The Economics Of Accelerating Technology And Disappearing Jobs

In his State of the Union Address US President Obama proposed that the national minimum wage be raised from the current $7.25 to $9.00 per hour. And then for good measure the minimum wage would be indexed to inflation. The reaction of most economists trained in traditional economics is that raising the price of labor above the market equilibrium level will only reduce the quantity of labor demanded and thus increase unemployment. Business will economize on low cost labor, thus forcing those on the lower end of the market—which has a large minority component-- into the unemployed status.

Economists might ask how can Obama be so stupid and propose something which will produce greater unemployment in the African American and Hispanic communities? Don’t look to the Republicans for answers since they have abandoned the ideological/economic arguments against the minimum wage a long time ago. Probably they will look like cheapskates and wind up bargaining Obama down to some number lower than $9.00.

The cynical answer is that Obama is not stupid at all. He knows raising the minimum wage will increase unemployment. But his raising the minimum wage makes great political sense because:

1. Those unemployed as the result of this action will likely not realize what has happened but instead will qualify for the panoply of unemployment benefits, food stamps and welfare that Obama has so thoughtfully expanded. The Republicans just don’t get it. Higher unemployment is good for the Democrats since the unemployed will be totally dependent on the government and will vote for the Democratic Party which is viewed as the party of dependable government handouts.
2. Those who get a raise as the result of the higher minimum wage will of course be grateful to the President.
3. He will get points from the populist left which will approve of this action on ideological grounds.
4. The general public which is in a down-with-the-rich mood and has a less than rudimentary understanding of economics will approve as well.

I could stop here with my cynical summary. Democrats and populists are always in favor of raising the minimum wage. Why bother to beat a dead horse?

But in all fairness, it is just possible that Obama, perhaps unconsciously, is reacting to an underlying economic force which is global in nature and which may have been driving government policy for the last thirty years.

All around the world we are hearing the same complaint: “The rich are getting richer and the poor are getting poorer.” This complaint is heard in Europe and the US and even in such hard money places as Switzerland and Singapore. Similar lamentations are heard in that once bastion of free markets Hong Kong which now has a minimum wage. Many conservative economists think this complaint is overdone – adjusting for benefits the middle class has not done that badly – but wherever you go you hear the same refrain that the middle class is shrinking and falling behind and the rich are getting too rich.

Creative Destruction: The Economics of Accelerating Technology and Disappearing Jobs

There is an alternative justification for raising the minimum wage other than my cynical list above. That is the hypothesis that technology is accelerating so fast that it is eliminating traditional middle class jobs. This if true is a global phenomenon. Classical economics predicts, in an economy where real wages are downwardly flexible, in an accelerating technology world there will always be an equilibrium wage (or set of wages) at which there can be full employment. But this equilibrium set of wages at the lower end may be too low to be socially acceptable in a democracy, especially when people compare themselves to the upper end of the income spectrum which is benefitting handsomely from technology’s acceleration. It is not that the lower end is in abject poverty. But on a comparative basis they have fallen behind. Hence the urge to redistribute income via the non-market political interventions. Raising the minimum wage and maintaining very generous welfare benefits for the unemployed are interventions (not optimal to be sure) to effect this income transfer. The lower end of the income spectrum gains via political means what it cannot obtain via participation in the market.

A very interesting book has come out by Eric Brynjolfsson and Andrew McAfee entitled Race Against the Machine: How the Digital Revolution is Accelerating Innovation, Driving Productivity, and Irreversibly Transforming Employment and the Economy. The book is based in part on Ray Kurzweil’s law of accelerating returns. Kurzweil’s “law” is that technology is accelerating at an accelerating rate and that technology’s acceleration is an essential part of human evolution. I’ve been of the view for some time that Kurzweil is not given enough credit in economic circles.

Byrnjolfsson and McAfree argue that technology is eliminating what were once upon a time well-paying middle class jobs and that America’s (and presumably other Western countries’) stubbornly high unemployment rate in part reflects that fact. Byrnjolfsson and McAfree talk about general purpose technologies (GPTs), “a small group of technological innovations so powerful that they interrupt and accelerate the normal march of economic progress.” Steam power, electricity, and the internal combustion engine are examples of previous GPTs. The computer/IT revolution today is a GPT that is totally transforming economies globally and bringing about unprecedented Schumpeterian creative destruction. Without question, humanity as a whole is benefiting enormously. But automation, robots, outsourcing, disintermediation, technology enabled globalization, even social media are all enemies of traditional American middle class jobs.

Byrnjolfsson and McAfree list three classes of winners and losers from this process:

1. High skilled vs. low skilled workers – Obviously it is the high skilled, educated group that wins.

2. Superstars vs. everyone else – Aided and enabled by digital technologies with a global reach, superstars clean up and it’s winner take all. CEOs, rock stars, super athletes, even super professors, earn multiples of the earnings of even their educated competitors.

3. Capital vs. labor – It’s capital hands down. The law of accelerating returns underlying the computer/IT GPT ensures that productivity is rising. Gains in productivity by the way as conventionally measured according to Byrnjolfsson and McAfree tend to be understated. Rising productivity will drive profits and the share of profits will remain high vs. that of labor.

Implications for Investors
There’s a war ahead of us and it’s not clear what the outcome is. On the one side we have corporations who are creating and using ever more productive technology and capital on a global basis. That includes just about all major corporations which are global and massive users of computer/IT (even if they don’t all invent technology themselves.) All of this means greater productivity and profits. I can’t imagine a more bullish scenario. Investors and those well-educated knowledge workers who work for these companies will be handsomely rewarded.

But will they be able to keep those rewards? Or will the losers confiscate the earnings of the winners via the democratic political process? This complicates an already complicated political situation. We already have bankrupt Western governments with massive unfunded entitlement obligations and overpaid and overstaffed bureaucracies. John Williams, of the respected Shadow Government Statistics newsletter, estimates that if the US reported on a GAAP accrual basis like the corporate sector does, it would have reported a deficit of some $6.6 trillion in fiscal 2012 instead of the reported $ 1.1 trillion. Other commentators like former Reagan OMB Director David Stockman come to similar scary conclusions. If you add to this a growth scenario in which skilled and educated beats unskilled, winners take all and capital beats labor, you have a situation where a good part of the electorate have come or will come to realize they are the losers. Angry electorates don’t usually blame abstract concepts like technology—they prefer to blame greedy “overpaid” corporate executives (but not overpaid movie stars). No matter. The electorates are now demanding that the “rich” and the corporations fund the bankrupt governments and transfer income to them.

The situation is particularly sensitive in the US. The key to being a “winner” in this accelerating technology environment is the right kind of education. But the statistics show unacceptable academic performance by the African American and to some extent Hispanic communities along with underperformance by a significant part of the white community. Children of affluent two parent families go to school, become computer and math literate, develop their English skills, participate in a variety of after school activities, maybe study Mandarin and then go on to college. This may sound harsh. But by contrast, so many children of lower income single parents are lucky if they can just read and write and stay out of jail. They are ill prepared for college or remunerative employment in this high tech new world. America needs to address this problem.

Déjà vu -- 1937 All Over Again?

Cries of moral outrage are now being heard on the European side of the Atlantic against corporations who legally manage to avoid paying taxes. So-called conservative UK Prime Minister David Cameron is leading this crusade. This is part of the war mentioned above. Bankrupt governments go where the money is and following the law is apparently now an immoral act. Where David Cameron goes Barrack Obama is sure to follow.

Believe it or not, we’ve seen this play before. Attacking perfectly legal tax avoidance was a pet pastime of US Depression President Franklin D Roosevelt. (Although he was not above tax avoidance himself!) I quote the following:

“In the spring of 1937, President Franklin D. Roosevelt launched a public campaign against tax avoidance. It was not his first. After taking office, the president raised the issue repeatedly. Indeed, the revenue acts of both 1935 and 1936 -- the crown jewels of New Deal tax reform -- had both been privately conceived and publicly defended as anti-avoidance measures. But in 1937, Roosevelt decided to take a more direct approach.

During his first term, Roosevelt generally used tax avoidance as a justification for tax innovation. In 1935, for instance, he proposed a new federal inheritance tax to backstop the existing estate levy. In 1936 he argued that a new tax on undistributed corporate profits would bolster the personal income tax, forcing companies to disgorge profits they had previously sheltered from steep individual rates by retaining earnings in corporate coffers.

By contrast, the 1937 anti-avoidance campaign was not designed to build the case for any sort of new levy. Rather, it was a simple and direct attack on popular avoidance techniques, and on the taxpayers who used them.”

-From Who You Callin' a Tax Cheat?, by Joseph J Thorndike, www.taxhistory.org

As I mentioned in a prior note, FDR in 1937 partly due to his increases in taxes and his anti-business policies, managed to plunge the US back into the Depression from which it was emerging. The only policy difference between 1937 and 2013 is today’s expansive Fed.

I would ask one question. Which entities are the better users of capital? Corporations which are the major instruments for technology which will change the world for the better? Or bankrupt governments seeking both to honor entitlements they never should have promised and to pay overpaid government workers?

You are right. I loaded the question to get the answer I wanted. But tell me why the bankrupt governments are better users of capital than market driven corporations.