May 19, 2010

Bourgeoisie vs. Proletariat

Jobs are being lost and we are near record unemployment levels in America. Employment as a fraction of total US population is at levels not seen since single-income families were the norm. Today’s unemployment is more than a symptom of a cyclical economic bust. This is the structural adjustment of an over-extended global economy.

The US has entered a new era of unemployment.
Jobs that were once thought necessary in 2005 are now considered unnecessary. How is that so? Were these people idle while employed? No – the best explanation for the job creation of the past decade is the leverage that ran rampant throughout the global economy. Credit growth begot economic growth, and businesses based growth forecasts on historical data and hired labor capacity to fulfill anticipated demand. However, when the anticipated demand blew to pieces in 2008, it became clear that businesses were overflowing with overhead.

Today, businesses have reinvented their models to operate with fewer resources – in particular, fewer people.

Instead of firing and re-hiring workers, as would occur during a normal cyclical recession, businesses are firing and tilting business models towards permanently higher operating leverage (i.e. low level of fixed overhead).

When business run with high operating leverage a rise in revenues is significantly amplified by the time it flows through the income statement. Given the new levels of operating leverage, as revenues return to their post-crash levels profits will rise dramatically. However, without the unrealistic expectation of significant perpetual demand growth, future phantom production needs will no longer dictate today’s staffing levels. Also, businesses that have undergone expense rationalization are discovering that they can do much more with much less. For these two reasons, hiring will remain subdued.

This is bad news for the proletariat and great news for the bourgeoisie, as Karl Marx might put it.
Those who are part of the 20-30 million surplus of US workers will likely work for pittance. While capital is scarce and labor plentiful, those that own businesses will likely benefit from a higher return on capital via cheap labor.

Despite today’s low marginal cost of labor, without the means to simply scale back the real wages of the presently employed (wages are sticky), the average cost of labor remains high. Therefore, the mechanism to speedily return the labor market to full employment is impaired. Consequently, labor will remain in excess supply for a while.

If one were to dust off some David Ricardo texts, one would find that aggregate wages from labor should not exceed the marginal value created by that labor, thus constraining the worker to a life of subsistence. Wages are set based on the marginal value created by labor into perpetuity, discounted to the present. Until recently, the forecasts for future value creation by labor far exceeded what was realistic. This phenomenon enabled workers to earn and borrow far beyond subsistence levels.

However, much like the valuation of any asset, the reduction in the long-term demand forecast has shrunk the present value of the marginal productivity of labor, and therefore has shrunk the fair value of labor. Without the boost from overly-optimistic demand forecasts, wages now must now trend back to fair value.

This is good news for the owners of capital…bad news for the wage earner.