Why Wages Remain Low for Unskilled Work

My spring semester Introduction to MacroEconomics course has started.  Income distribution is covered in the first assigned chapter and a number of students had questions concerning the low wages of unskilled workers.

Wages are the price of labor and, like other prices, wages are determined by supply and demand.  While there is still demand for unskilled labor in the United States, supply has been shrinking and this should cause wages to increase.

One reason why wages for unskilled labor do not  increase very much is the fact that output per worker is low.  Thus, when wages begin to increase due to declining supply, companies tend to either invest in and begin substituting capital for labor or move production overseas to a place where such labor is cheap and plentiful.

However, another reason is that the role of the price mechanism is to attract resources to areas of scarcity.  So whenever the supply of something decreases its price increases and this increase in price (and the potential profit from meeting this shortfall) results in efforts to increase the supply.

In the case of unskilled labor an increase in wages results in an immediate increase in supply.  

Unskilled workers, due to lack of training and education, have nothing to offer employers beyond time and muscle.  The fact is that any able bodied individual can provide muscle power.  As to time, if the wage rate is high enough, the opportunity cost of such jobs is generally greater than using their time working in their skilled job.

Because the supply of unskilled labor is so elastic, noticeable increases in unskilled worker wages results in the supply increasing and driving the wages back down.

Skilled jobs require training which takes an investment of time and money.  This tends to set skilled workers apart and limits the supply to only those with the necessary skills.  

So, while an unskilled worker can never compete with a skilled worker for a skilled job without first making the necessary investment of time and money to acquire the skills, a skilled worker can easily compete for unskilled positions.  Skilled workers generally don’t compete for unskilled jobs, but if the wage is high enough, they can quickly move into that market, thereby increasing the supply of available workers.

B to B Bartering - A Tool for Small Businesses

Barter is an ancient form of exchange in which a person traded something he owned for something that someone else had and he wanted or needed.

A major problem with a barter system is the fact that one has to spend time searching for another person who both has what one wants and is willing to trade it for what you have to offer. 

The introduction of money removed this inefficiency as money is a universal good that everyone wants and thus be traded for anything anyone is willing to sell.

However, while the use of barter has for the most part been replaced by the use of money it still comes in handy on occasion.

In a previous article, Bartering Pepsi Cola for Vodka and Tanker Ships, I described how Pepsi Corporation got around the problem of repatriating profits from the production and sale of Pepsi Cola in the old Soviet Union by basically accepting vodka and tanker ships in exchange the cash it earned in the Soviet Union.

Currency controls and lack of foreign exchange in some countries make it difficult for foreign companies to do business in these nations.  In these cases, barter may be a solution.  In essence the company selling its product in the country accepts goods produced in the country in lieu of cash.  It then brings the bartered goods to its home nation where it sells the bartered goods for the cash it would have earned in dealing with the nation which either forbid the export of currency or lacked hard currency reserves to make the payment.

Small businesses, especially those starting out often lack the funds to obtain the supplies they need to produce their product.  Barter can be a solution in these cases as one small business can trade the goods or services it has to offer for goods or services it needs from other small businesses.  However, searching for such matches is inefficient.

Enter barter exchanges.  These are organizations that enable small businesses to trade their services without having to spend time searching for those  both offering the good or service the business needs and also wanting what the seeking business has to offer.

With a barter exchange, a business simply provides its good or service to a business seeking that good or service and receives a credit to its account with the exchange for the value of what it provided.  The selling business can then use the credit to purchase a good or service it needs from another participating member. 

For example a motel (most of which, despite bearing the name of a national or global chain are actually franchises and thus operate as a small local business) may need some computer work done.  Rather than searching for a small business providing tech services, the motel owners simple look in the local barter directory for a tech company and call to have the work done. 

The motel pays for the work by transferring barter credits (either by writing a check against its barter account or transferring them electronically) from its account with the exchange to the tech company's account.  The credits are equal to the dollar value of the services it received. 

What the tech company receives is not motel services but the dollar value of these services.  It can then use those credits to purchase some other good or service it needs such as tools or replacement parts for computers or services such as marketing, printing, meals at a restaurant, etc.  However, somewhere along the line some other member, who has never provided services to the motel may need a motel for a meeting or workshop will use its credits from other trades for the room at the motel.

Generally the barter exchange will charge small membership and exchange fees which have to be paid in cash but these are small compared to the value of services being exchanged.  Also, the dollar value (which is what is credited to a member's account when trades occur) is reported to the IRS for income tax purposes.

The best way to become involved with barter is to join an exchange or use a service like Craigslist.  Links for some large exchanges are listed below.

IMS Barter Exchange Network

Barter Exchange Network

Superbiz

Trouble Ahead for Social Security Recipients

As I described in a previous, December 11, 2012 post, a stock of productive capital is needed to generate the output and associated income needed to support people in retirement.

In other words, current workers need sufficient capital to enable them to produce enough goods and services to not only support themselves and their families but also current retirees.

The economy is like a pie in that the larger the pie, the more people it will feed and what retirees need is an economic pie that is large enough to feed them along with everyone else even though they are no longer working and producing.

The U.S. Social Security System has always been a risky bet at best, being basically a ponzi type system in which current investors (eg., workers) payments are used as payouts to existing retirees rather than being invested for their own retirement.

Like any ponzi type scheme, the system worked initially as the number of working people was more than enough to support existing retirees.

By having large families, the post war generation of workers ensured that the system would take care of them despite the fact that their life expectancy ended being considerably longer than that of the first generation of retirees under the system.

However, the post World War II Boomer Generation (of which I am a member) is not going to be so lucky.

First of all, this generation tended to postpone marriage and having children until later in life with the result that the generation immediately behind them is small.  As the boomers approached their forties, they did start having children and, on net, have a generation as large as their own behind them.

However, most of this generation was born late and is just now entering the workforce at the same time their parents are beginning to retire.

Second, the prolonged 2008 recession has resulted in double digit unemployment for the new generation just as they begin their careers.  Not only is this high unemployment among youth keeping any of them from working and paying Social Security taxes now, the late start in the labor force will impact their future wages which will further reduce money available for benefits.

Finally, the recession has also resulted in many members of the boomer generation losing their jobs and having to take Social Security early putting further pressure on the system.

Many people may be surprised to learn that Social Security is not a pension plan in the sense that benefits are paid out of earnings on the investments made with their tax payments.  Instead, the program has always been a simple transfer of income from current workers to retirees.

For the Social Security System to work as planned for the boomer generation, the U.S. will need a quick end to the current recession as well as strong economic growth.

Given what is happening in Greece and other places where Social Security type systems are breaking down, it is probably a good strategy for current recent retirees and those near retirement to have a back-up plan for possible cuts in the system.

I doubt that the system will disappear completely, especially for older retirees.  However, at a minimum the cost of living adjustment (which was not a part of the original law but an amendment added during the inflation of the late 1960s and early 70s) will be adjusted or eliminated completely.

There is also talk about means testing for benefits which means that benefits would be reduced or eliminated for those with other sources of income (pensions, IRAs, 401(k)s, part-time jobs or other household income.

As mentioned above, Social Security is not a pension plan but basically a welfare program designed to transfer income from those with wage incomes to those retired and not receiving a wage income.

While I doubt that the Social Security program will be eliminated completely (as retirees plus those who have been paying Social Security taxes for a number of years probably outnumber, in terms of votes, those who are just entering the labor force and have no real financial stake in the system, as either long time tax payers or recipients) but I will not be surprised if cuts and restrictions are enacted in the foreseeable future.

I elaborated these concerns about Social Security cuts and arguments supporting my concern (including links to Supreme Court cases stating that Social Security is not a pension system but a welfare plan which Congress can change at any time) in a HubPage article entitled The Social Security System's Achilles Heel. 

In a third and final post I will explain potential problems with employer administered defined benefit pension plans.

Hang On We're Heading Over the Fiscal Cliff

As usual, listening to the Washington Beltway crowd and their friends in the Mainstream Media one can easily conclude that the American economy is headed for a major crash as the economy careens over the January 1, 2013 Fiscal Cliff.

Despite Chicken Little scaremongering by the chattering classes, most people seem to be taking the cliff fairly calmly.  The stock market has declined a bit as it usually does when faced with uncertainty and potentially bad news but the nation has remained calm.

The so called Fiscal Cliff is basically a fiscal tightening or anti-stimulus that involves cuts in Federal spending and increases in taxes.  This is the opposite of a Keynesian obsession with throwing money at the economy.

Following the end of World War II we hit a major fiscal cliff in 1946 and beginning of 1947.  Then as now, Keynes and his followers were certain that going over the fiscal cliff would result in an economic crash and renewed economic depression. 

According to popular myth, World War II brought us out of the Depression.  Granted, everyone not drafted into the military had a job and factories, mines and farms were at full production throughout the war.  Government spending on materials needed to fight the war amounted to a huge economic stimulus which had the economy operating at maximum capacity.


While the statistics looked good, consumer production was minimal leaving workers with little on which to spend their earnings. Everyone had a job but only limited quantities of bare necessities were available for purchase by consumers.

It was in this immediate post war period that President Truman in a speech uttered words to the effect that war is hell but peace could be worse, alluding to the Keynesian belief that, without the continued stimulus of massive government spending, the economy would quickly collapse.

The dropping of the atomic bombs on Hiroshima (August 6, 1945) and Nagasaki (August 9, 1945) coupled with the Soviet Union joining the war against Japan on August 8, 1945 quickly brought the war to an end on August 15, 1945.

Not only did the war end much sooner than expected, but, under pressure from the people who were sick the austerity that marked the Depression and World War II, the U.S. government immediately began demobilizing the troops (which represented about 18% of the labor force), canceling contracts for military material and lifting wartime regulations and restrictions on consumer production.

 

In the1946 mid-term Congressional elections the Republicans retook the House of Representatives defeating 54 Democrats and 1 left wing Progressive Party member to obtain a majority of 246 seats against the Democrat's 188.  In the Senate the Republicans picked up eleven seats from the Democrats plus defeating the left leaning Progressive Republican Robert LaFollette Jr.in the primary and keeping the seat for a 51 to 45 Republican majority in the Senate.

While Democrats and believers in Keynesian economic theories fanned fears that there would be a major Depression in 1946, it never materialized as the private sector, freed of many of the New Deal regulations and controls quickly switched from war production to civilian production. 

Federal spending fell from $84 Billion in 1945 to less than $30 Billion in 1946.  The sharp drop in spending  enabled the Federal Government to both quickly begin paying down the war debt. The deep cuts in spending also resulted in a small Federal budget surplus in 1947.

Both the Depression of the 1930s and the current massive economic downturn under President Obama have resulted from the ill conceived stimulus spending and massive increase in unnecessary regulations. 

Going of the Fiscal Cliff may not be that bad and could result in the economy quickly turning around and recovering early in 2013.


Click the links below for more on the feared Depression of 1946:

Stimulus by Spending Cuts:  Lessons from 1946 - Cato Institute Policy Report

Cheer Up!  The Cliff Doesn't Look So Grim - Barrons December 31, 2012 issue 



 

Will Charities Survive if Congress Eliminates the Charitable Tax Deduction?

The Christmas Season is upon us and this is a traditional season of giving.

It is not just the gifts for family and friends, but also the giving of goods and money to charitable causes. 

Giving and sharing with those less fortunate makes the giver feel good.  Giving is also a part of most cultures and is reinforced by the dictates of most religions which require believers to give as a part of their religious duty.

In the United States people who give money or goods to charities have an additional, financial, incentive to give and that comes in the form of lower income taxes.  Both the Federal government and most states with an income tax allow people to deduct the value of charitable contributions from their gross income for tax purposes.

Now with concerns about the fiscal cliff and the Federal government's need for more revenue to pay for its out of control spending the search is on for ways to increase revenue.

While logically the solution should be to bring spending into alignment with revenues, politicians and bureaucrats tend to take spending as a given and look to tax increases to make up the difference.

Currently, two approaches are being explored for increasing tax revenues.  One approach is to simply raise tax rates despite the fact that, historically, that tends to result in less revenue.  A second approach calls for keeping current rates but restricting or eliminating deductions.

Deductions allow people to subtract certain types of expenses from their gross income thereby reducing their income for tax purposes.  Eliminating or restricting deductions would certainly result in more revenue for the government as people's ability to reduce their taxable income would be curtailed.

Of course, organizations and businesses, whose activities or products are affected by people's ability to reduce their tax bills by contributing to or buying from these organizations, are opposed to this solution - at least as far as their activities are concerned.

However, while it is clear that deductions for home mortgage interest and local real estate taxes provide a powerful incentive for people to buy rather than rent their living quarters, there is some question as to whether allowing people to deduct charitable contributions is an incentive for people to give to charity.

Proponents of eliminating the deduction cite statistics showing that charitable giving in the U.S. has remained a relatively constant 2% of Gross Domestic Product despite numerous changes in tax laws affecting such giving. 

Charitable giving also has a long history going back to ancient times - long before there was an income tax and the need for income tax deductions.  Long before governments became involved in building social safety nets, churches were involved in soliciting money from members to help those less fortunate.  Hospitals, orphanages, poor houses, etc. all began as services provided and paid for by churches.

In the Western world the idea of people having a duty to look out for those less fortunate has long been ingrained in the culture.  Sharing one's good fortune with those less fortunate is the thing to do for many people.

As one who not only contributes to charity but also keeps records of contributions for tax purposes and benefits from the deduction, I can honestly say that I would miss the deduction but, after reviewing my contributions haven't found any that I would stop donating to in the absence of the deduction.  Friends I have spoken with have said the same thing about continuing their contributions in the absence of a tax deduction.

That being said, eliminating the tax deduction will reduce contributions to many non-profits.  Part of this will result from people taking a closer look at an organization, its mission and how efficient it is with their money. 

In the absence of  a tax deduction, those donating to charities will be apt to take a closer look and how the charity uses their money.  Those charities in which administrative and/or fundraising consumes most of each dollar received will find contributions being redirected to other charities where the bulk of each dollar goes to helping those in need.

French Actor Gérard Depardieu's Reply to Prime Minister Ayrault

 Conservatives and reputable economists for years have argued and used income tax data to show that high marginal income tax rates result in lower tax revenue as people adjust their work to reduce income and the tax burden or avoid the tax by leaving the jurisdiction.

So it was no surprise when French actor Gérard Depardieu, best known as the star of the world-wide 1990 hit movie Green Card, quietly relocated his residence to the Belgium town of  Néchin, located a stone's throw from the French border, earlier this month.

It was obvious that Depardieu's move, like that of many other wealthy French people in recent weeks, was in reaction to Socialist French President François Hollande's plans to levy a 75% tax on incomes above 1 million euros.

Most of the others left France quietly as Depardieu tried to do.  However, unlike some of the others who ignored the insults from socialist government officials and France's far left press, Gérard Depardieu reacted publicly and with anger this past weekend following last Wednesday's (Dec 12) harsh and insulting comments about him by France's Socialist Prime Minister, Jean-Marc Ayrault.

Speaking on the television channel France 2, the Prime Minister referred to Depardieu's decision to leave France as being "rather pathetic."   Adding “He’s a great star, everyone loves him as an artist,... [but] to pay a tax is an act of solidarity, a patriotic act.”


The actor responded the Prime Minister's comments with a three page, open letter that was published in the Saturday (December 15th) edition of the French weekly Journal du Dimarche.

In his letter, which I translated using Google Translate, Depardieu starts by writing:

Miserable, you say "pathetic"? As it is pathetic.

I was born in 1948. I started working at the age of 14 years as a printer, then as a warehouseman then as dramatic artist. I always paid my taxes regardless of the rate under all governments.

He goes on to state that he has always paid his taxes, including his 2012 taxes and further notes that over his 45 year career he as paid over €145 million in taxes to the French government. 

In a telling line he states:  I am leaving because you consider that success, creativity, talent, in fact, the difference must be punished.  

And toward the end of the letter he adds, 

I am a free being, sir,...

These last two comments reveal what the true objectives of socialist leaders like French President Hollande and U.S. President Obama with their tax the rich policies.  The goal here is to discourage individual initiative and freedom and, instead replace it with dependency on government.

While not good for freedom loving individuals, this is the perfect prescription for big government politicians who want to ensure the continued growth of big government.

Capital Stock and Retiree Income

Social Security and pensions are a growing concern for many people these days.  Retired people and those nearing retirement are especially concerned about these issues as they affect such people directly.

Most people look upon this crisis as a financial or money issue and it is true that a growing lack of money available in retirement funds is the main indicator that a problem is at hand.

However, money itself is merely the means by which we measure the ability of the government or private employer to pay the promised retirement benefits.

No one can survive without access to the food, clothing and shelter needed to sustain life.  And, most want more than the basic necessities of life.

There are only two ways to obtain necessities and desired extras and that is to either work and produce these things or rely on the labor of others.   However, relaying on the labor of others assumes that the others in question are both able to produce more than they need and are willing to share the surplus they produce.

The ability of working people to support themselves plus those who are unable to work is dependent upon the availability of capital, developed land, knowledge and organization accumulated through past savings and investment. 

These tools make workers more productive and better able to produce sufficient quantities of goods and services to meet both their own needs and desires as well as the needs and desires of those not working.

Investment requires that some production be diverted from production of consumption goods and devoted to producing the capital goods needed to both replace capital stock that is wearing out due to use as well as creating the additional capital goods needed to keep the economy growing and expanding.

Savings requires sacrifice.  Sacrifice in the form of choosing to forgo consuming a portion of one’s income now by either setting that portion aside for a future emergency or investing it in tools that will enable them to produce more in the future.

In times past a farmer could increase his wealth by a combination of working extra hours clearing new fields for planting and then he and his family tightening their belts and saving and extra portion of the current year’s crop as seed to plant in the new fields next year.

Then, instead of enjoying all of the new, larger crop, some could be sold or bartered in exchange for better equipment and/or draft animals to enable him to produce more in the same amount of time.

Modern urban workers do the same by setting aside money out of current income for emergencies and as savings for retirement.  

This savings takes the form of investments in income producing assets such as bank accounts, stocks, bonds, real estate, a business, etc.  Unless the worker owns a business in which he is investing in and growing, the savings is usually assigned to organizations or professionals who do the actual investing on behalf of the worker.

It doesn’t matter whether the worker is a famer or small business person investing in their farm or business or simply one who places their savings with professional investors.  The result is the same, namely resources going into the production of tools to enable workers as a whole to produce more in the same amount of time.

Continuing investment is needed for two reasons.

First, a certain level of current investment is continually needed to replace equipment that wears out and is no longer operational.

Second as the population increases or, as is happening in many nations, ages and the aging workers retire, existing workers have to produce more simply to provide for themselves and the young, old and infirm who cannot work and produce. 

While older retired workers are still consuming but no longer working and producing the legacy of productive capital produced from their savings leaves the new generation of workers with the ability to produce and support both themselves and the retirees.

Next:  Why Social Security and Pensions are in Trouble

Allowing Bush Tax Cuts to Expire Now Makes no Eonomic Sense

 As we approach the December 31st Fiscal Cliff one of the major points of debate is taxes.  Specifically increasing taxes on the rich.

President Obama and other left-leaning Democrats are targeting three types of income the taxes on which were reduced during the administration of former President Bush and which are slated to automatically increase at the start of 2013.

The first is the tax on dividend and capital gains income.  Capital gains refer to the difference between what a person paid for and asset (with stock being the most common asset affected) and what that person received when the asset was sold.  If the sales price is higher than the purchase price the difference or profit is referred to as a capital gain.

Dividends,of course, refer to the periodic dividends or portion of a company's profit that corporations pay to their stockholders.  Profits are already taxed once in the form of the  tax that the Federal Government levies on a corporation's  profit (i.e., revenue minus expenses).  Any dividends paid come out of the corporation's after tax profits.  Stockholders then have to turn around and pay additional tax on the dividends they receive.

The Bush Tax Cuts eliminated the tax on capital gains and dividends for those in the two lowest income tax brackets which are currently the 10% and 15% brackets and set the maximum tax on these for people in the brackets above these two bottom brackets at 15%.

These two taxes will go up unless the current rates are extended by Congress

The second area of income affected will be income from sources other than capital gains and dividends.  This is basically wages, salaries, bonuses and other income earned as compensation for work performed.  

Here the President is claiming to want to keep current rates for those with this type of income below $250,000 and raise the rates on those earning more than $250,000.

Since our income tax system is progressive this means that the government will accomplish this increase by increasing the tax rate on upper brackets of income as well as creating some new brackets at the top end of the bracket scale.

The problem with increasing the tax rates on the top income brackets is that many wealthy people have the ability to reduce their income by working less.

It makes sense to work less when the tax rate on the higher income resulting from working longer and harder is such that most of this extra income is taxed away. 

When high income earners do this the government not only loses the projected tax revenue that the high top rate would be applied to but also stand to lose taxes from other workers in lower brackets.

Take a small business owner planning to expand by adding an additional production plant, restaurant, store etc.  The expanded business will result in more income for the owner.  However, the expansion will also require the small business owner to hire more people. 

With almost 8% of the workforce currently out of work and looking for work and an additional 6% to 8% or more of the workforce wanting to work but has given up looking for work (thereby no longer considered by the Department of Labor as being in the workforce and unemployed) the government could collect considerably more taxes if large numbers of these unemployed people were earning wages and paying taxes on those wages.

The only things that President Obama will accomplish by raising taxes in the current economic climate will be to continue the present recession and continue running large deficits.

Could Retailers Begin Declining to Participate in the Black Friday Frenzy?

Today is Cyber Monday when workers who have been off for the four day Thanksgiving Holiday return to the office and continue their post-Thanksgiving shopping online using their office computers.

This is assuming they have any money left to continue shopping following the Black Friday shopping frenzy that retailers began on Thanksgiving afternoon and have continued through the weekend.

Is it possible that Black Friday could be losing it appeal to retailers?

Black Friday, of course, is the day following Thanksgiving that, for stores and shoppers, has assumed holiday status itself.   For many shoppers Black Friday almost eclipses the real holiday, Christmas, for which it is associated.  And, for sellers, Black Friday sales can mean the difference between a profitable Christmas Season or a not so profitable Christmas Season.

Normally black is associated with things that are bad or even evil.   Blackmail, black markets, black ops, black arts, etc. all conjure up images of crime or other anti-social behavior.

However, for one profession, accounting, black is good given that accountants have traditionally recorded profits with common black ink while making losses stand out by recording them using red ink.  

As Christmas and the tradition of extensive gift giving began becoming more popular beginning in the late nineteenth century, retailers began to see profits rise during the Christmas Season as shoppers began opening their wallets wider and spending more lavishly  on gifts for family and friends.

Occurring about a month before Christmas, Thanksgiving began to be looked upon as the day before the start of the Christmas shopping season.  This image was helped by the fact that, because Thanksgiving always fell on a Thursday, it didn’t make sense for most factories to re-open for just one day, Friday, and then shut down again for the weekend. 

Thanksgiving thus became the start of a four day holiday weekend and the day after Thanksgiving, Friday, became the start of the Christmas shopping season.

Thanksgiving, of course, brought families together for a day of feasting and fun and, being close to Christmas, got their minds on that big holiday get together that was only a few weeks away.  This was just the frame of mind people needed to get started right away on Friday, the day after Thanksgiving, with their Christmas shopping.  

Retailers, of course, saw this and began fanning the flames of the Christmas shopping spirit by offering special deals to lure shoppers out – after all, the sooner people start Christmas shopping the more time retailers have to lure them in.

The competition associated with the free market meant that all stores soon entered the fray with sales and promotions and, as time went on the sales and promotions became increasingly intense and widespread.  

All of this hype, of course, succeeded in firing up the competitive spirits of shoppers causing them to come out en mass and eager to hunt for deals.

The Friday after Thanksgiving soon became such a big shopping day that, for many retailers, the sales volume was such that it tipped the scales from breaking even or even losing money for the year to profit – i.e., the accountants began writing the bottom line numbers with black rather than red, ink.

However, Black Friday may be approaching the point where the shopping frenzy associated with it reaches a tipping point where store hours, shoppers and sales all begin to decline.

Shoppers in increasing numbers may be tireing of this and begin declining to join the Black Friday frenzy and, instead, enjoy their Thanksgiving while choosing to  spend the next day relaxing with their families.

More important, many businesses will begin finding that the ever increasing price reductions needed to lure consumers on Black Friday combined with the increasing costs associated with opening earlier and staying open with extra sales personnel result in losses rather than profits.

Results from last year indicate that, rather than getting the Christmas shopping season off to a strong and sustained start that added to sales and revenues, Black Friday tended to be a buying surge followed by a significant drop off in selling the following weeks.

Overall sales were as expected and in line with previous years but rather than being spread out over the weeks between Thanksgiving and Christmas, were concentrated on Black Friday.  

The problem with this for retailers is that while total sales are good in terms of merchandise sold, revenue is down due to price cutting and costs up due to extra costs of added staff and hours on Black Friday.