Arnold Kling  

The Great Factor-Price Equalization

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Job Satisfaction and Biblical ... What I'm Reading...

Tyler Cowen writes,


job creation from start-ups has been falling since the 1980s.

He cites a paper by E.J. Reedy and Robert Litan.

Once again, I want to point out that low job creation and stagnation are not the same thing.

One story we could tell for the past twenty years might be The Great Factor-Price Equalization. In international trade theory, when you open up trade between countries, factor prices tend to converge.

Let us be really crass, and describe as a factor of production the supply of average-IQ males in the U.S. Over the last several decades, we have opened up more opportunities for trade with average-IQ females in the United States and with average-IQ people of both genders in China, India, and many other countries. These opportunities have arisen for both cultural and technological reasons.

Technology has changed so that the muscle power is relatively less important. It has lowered the cost of transportation. It has created new means of delivering services, e.g., over the Internet.

Cultural changes include greater acceptance of women in the market labor force. They include cultural changes in China, India, and in American business so that it has become easier to integrate foreign workers into the production processes of American firms.

The net result of all of this is a tendency toward factor-price equalization among average-IQ workers. This raises the wages of average-IQ women in the U.S. and of average-IQ workers in other countries. However, it puts downward pressure on the wages of average-IQ U.S. males. Although everyone is benefiting from more capital and greater total factor productivity, the net effect on average-IQ U.S. males is negative.

One could argue that the new equilibrium ought to be full employment of average-IQ U.S. males at a much lower wage rate. However, for a variety of reasons, primarily cultural, we do not observe this. There are many institutional mechanisms that resist such an adjustment and instead promote higher unemployment rather than lower wages.

Under the Factor-Price Equalization hypothesis, the reduced rate of business formation and business hiring would be a symptom, not a cause. In fact, under most hypotheses, that would be the case. For reduced rate of business formation and hiring to be a causal factor, I think one would have to ask what has changed in the regulatory environment to make these processes more difficult. I can tell stories about this (cost of employer-provided health insurance, credential restrictions in health care and education), but I could also tell stories that run the other way (low cost of starting a business on the Internet).


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COMMENTS (10 to date)
mark writes:

Technology has also caused factor substitution, i.e., equipment for labor. ATM's, bar code scanning and OCR software, digital storage vs filerooms, etc.

Troy Camplin writes:

Regulations and barriers to entry should also be looked at over the same time period. Fewer startups would occur under those kinds of bad institutions.

Colin k writes:

I'd like to see how annual revenue of startups has fared. Startups by definition have no legacy structure and can take full advantage of modern labor-saving technology.

[broken link fixed--Econlib Ed.]

Matthew C. writes:

Troy has a great point.

We also need to consider how our best and brightest have been sucked into non-productive rent-seeking careers, such as Wall Street and K. Street.

Costard writes:

Rather you should say that American businesses generally have created jobs in China rather than at home. Fair enough. But you have not answered the question - why fewer new jobs from start-ups?

Everything you mentioned should favor entrepreneurial activity. Lower costs, cheaper transport, the availability and inexpense of information.... Economies of scale have been gutted by the outsourcing of labor, the rise of mercenary manufacturers, and technology that allows a factory to be versatile and cost-efficient even at low volume. Unemployment and sticky wages should benefit start-ups particularly; while existing industry readjusts, new businesses have the run of the labor market. Not to mention the heavy incentives for someone who doesn't have a job, to consider employing himself in some new venture.

The weight of regulation is more apt to crush something small, certainly. Imposed labor costs matter, and probably more important are the myriad health and safety regulations imposed by three levels of government and countless influential trade groups. But I would argue that a startup in 2011 has the ability to avoid many of these costs, by outsourcing all physical presence to those can effectively bear it. If startups are creating jobs in existing industries, this might go some way towards explaining the observation that began this article.

Additionally, in the technology sector, existing companies have been growing at such a rate, and startups have demonstrated such volatility, that there is every incentive to invest big.

Lastly I would say that in a forest fire, the larger tree lives; and in an economy dominated by bubbles and busts, the larger company gets the bailout, the subsidy, and the implicit guarantee.

Sergei writes:

[Comment removed by request of the commenter.--Econlib Ed.]

Don Lloyd writes:

"... For reduced rate of business formation and hiring to be a causal factor, I think one would have to ask what has changed in the regulatory environment to make these processes more difficult...."

Actually change is not necessary, only expansion. The incentives for a regulator are all wrong. He will hardly ever get fired for forbidding something and will routinely get criticized for allowing almost anything by somebody. Something new today is at best a danger to a regulator.

Regards, Don

Jonathan Bechtel writes:

I think the startup scene, in terms of sheer volume, is doing fine, it just makes less and less sense to hire lots of people in a startup.

Most startups are technology oriented by necessity, and in technological industries there are huge differences in employee productivity. Hiring a few great programmers and paying them in equity makes a hell of a lot more sense than picking up 20 mediocre ones. The value added by a few great employees is even larger than the cost savings produced by outsourcing.

This was one of the things that came into greater clarity after the tech bubble burst. Before the bubble MBA types were approaching VC's, and then hiring large teams of Indian programmers to do the dirty work. Now that's hardly ever the case. MBA types, it turns out, are almost totally irrelevant. Since the coding is the proprietary technology, it makes more sense just to go straight to the engineers. And a few great engineers working together harmoniously works a lot better than a business type managing 20 guys in Bangalore, even if they are only earning $10 an hour.

The advent of 'the cloud' has made it a lot easier for small groups to automate a variety of business functions like accounting and marketing.

If you combine that with various regulatory hurdles, the result is that it's a lot easier to start a business than it was in the past, but it's a lot harder to start a business that hires a lot of people than it was in the past.

If you're a bright, enterprising person there's no better time than today to start your own business. And really, to an entrepreneur, the ability to start a business without hiring a bunch of folks is a positive, and not a negative.

Harun writes:

To add on to what Jonathan Bechtel is saying, imagine that the product is physical, and thus does demand factories, workers, etc.

Most start ups would not actually sets up a factory to make the new products in America. They won't even set up a factory in China.

Instead they just place orders with a previously existing Chinese factory. No need for workers, plant, equipment, etc. on our side.

Oh, maybe a warehouse and two guys to run the fork lifts and make shipments. And now you can even outsource that to fulfillment companies.

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