case because we are confused in our understanding between wage rate, which is the amount paid to the worker for his hour of work, from the cost of labor, which is the amount that will cost the employer per unit of output.

American economist Thomas Sowell said such belief is unfounded: “When workers in a prosperous country receive wages twice as high as workers in a poor country and produce them three times the output per hour, then it is the high wage country which has the lower labor cost per unit output. That is, it is cheaper to get a given amount of work in the more prosperous country simply because it takes less hour, even though individual workers are paid more for their time.”

In that, one could see that the rate of wage is the concern of the workers, it being the basis of how much they expect to earn per hour or eight hours of work, while labor cost is the amount employers estimate will cost them per unit of product or output. Thus, if the rate of wage exceeds the cost of labor, after considering the total costs which include raw materials, electricity, rent, water, freight, insurance, currency loss adjustment, etc., most likely they would end up in losses.

But despite the high wage rate, Sowell says the price of US products remain competitive because their labor cost remains low than if the same is produced in poorer countries. That is only half the truth. Although we can never compete with the highly advanced countries in the manufacture and production of high-value and technology-based products, which is their absolute advantage, or compete in terms of capital to build industries that will usher in the economies of scale, that assertion remains true if there has been no massive migration of jobs to China and to other countries in Asia offering cheaper wage rates.

Even if 18th century economist David Ricardo acknowledged the indefeasibility of the so-called “absolute advantage” in trade, there are other factors we could develop to produce certain products in vast quantity at cheaper cost. There is still a room for us to hone ourselves in areas where we could exploit as our comparative advantage and even transform to one of economies of scale. China and India initially used their manpower surplus as their comparative advantage, and to catch up the cheaper labor cost in the US and Europe, they opted to deregulate wage.

As Sowell admitted, trade as a tool for economic advancement is not a sum-zero game where for one’s gain, one has to trade off something. If we lost in the comparative advantage to manufacture and produce textile, garments, rubber shoes, gloves, laundry soap, toilet products, toothpaste, in the packaging and assembly of computer chips, medicines, glass, cars, and, mind you, in the production of sugar and coconut, that was because we unnecessarily pushed the cost of wage to a point where ultimately it became unprofitable in terms of labor cost to produce them.

It was the system of regulated wage that destroyed the viability of our labor cost. We simply do not have that absolute advantage and the economies of scale to allow us to offset our high minimum wage to lower our labor cost. To concretize that we do not have the sufficient capital as well as technology to create that environment that would usher in the economies of scale.

If only we opted to deregulate wage, that would have given us a chance to exploit our inherent advantage of enormous manpower. Looking at it positively, wage deregulation could have become our automatic defense mechanism. So, every time a new technology is introduced in the US that will reduce their cost of labor per unit, we could easily adjust our wage to avert unemployment through retrenchment or deter employer from resorting to contractualization. Such equation is likely to happen because the application of new technology is a sum-zero game that would demand a reduction in manpower.

I am saying this because despite the rapid advancement in industrial innovations, there remains a vast portion in production activities still dependent on skilled manpower. When Sowell said that high wage per hour could be offset by lower labor cost per unit of output, he was unmindful there is a curve to his supposition. Time will come that the cost of labor per unit of output will be overtaken by the rate of wage until it reaches the point that it would no longer be feasible to offset the two. Besides, high wage rate has been the cause of festering inflation in the US rooted on the unmitigated importation and purchase of cheaper products from China, Vietnam, Cambodia, and Latin American countries.

In fact, if his theory is correct, the US car industries, then considered the colossus and most advanced, would not have collapsed had their capital and technological advantage not been affected by high wages sought by labor unions. Similarly, US computer industries would not have consigned their production of the microchips to Taiwan, China, and now India had they been able to maintain their competitive prices despite high wages paid to American workers.

This explains why our politicians make fools of themselves knowing every time they legislate to increase wage, there is always that corresponding increase in the prices of goods that adds to labor cost. The bitter joke is only about 25 percent of the country’s workers are receiving the minimum wage. Nonetheless, even if we pay them P50 to P100 less from the current amount of minimum wage, we already tampered the cost of living by our system of paying high wages. More than that, the system has rendered increases in the prices of goods inelastic, meaning that sellers would seldom reduce their prices even if there are evident factors to warrant their reduction.

• rodkap@yahoo.com.ph