Wednesday, 3 February 2010

Labour pricing - don't score an own goal

One of the most amazing consequences of the recession over the last two years is that, for the first time, employees are willing to accept pay cuts, or even zero pay for periods of time, in order to retain their jobs. Labour has realised (the unpleasant truth) that just like any other factor of production, there is an equilibrium price. Go above it and business will be killed. Its much better to have low pay than no pay. High pay and constant increases are not an automatic entitlement.

This post is primarily for the developed economies where cost of labour is high. Because this has been accepted as a given, manufacturing has inexorably moved to the east, notably China. So the developed world has accepted, without challenge, that their costs will be high and therefore they can do nothing about jobs going away. Such a defeatist attitude is unbecoming of the great innovative cultures they are. Any cost, even labour cost, can , and should, be controlled to keep manufacturing jobs from going away. But how ? Here’s an unpalatable prescription.

Lets take a typical situation – the cost of a worker in a factory is say $ 25,000 per annum. The equivalent cost in a developing country is $ 2,500. Now that’s a huge gap – 90%. While there is no magic bullet, we can chip away at the difference.

Firstly, a significant portion of the cost in developed countries is the social costs that are imposed by the government. Generous pension rules. Unbelievable medical rights (for god's sake, artificial breast implants should not be an entitlement in any medical scheme). The US system of employer paying the medical insurance is a horrible way to drive labour costs up and ensure that manufacturing jobs keep going to China. Retain very basic social costs and remove everything else. Costs are down by 10%.

Employees must work longer hours. No 6 week holiday entitlement. Work five and a half days a week; maybe even six days. Work eight and half hours a day. Another 15% reduction.

Governments must provide an incentive for lower level manufacturing jobs in the form of tax concessions (argued in the previous post). Abolish investment related subsidies (the amount of pork in the US is unbelievable). Channel that money to tax breaks for the low end manufacturing jobs. Another 10% reduction.

Allow inflation to chip away another 10%. Wage inflation in developing countries will always be higher than wage inflation in developed countries. Aspirations rise everywhere – even in the poor world. And contrary to economic theory it will not be nullified by exchange rate movements. Keep wage inflation in developed countries to 0%. In 5 years, you’ve made up another 15%.

The employee should take charge of his destiny and guarantee a 5% productivity higher than in the low cost developing world. By working smarter; not necessarily harder. Write it into the employee contract. Another 5% is chipped away. Give up some “luxury perks” like swank canteen, gym, etc. 5% more goes. And finally exempt them from paying the union subscription. Another 5% gone.

That still leaves a 25 % differential. But that is safe. No company will ship jobs to another country for a mere 25% savings in labour costs. The additional costs of shipping, supervision, risk, etc will outweigh such a differential.

Does this all look like a horrible killjoy proposal ? Capitalist pig being anti labour ? A sweatshop ? For sure it would seem like that to the entrenched employee with a “safe” job. But stand on the outside. Ask the unemployed single mother struggling to find work – any work. Ask the person who’s on the street having been evicted from his house. Ask the guy who’s applied to 436 jobs and got deafening silence, not even the courtesy of a reject letter. You’ll get a very different perspective.

Is this politically saleable ? Absolutely not. But try introducing this with an undertaking that anybody who opts for this is guaranteed a job for the next 10 years. Purely optional. Only in new plants being set up afresh. Whoever wants to take this up can take it up, purely voluntarily.

Try this in El Centro, CA, the town with the highest unemployment in the US. Somehow, I think you’ll find enough people signing up to fill 5 factories.


mahesh said...

Good thought - but difficult to achieve especially the pension rights and the medical costs in protective countries. Rest are easily doable.

Question is when you do get to the desired 75% saving is there no country in the east that will be able to replicate what China has done currently (provide the service at 10% of the new cost)... no one thought 15 years that you could do the manufacturing in the east at 10% of the current cost.

Also with the east now being able to retain some of the great talent that they were loosing to the west the chances that they will come up with better technology which could reduce the requirement of labour and things could probably tip again!!!

Sandhya sriram said...

coping with cheaper labour available from developing economies has been a challenge which developed economies have been facing even before all the offshoring started happening. and when imports got cheaper, people saw it more as a benefit in terms of cost rather than someone taking away their jobs. its just the multiplier effect of recession, investments sinking, housing sector going down that now people are feeling they would be better of without china.

while i agree with all your points if someone decided to ever implement them, i still dont beleive there lies the solution. developing economies can soon catch up.

the developed economies strength lies in the fact that they are developed and they dont need to invest enormously in infrastructure, education and all the rest which developing economies are battling.

so then, they need to invest in training and moving their workforce up the value chain where they could add value given that the education, training and quality of life is far better

i somehow feel recession has somehow brought out the phenomena of abundance and how they are not using it to add incremental economic value any more. even now all fixes are temporary like bailing out greedy corporates to save faces. they need to have a 5 year plan on where they visualize their workforce to be then and now itself channelize them in that direction

this is my view. i know i may be wrong, but the advantage of this portal is that i get your expert feedback on every rambling which gives a great insight.

so will await your nice insight on this rambling as well

J said...

I guess if there was a time to try to cut labor costs in developed countries with the plan to create more jobs, this is the time. Taking up the issue of benefits, there was an interesting NPR program on how the employer based medical insurance system came to be in the US. It started because during World War II, there were caps on pay but not benefits and so medical insurance was a back door way of paying labor more and then some tax benefits to the employer further solidified the trend. The effect was that 9 percent of the population in 1940 had such insurance to 63 percent in 1953. The argument against such employer paid medical insurance is that the consumer of the insurance (employee) is not paying for the product and that leads to some unnecessary medical treatments and this drives up labor costs. However, there may be offsetting benefits to negotiating group plans, but still who should pay for these?
Here is the link to the NPR program:

But you make a good point that the developed world has accepted the labor costs disadvantage relative to China as inevitable and something that cannot be challenged and I think if there is a change in the mindset, solutions will naturally evolve.

Ramesh said...

@Mahesh - Yes its an ongoing competitive war and the east will reduce their costs too. But if there is a cost differential of not more than 20-25% on labour with pehaps costs as competitive or even lower, jobs won't go away.]

@Sandhya - The challenge for developing economies is that their labour costs will rise. Their cost advantage will slowly start to erode. Already happening in China - China's labour costs are now actually higher than India's. So I believe developed countries can also compete at the lower end of manufacturing where the most jobs are. Yes, training, skills etc are other means of keeping competitive advantage, but they don't need to necessarily lose the war on costs.

@J - Very interesting info on how employer paying for medical insurance came about in the US. Its ballooned into a monster where there are huge costs and entitlements as ridiculous as the example I quoted in my post. In any free market there must be multiple range of services at multiple price points and the consumer chooses. In health care there seems to be only one price point - the highest. I believe there must be a basic package - which covers debilitating illnesses and basic care (some of which can be cost effective solutions such as medical tourism !) and the rest is optional for the consumer who pays for what level of care he wants.

Vinoo John said...

Ramesh...I loved your case...although very hard to implement but time will catch up.....and things will turn around...I find it even more strange that people are not willing to still work that hard and put in that effort because they have minimum standard of living no matter what the need is not strong enough yet!

Half Indian said...

Wonderful topic, a thoughtful essay. I enjoyed your writing and all of the comments, specially J 's opinion: "if there is a change in the mindset, solutions will naturally evolve."

gils said...

enaku sila para's ithula skipping them and targeting only those i cud follow :)

first para : unpleasant :) me sticking to same kambeni for past 2 plus bonus and 5% sal cut too :) but to me..the work env matter(ed/s)more than few thousands per month..but the bitter truth for me is..there is a limit to my patience :D

ur theory of how to bring down the 90% to 25% is quite interesting. aana neenga solra antha perkslaam thookita..wats the difference between a "developed" world and the "developing" one?? to me the word is comfort..salarywise (i wud rather say purchasing power driven salarywise) i feel..with my lil exposure to these stuff..the gap between dev and is pretty marginal. the only driving factor is comfort. Detroitla car thodaikarathuum..Sriperambudurla thodaikarathukum oray difference anga car thodaikaravanum carla varuvan povan..inga thts missing.
and velai ilaatiyum..medicare and pension are something..which i wud make it as something of a fundamental right when i become the president ( oh yeah :D plans are ON for past 20 years :D )..LOL breast implant :D definitely the claims shd be pruned a bit..but mothama thookarathu..uhum..and 58ku mela work panna venaamanu solitu..veetuku anupa padra makkaluku unless there is an alternate option of employment made available..pension is a must. neenga solra 6 day week 10 hr dayslaam..enga kambenila implement panna arambichitanga :) so it proves ur point :) politically saleable!! hmmm..kushtam thaan..neenga amirtham distribute of costnu board vaingalaen...deprival of right to deathnu sandaiku vara gumbal iruka thaan seiyum..onum panna mudiathu :)

gils said...

oops...kament solpa jaasthiga unthi..overa pesiten nenakren. pesama word verification mathiri word restrictionum potrunga baas :D

Ramesh said...

@Vinoo - Thanks for visiting and commenting. Yes, very hard to implement (the beauty of blogging is that I can do so irresponsibly !). I believe the current recession has changed a lot of attitudes, especially in the US. It has been much more brutal there than in Europe, and people are now willing to do virtually anything to hang on to their jobs.

@Qin Li - Thanks. Yes J has super comments always

@gils - Please gils, write even longer comments if you feel like it. You are one of the most entertaining and perceptive commenters of all.

I know how you feel when there's no increment, no nothing for two years while you slog. But the Indian environment is different gils. We aren't losing jobs. In the US they are getting sacked left right and centre. The family then is dumped on the road because the house is repossessed. They would gladly take a 25% cut and have a job; any job. This post was largely meant for them.

Yes comfort and standard of living is a big differentiator. I am now arguing that its better to lose a little comfort and retain a fair portion of it than to lose everything. Imagine the plight in the US, gils. Lose your job and you'll lose your house. Your medical insurance is gone. What do you do ??There are heart rending stories plenty.

One of your best ever comments. Thanks

gils said...

hmm..kushtam thaan...wen i read news abt indian families in US committing mass suicides over job loss..padikavay kashtama irunthichi

Deepa said...

A great post Ramesh. But I would see it as a mirror in the face to the developed countries for mindlessly ballooning their labour costs, without any foresight, rather than a plausible solution because perhaps its one of the most logical and intelligent solutions and logic and intelligence can't thrive where Political will comes into play.

Abt the med. insurance- that probably can be a subject of one of your blogs. Even if these employers gave basic med insurance, the cost is huge. And med insurance out here is as indispensible as breathing. If someone met with an accident here without an insurance, he would rather die. One can argue that it should be individual responsibilty. But my point would be, firstly, salary has to be sufficient to meet someone's basic needs atleast. And secondly, med insurance taken by employers in bulk are cheaper.

On working hours, luxury perks, its easier to move from hardwork to comfy, than comfy to hardwork, and more so if you havent seen it for generations now. You can expect as much maturity as you can from a pampered kid who is an adult now.

But having said all of the above, the lower level work force here is not averse to hardwork, and very motivated. And they are infact the hardest hit. Govt. incentives can definitely get them back into the game.

Personally, the one that I liked the most was, employee guaranteeing a 5% productivity.

I think the comments on these series just can't be kept brief. Was going to say sorry, but then infact its a compliment.

Vishal said...

// any cost, even labour cost, can, and should, be controlled to keep manufacturing jobs from going away. //

Allowing wage inflation without any increase in contribution is a dangerous scenario. One must look out to increase productivity, other thing being equal, to drive sustainable business. I think it is about creating that productivity culture which is a blessing in disguise. I am sure that this culture if sustained over longer period will never let the business down. Somehow, I am too gung-ho about this piece of your advice. And not only developed economies, this can save developing economies also in long-run.

Thanks to this recession, at least, there is a realization that cut in pay is better than no pay. Something called as safe job must not be taken for granted. 5 days work, 5 weeks holiday etc. – nothing should be taken for granted. It is not just need of the hour but a great asset to have in trying times.

Very relevant remedies and you make it look so simple!

Ramesh said...

@Deepa - Yes, its less a prescription and more a reflection on where developed countries have become uncompetitive. Medical Insurance in the US is , a wonderful topic with everybody holding every possible view under the sun. I'll steer clear !!

@Vishal - The problem with productivity Vishal is very often it replaces man with machines. Hence the absolute cost of labour is also critical so that the man machine equation is not so heavily weighted in favour of machines to make job losses inevitable.

Vishal said...

This equation (man-machine) is very important as you suggest. Productivity can be in form of smart outputs, longer working time and waste elimination in mundane activities, but should not replace man with machine.

J said...

@ Half Indian, Ramesh,
Thanks, such generous words could go to my head!

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