With 3.6 million jobs lost since the December 2007 beginning of what we are still optimistically calling “the recession,” it is time to rethink the relationship between capital and labor. In mainstream economics, a business is said to be productive when it is able to increase the dollar value of its output compared to the dollar value of its labor costs. Keeping labor costs down is usually the key to increased productivity, and one of the most effective ways to do that is to invest capital in, say, machinery or computers to get more from every labor-hour. But even before the financial crisis, there were signs that this model, under which United States enjoyed years of productivity and growth, was showing signs of strain.
Until now, if an enterprise keeps its cost of labor, energy and materials low relative to its revenues, it earns a high profit margin. And if it can keep the amount of capital it takes to earn that profit low, it maximizes the return on capital, thus minimizing its cost of capital, attracting more capital and generating outsized rewards for the deployers of that capital.
Until now, our model of capitalism has relied on markets to allocate capital to businesses with the best risk-return relationship–where, given the level of risk, capital could earn the highest returns. Businesses that have the best returns get capital more easily and pay less for it. But if we move from the current 7.6 percent unemployment rate to the more than 20 percent jobless levels of the Great Depression, the pain will spread, as millions lose their homes and it becomes increasingly difficult to maintain law and order. If that scenario comes to pass, we must face the difficult question of whether we can continue to allow the market such free reign in allocating societal resources. Economics is about to become political economics: capital will be valued for the jobs it creates, not just for the returns it generates.
Since 1978, when Deng Xiaoping set China on its growth path, the United States has been competing with a system that does not value productivity the way we do. As jobs flowed to China and other countries whose main objective was to lift millions out of poverty by providing them work, America stopped caring about preserving jobs and making tangible goods. But what the Chinese and other Asian state-owned enterprises cared about was jobs. Their for-profit businesses benefitted from workers who had a low opportunity cost in leaving the ricefields and a relatively low amount of social capital invested in them.
We yelled that their too-weak currency was an unfair means of competing with us. Even if by our standards their plants were inefficient and unproductive, these countries could afford to use “too much” labor per unit of output, because of their value system and where they were on the scale of development. In the end, we bought their goods and they did the work.
Before the financial crisis, the US economy had achieved such great productivity of capital in manufacturing and agriculture that one of the best places for capital to go for good returns were businesses where you could earn money on money itself–mortgage securitization, derivatives and various forms of leveraged investing. The financial services sector had come to represent more than 20 percent of our gross domestic product.