Eerie Parallels Between Soviet Planned Economy and American Capitalism
Friday, 05/29/2009 - 5:29 pm by Marshall Auerback | 4 Comments
The foolish consequences have now come home to roost, consequences of pursuing a policy that encouraged short-run speculative trend following capital inflows, which buoyed domestic stock and bond markets and kept domestic interest rates low at the expense completely ignoring trade competitiveness, a rising current account deficit, and a growing net debtor position.
In fact, there are broader, ominous parallels between the former Soviet Union’s planned economy and current trends within today’s American finance-dominated capitalism. Just as the Soviet planned economy venerated “the State” above all else, American capitalism today views the health and eternal expansion of globalized, free-flowing capital and of manufacturing as the ultimate goal. Both Soviet style communism and American “finance capitalism,” however, propagate vast and harmful income gaps; both rely on and promote militarism increasingly to obtain their geopolitical and economic objectives, and neither leaves much room for consideration of workers’ well being.
We all know what eventually happened to the Soviet Union. Although different in degree, there is no law of nature that exempts the United States today from the same devastating effects that eventually ran the Soviet Union into the ground if current trends, as appears likely, prevail. GM and its counterparts cannot hang on if they are the only existing part of the manufacturing sector. Like a clump of rainforest that is too small, they will eventually disappear, unless they are reconnected to a large, thriving manufacturing sector. Most observers blame the automakers’ decline on some kind of historical inertia created by the dominance that these firms wielded for so long. Certainly, that may have something to do with it. But these observers miss the importance of the ecology of the industrial system because they understand marketing and finance, not production (both companies have arguably been transformed from car makers to banks through their finance subsidiaries). Ford’s “world” cars are “bad” cars precisely because they are “world.” The engineers need to “kick the tires” of the new production processes they design. So while a market may be global, production and the growth of production take place most efficiently at continental or sub-continental distances. Ford used to have a huge, centralized production complex in River Rouge; if they really wanted to turn things around, they would go back to their roots.
Additionally, out-sourcing and pursuing a low-wage policy are not the paths to economic growth. The engineers who design the machines and the skilled production workers who make the machines are the people who drive technological progress and economic growth. The central factor in the creation of economic wealth and growth is not the cheapness of labor, but the productive power of machinery. If cheap labor were the road to international competitiveness, then the oversupply of near-starving peasants in China and India would have kept them at the top of the world food chain for the last 1000 years. When Great Britain first invented industrial machinery, it was able to use this advantage to conquer one third of the world’s surface. When the British decided that empire was more important than industry, the U.S. took over the global economy, until it now, like the Mother Country before it, has become blinded by empire. But while it was on top, until the mid-1970s, the U.S. consistently paid the highest industrial wages in the world. According to the late Seymour Melman (a professor of industrial engineering at Columbia University), this fact actually helped the U.S. maintain its lead.
Melman’s called his explanatory theory “alternative cost.” The basic idea is this: Faced with high labor costs, firm managers will be more willing to mechanize–that is, to use more machinery, and more sophisticated machinery–instead of using labor. By using more and better machinery, firms increase labor productivity, which leads to higher wages, and they also stay at the cutting edge of technology. Melman compared factories in England and the U.S. after World War II, and found that the English, who paid lower wages, were using more primitive equipment than the Americans.
More recently, his theory has been echoed in Suzanne Berger’s new book, How We Compete, in which she argues that employing cheap labor is not the most effective way of responding to global competition. The activities that succeed over time are those that involve conditions–such as long-term working relationships with customers and suppliers and specialized skills–which companies whose main asset is cheap labor cannot match. A company policy of forcing down wages is not a recipe for long-term economic success.
Equally controversially, Melman also argued that the productivity of capital was more important than the productivity of labor. If machines are central to the process of production, and if the machinery costs millions of dollars, then it makes sense that keeping machinery running as efficiently as possible is more important than the exact number of workers one is using or even how much they are being paid.
By driving down the price of labor in the U.S., manufacturing companies have reversed the power of “alternative cost.” Instead of using more and better machinery, they think it is easier or cheaper to move production to a country such as China. As a result of this process, the general level of competency in a given country’s manufacturing firms will decrease. The U.S. has a huge and growing trade deficit in manufactured goods, because American manufacturers are losing the competence to produce. Equally significantly, inefficiency in many countries arises from unemployment. People who are not working do not produce, and the loss of their goods and services makes everyone else poorer than they would otherwise be. So higher wages were a competitive advantage, not a disadvantage (not to be confused with comparative advantage).
Additionally, studies indicate that there is no trade-off between efficiency and inequality. As James Galbraith notes in The Predator State: “If the iron trade-off between efficiency and equity held, rising minimum wages would cause unemployment. But, as economists David Card and Alan Krueger demonstrated, they do not. California and New Jersey raised minimum wages in the 1980s and unemployment fell; the same happened when the national minimum wage was raised in the 1990s. Why did unemployment fall? With better pay, quit rates declined, hence job tenure increased, and vacancies fell. For the firm, there was also efficiency gains, since less had to be wasted on training. Finally, if we were living in the theoretical world of free-market economics, less skilled workers should be more heavily employed, relatively, in the United States than in Europe. But they are not. The United States and Europe employ roughly similar proportions of skilled and unskilled workers.”
As an aside, the Chinese are not doing themselves any favors by keeping their wages low either, because this will suppress their technological progress. In contrast to Washington, however, there are increasing signs that policy makers in Beijing are beginning to appreciate this fact.
Braintruster Marshall Auerback is a market analyst and commentator.
I’d be interested to read some of these views applied to Japan, which has long enjoyed a current account surplus driven by high-tech manufacturing but has seen a lost decade during which sovereign debt ballooned without leading to economic recovery.
Posted by Adam Buresh | June 3rd, 2009 at 8:11 am
Well, I think Japan has a different problem (ironically being repeated by the US today). The “lost decade” was really a consequence of failling to deal with their “zombie” banks quickly, and continuing to frustrate recovery via misconceived attempts at fiscal consolidation before the economic recovery could really take root. Read Richard Koo’s excellent book on this. BUT, Japan still has a vibrant manufacturing sector and an unemployment rate of around 5%. Japan today is a victim of a major global recession, but the country still has goods the rest of the world wants to buy. It also has social cohersion. I don’t think either of these qualities pertain to the US.
As an aside, I don’t think Japan’s own long term prospects have been helped by acting as America’s “51st state”. . In the absence of the Bank of Japan acting as “dollar sub-underwriter of last resort,” it is hard to envisage a chronic debtor country like the U.S. mounting successive wars with little financial strain and an absence of the kinds of tax increases which might otherwise politically constrain the country. Indeed, part of Japan’s own national debt is itself a product of its efforts to help prop up America’s global imperial stance.
Posted by Marshall Auerback | June 3rd, 2009 at 10:07 am
Marshall Auerback,
Good to find you posting here. Having found invaluable your writings on the Prudent Bear website, also the Japan Policy Research Institute and PIMCO, I have felt we could usefully hear more from you on the current shambles than your — somewhat sporadic — comments on Edward Harrison’s blog.
On the relations between wages, labour scarcity, and technology development, an interesting paper by Daren Acemoglu of MIT argues that the links may be highly context-specific. The argument is described in the abstract:
‘This paper studies the conditions under which the scarcity of a factor (in particular, labor) encourages technological progress and technology adoption. In standard endogenous growth models, which feature a strong scale effect, an increase in the supply of labor encourages technological progress. In contrast, the famous Habakkuk hypothesis in economic history claims that technological progress was more rapid in 19th-century United States than in Britain because of labor scarcity in the former country. Similar ideas are often suggested as possible reasons for why high wages might have encouraged rapid adoption of certain technologies in continental Europe over the past several decades, and as a potential reason for why environmental regulations can spur more rapid innovation. I present a general framework for the analysis of these questions. I define technology as strongly labor saving if the aggregate production function of the economy exhibits decreasing differences in the appropriate index of technology,, and labor. Conversely, technology is strongly labor complementary if the production function exhibits increasing differences in and labor. The main result of the paper shows that labor scarcity will encourage technological advances if technology is strongly labor saving. In contrast, labor scarcity will discourage technological advances if technology is strongly labor complementary. I provide examples of environments in which technology can be strongly labor saving and also show that such a result is not possible in certain canonical macroeconomic models. These results clarify the conditions under which labor scarcity and high wages encourage technological advances and the reason why such results were obtained or conjectured in certain settings, but do not always apply in many models used in the growth literature.’
The full paper is at http://econ-www.mit.edu/files/3933.
The ‘Habakkuk hypothesis’ to which Acemoglu refers was set out by my late father, H.J. Habakkuk, in his 1962 study American and British Technology in the Nineteenth Century.
He was himself prepared to contemplate the possibility that he had been wrong, and might have greatly underestimated the importance of cultural factors.
When one contrasts Britain and Germany since the war, my own conviction is that these are fundamental. A long time ago now, a marvellous man at the National Institute of Economic and Social Research here in London had the eccentric idea that if economists wanted to understand technological change, they should act like anthropologists and actually go and look what happened in factories.
I made a television programme based upon a paper his team did on the production of fitted kitchens — we selected it because it was an apparently low technology product. There was simply nothing in the British factories corresponding to the very strong ‘engineering culture’ in their German counterparts. This was rooted not simply in training systems — which can be replicated — but in the values underpinning those systems.
What certainly became apparent was how far these matters were context-specific. The early fitted kitchens had been standardised products, where the demands for skill in the labour force were much less. Computerisation had made possible a very highly customised product, which, ironically, meant that it greatly increased the skills required of the workforce — as all the different components had to come together at the same time, small delays and disruptions could be fatal. Unskilled British workers simply could not make this kind of customised kitchen on an industrial scale.
Trying to persuade people in the U.K. that the ‘Thatcher Revolution’ did not touch certain fundamental problems in the British economy was a thankless task at the time. It got even more thankless when the conventional wisdom came that manufacturing did not matter, and that Britain — and the U.S. — could flourish on the basis of finance and services.
Now that dreamworld has ended.
Posted by David Habakkuk | June 24th, 2009 at 4:40 am
I am not as qualified as the author of this article or the commentator from Prudent Bear, but I work in the global outsourcing business in the data communications field and have a lay person’s fascination with Macro economics. This was a fascinating article to read as I see it’s point played out as part of my working life.
I find that as we move operations to the cheap labor markets, those of us that are engaged in the transition witness the immediate impacts of the above mentioned problems. The skilled work force here in the US loses their high-income work (client looses some business too, but that’s not something that get’s discussed in our culture), the low income replacement steps in and immediately the service levels go way down; the crash in service levels stem principally from language barrier, time zone, indifference to and often a complete ignorance of what role the operation plays within the company that employs them. Part of this is because most of the high tech services the outsourcing party makes it’s living on are not available in the place where the labor is now performed (the mud hut problem).
The cost savings to the client are usually short term. In order to restore fallen service levels to a dwindling customer base, they are saddled with ever higher prices to replace good service levels and keep what remains of their customers. The client is now getting charged a fee for every last thing they might previoulsy have been able to do as part of salaried efforts. This stems from the “get what you pay for” paradox that seems to baffle many very well credentialed managers and executives. This stems largely in part form them not understanding or reading the terms and conditions of their contracts.
The net result is that any innovative ideas that we in the transition end of business identify that might be brought to bear on the client’s operation are lost as they have to make up the service level costs.
I think we are looking at a lost generation in America and not a lost decade. I am in generation X and my whole life I have been hearing about how we would be the first to live at a lower and declining standard of living, and I am now halfway through my life and the predictions are coming true. Fortune or Forbes did a good case study on generational cost structure changes, and in order for me to raise my small family in the same manner that my father and mother we’re able to raise me, I would have to earn five times what I earn now. I live in a far smaller house. My child has far less programs at school, and the cost to educate her is fast becoming out of my reach. This is really saddening to me as I am a person who lives well within their means and am one of the few people I know who can honestly say they save 10-15% of their income annually. Even within that lifestyle, the costs of everything I want to do with my life far outpace my earnings.It’s getting more and more tiring hearing Boomer generation wealthy guy’s who have made gazillions of dollars through generous public spending and investment in a flourishing middle class turned around and say, “that great society stuff sucks”. Blaming the victim is the point at which you know the perpatrator has slid into madness and may be beyond reason or help, and one could argue we have reached tht point with the FIRE sector of the economy (I always find it amusing that Finance, insurance and real estate sectors would be called FIRE….. sort of like Bernie Madoff, what would posess someone to put their money in the hands of a guy whose name is pronounced “made-off, like made off with the money).
As the wealthy people in charge of US companies seek absolute advantage through the vehicle of cheap labor, they are biting the hand that feeds them. I am continuously stunned at how much the political leadership, business leadership and fourth estate leadership continue to talk around the problem that is crippling the USA, namely the systematic underpayment of the work force for thirty plus years and counting. This has broad and bad implications for we here in the USA, (and arguably the world). Most Research and Development advances are coming from Asia and not the West now. All we seem to be able to do anymore is run up bills we can’t pay and fight about free market mythology. The only thing that made America great was our ability to do large scale technological innovation, without that we’re just another country with halfway decent courts, but not much else…..
As more cheap labor markets replace US labor markets and do not provide a replacement customer base where does that leave the company? Henry Ford said it best, if I don’t pay my people enough to buy my cars, I won’t have any customers……….. How this simple axiom has been so systematically underestimated in American Business culture is beyond me……
Many of my peers citizens are learning now that all of that borrowing they did has taken them from Wage Slave to debt slave. With our government spending an enormous amount of money to make Bankers whole on their out-sized bonuses and our lack of a manufacturing sector, we are becoming some sort of 21st Century sharecropper economy. The mansion used to be visible on the hill, now that hill is in France and it’s harder to see, but it’s still there.
I hate to think of what sort of brutal nationalist revolution may take root in our country as the divide between the rich and poor keeps growing. Socialism may take root as it responds to the injustice which is practiced capitalism, but in a country as religious, violent and uneducated as ours, I fear something far worse that socialism may be looming on the horizon.
Posted by Sam | July 1st, 2009 at 1:03 pm