On this subject, let me point out that low labor costs alone are not the only reason behind the growing trend to outsource the production of both goods and services. If it were, countries like Sri Lanka, where labor costs are among the lowest in the world, would be the locale of choice (Chart 1). That it is not reflects the old adage, you get what you pay for: Sri Lanka’s labor force is not very educated, thus not suited for most U.S. companies’ needs. On the other hand, the people of India, Pakistan, China and the Philippines, just to name four countries, are highly skilled, and in some cases, speak perfect English. Yet, because they get paid a fraction of what their American counterparts earn, their services are very much in demand by U.S. companies for the production of both goods and services.
Another point worth noting is that there are good reasons for some firms to keep their operations here in the United States, even though it might be cheaper to move part of them offshore. Remember the trend to just-in-time manufacturing? This requires suppliers to be close to their customers. Other firms may not want to deal with the uncertainties of foreign exchange and possible delays when goods are transported long distances. Still others value the importance of “face-time” with their customers, suppliers, elected officials, and so on.
All well and good, but the bottom line is that we still need to jump-start the job creation process here in the United States so that this recovery will survive to celebrate its third birthday a year from now. For as you can see from Chart 2, while the reported unemployment rate may not be all that high compared with past experience, the labor market is far weaker than it looks. Because of the difficulty the unemployed are having finding new jobs, many people have become so discouraged they have stopped looking for work altogether. If these folks were added back into the labor force, along with those who are working part time instead of full time, or at jobs that require fewer skills and pay less than their previous position, the jobless rate would be nearly four points higher – close to 10 percent.
Any discussion that involves making it more attractive for businesses to produce goods and services here in the United States must begin by examining the cost of labor, since this is the typical firm’s biggest single expense item. As Chart 3 shows, while the rise in wages and salaries has slowed dramatically over the past four years, overall compensation costs are still rising close to their 20-year average of four percent. The reason: the cost of benefits, most of which is health care. These costs must be contained if American workers are to have any chance at all at being competitive in what has increasingly become a global labor market. Some of this is already beginning, since radiology is one of those jobs that are being outsourced, but more will have to be done – especially in the area of tort reform.
Other aspects of labor costs must be controlled as well. These include, but are not limited to, workers’ compensation premiums and companies’ pension obligations. This latter item in particular is draining corporate coffers, intensifying the need to cut costs elsewhere, in order to maintain profitability. According to the consulting firm Watson Wyatt, corporate contributions to traditional (defined benefit) pension plans will be eight times larger this year than they were just four years ago. As a consequence, the pension-funding gap for all such plans has shot up to $350 billion from as little as $23 billion. This reflects the “perfect storm” combination of the drop in both the stock market and interest rates. Washington needs to devise a new formula that will reduce the amount that companies must inject into these pensions without compromising their integrity.
Another suggestion deals with profits that American companies have made overseas. The Senate Finance Committee recently approved a bill that would give a one-time tax holiday to companies that bring back to the U.S. profits that they have been keeping overseas. What should be added to this is a provision that these funds would have to be used to create jobs within the United States in order to qualify for this tax break. On this subject, Washington should also consider tax credits for those companies that add jobs here in the United States, beyond a certain level or trend that may already have been in place, as well as for those that provide education and training for their current staff, so that they can continue to add value commensurate with their compensation.
Domestic labor costs are not just high relative to those in other countries. They are also high compared with other inputs, specifically the cost of capital and information processing equipment. Chart 4 shows the disparity between the cost of labor and the cost of computers alone, without regard to the cost of capital. As you can see, compensation per hour has gone up by about 175 percent since 1980, while at the same time, the cost of computers has been cut in half. And while there is nothing that the government can – or should – do about this, there is something that Washington can influence: the cost of capital.
As I said at the outset, the administration needs to make a few adjustments to its fiscal policy with the aim of creating jobs. One of these involves reducing the attractiveness of capital relative to labor. When the cost of capital falls relative to such other inputs as the cost of labor, most firms will use more capital and less labor in order to lower their overall costs and increase their profits. The administration’s reduction in the capital gains tax did just that. And while it had the salutary effect of boosting productivity, it did so at the expense of employment. This tax cut should be rescinded, or at least modified so that using labor will not be as costly relative to capital as it is now.
Other tax cuts that this administration has enacted have not provided much bang for the buck when it comes to job creation. For maximum effectiveness in generating the rates of economic growth that would be needed to overcome the ongoing rise in productivity, tax cuts should be concentrated among low- and middle-income households. These people will spend every additional dollar they get and then some. Cutting payroll (Social Security) taxes, the largest tax the average household pays, would be a good start. Extending jobless benefits and restoring unemployment compensation to those whose benefits have run out would be another step in the right direction.
There are other measures that Washington should consider as well. Since the federal government can run a deficit while states cannot (at least over an extended period of time), Washington should step up its grants to states and local governments. Most of their budgets are in the red because of the jump in such costs as Medicaid and pensions, so they are cutting spending and raising taxes, thus taking out of the economy much of what Washington is trying to put in.
Washington should also consider sending every taxpayer a voucher worth $300 that must be spent within 60 days or it expires. That’s $54 billion that would be injected into the economy fairly quickly, providing maximum bang for the buck with minimum damage to the budget.
Going further, Washington should encourage small businesses, since they are the backbone of our economy. According to the National Federation of Independent Business, these days, twice as many small firms are hiring than are firing – a distinct contrast with the big companies, where almost three times as many companies are firing than are hiring.
The Small Business Administration believes that small companies have for years accounted for the bulk of the nation’s job growth. By the same token, it would also seem to be a good idea for the government to offer seed money to encourage startups – provided, of course, that they are in sectors that are growing, thus likely to create long-lasting jobs.
Last but not least, the administration should take a leaf from our experience of the 1930s by implementing a WPA-style project to repair and enhance the nation’s infrastructure. By this I mean invest money in the country’s highways, bridges, tunnels, and even government office buildings. Not only does our infrastructure need upgrading, but also doing so would create lots of employment – both blue- and white-collar.
After all, you can’t build a bridge overseas and bring it to the United States. Infrastructure projects by their nature require the work to be done on site.
Zarb School of Business
Have you always wanted to earn a Master of Business Administration but never had the time?
The Zarb Executive Master of Business Administration (E.M.B.A.) program is specially designed to meet the needs of full-time, experienced executives. The E.M.B.A. program allows students to complete all the requirements for the M.B.A. in a 20-month period. With the exception of a two-day orientation class and an international practicum, classes meet one day per week on alternating Fridays and Saturdays.
The Zarb E.M.B.A. program features a global focus, state-of-the art classroom facilities, distinguished Hofstra faculty, and lock-step scheduling.
The Executive M.B.A. program has a limited number of openings for the Fall 2003 entering class.
For further information, please call Dr. Barry Berman, Director of the E.M.B.A. program, at (516) 463-5683. Dr. Berman will gladly arrange a tour of Hofstra’s facilities. Hofstra is located on Long Island in New York.
Dr. Irwin Kellner is the Weller Professor of Economics at Hofstra University and Chief Economist at North Fork Bank and CBS MarketWatch