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Stagflation: The Epic Battle Between Labor and Capital   (January 10, 2008)


Now that 25 years of high growth and benign inflation appears to be ending, the term stagflation--stagnant economic growth coupled with stubborn inflation--is once again in the news.

For a novel and perceptive interpretation of stagflation, we turn to frequent contributor Albert T.:

What is stagflation really? High inflation and low growth is what we hear but why? The truth is stagflation is the battle between labor and capital for the share of the economic pie--wage share of income as we call it in one of my classes. (emphasis added--CHS) This story is the trend in my view:
Italians Dressed in Sunday Best Forced to Dine in Soup Kitchens

Dressed in his best Sunday suit, Fausto Cepponi took his wife and seven-year-old son out for dinner -- at a soup kitchen.

``I never thought I would be in this position,'' said Cepponi, 45, a security guard, dining in an 800-seat charity cafeteria near Rome's main train station. ``I have a job, I had a car, but everything has become so expensive and what I earn just isn't enough. I panic every third week of the month.''

With salaries on hold, prices for staples such as pasta and bread rising and mortgages soaring, efforts to keep up appearances -- ``fare la bella figura'' in Italian -- can no longer disguise that thousands of job-holding Italians are failing to make ends meet. They've been labeled ``The New Poor,'' the title of a book published this year.
The problem with inflation is that repricing of contracts (labor contract being one of them) is problematic unless you have leverage. Hence the writers strike and stagehands strikes (both have tremendous leverage).

Inflation is in essense a gambit of attacking your costs by raising prices, assuming your own costs will rise but fall short of the net benefit between the two increases. Unfortunately for capital in this battle my guess is the writers will win out in the end. However that doesn't mean that labor won't lose out to capital in other areas.

I personally think the coming bankruptcy of small cities and towns will make them merge and eliminate work force, ergo "civil servants" and those people will rejoin the world of the living.

You think large corporations got great tax breaks before for shifting new businesses to one state or another, just wait. We will see deals of the century; I am sure offers of 99 years without taxation perhaps even decades of subsidy and tax free bonds financing. Ergo capital for capital that is intensive will become very very low cost but labor will be driven into a state of frenzy so high that it will force politicians to compete to placate it's plight.

Imagine having a tough time buying food like the people in the story above and I am sure any wage where you can buy food will look good. That is what we call subsistance wage in one of my classes. Subsistance wage is where you cover your necessities but have no money at all for savings--just like the U.S. wage earner on average--many Americans now live paycheck to paycheck.

Although some of us are thriftier and do choose to save, that choice will soon be gone for the majority. The wonderful point about subsistance wage is that is where the capital return is highest for capital.

It might seem odd that everything is falling around us but if we think about it the world is making perfect sense. Assets are repricing because they are being sold off by those whom aren't capital holders. People who are laid off by the job cuts in banks etc will probably sell off any 401k they managed to bulk up to pay for the mortgage or daily expenses until they get a job. I would be very reluctant to go to a lower paying job until all my savings were gone too, or if I didn't live with my parents. Prices take a long time to adjust.

Italy truck strike ends -- for now

The short end of the story is basically truckers in Italy stoped all traffic for about 3 days + with food shortages and store shelves going empty along with gas pumps, etc... To get higher wages ofcourse because their income hasn't kept pace with inflation.

Germany: Train Drivers Strike Again

German train drivers brought local rail services across the country to a standstill to press their demand for higher wages. The railway has refused to meet the union’s demands for a wage increase of as much as 31 percent.
Train strike brings Germany to standstill

French rail authority says labor unions announce plan for 36-hour strike next week

(French and German unions have struck before and continued to strike until their wages were bumped up or some other economic benefit is provided to keep pace with inflation.)
Thank you, Albert, for a very insightful and deeply provocative interpretation. Now I get to add my three cents. (It used to be two cents but costs have risen.)

Albert makes some key macro points. The first is what he calls labor leverage. Albert's example is the current Hollywood writers strike. The writers have leverage because the production companies are bound by contract to hire union writers. Legally, they cannot just go hire new screenwriters from Bollywood for a hundred bucks a movie/TV show. There is also a fraternal system in Hollywood which does not lend itself to outsourcing of creative material.

In other words, the writers have leverage. Eventually the media companies run out of new content and their advertisers go away. Corporate income drops, the stockholders scream, the head honchos' heads roll, and new management cuts a deal to restore profitability. If labor has a stranglehold on corporate revenue/profits, they can actually win. That's leverage. If not, they lose.

(NOTE: I think you can guess where my sympathies lie in this dispute. Recording artists receive income for decades from their original material, yet writers are supposed to give up their electronic (future) rights for nothing? Gee, I wonder why the media corporations are fighting so desperately for 100% of future electronic profits.)

The opposite of leverage is wage arbitrage. This is the term for moving factories and call centers to places with lower labor costs. Thus the factory moves from the U.S. to China, from Dusseldorf to Bulgaria, from Italy to Sri Lanka, and so on--in an endless chain which eventually leads--and has already led in some cases--to factories in "high cost" China being moved to "low cost" Vietnam.

How many jobs in the U.S. are vulnerable to wage arbitrage? A lot. Manufacturing jobs in the U.S. total about 14 million now, while China has about 110 million factory jobs. In one sense, this makes China far more vulnerable to wage arbitrage than the U.S. All the U.S. manufacturing jobs which could be shifted to cut costs have already been moved; those 14 million manufacturing jobs still here are here for a reason.

Like what? Like the materials are too heavy and the labor costs too small a percentage of the final cost to make offshoring the plant worthwhile. Examples include glass (heavy and brittle, often requires high-tech coatings better done here by robots), lumber products and various pharmaceuticals. (Pirating in China has destroyed many brands and pharmaceutical products' markets, so why bother even making stuff there?)

Meanwhile, we have friends whose family business manufactures specialty steel products. They have already moved their factory from China to Vietnam, and they are not alone. There are plenty of stories about wages rising in China to the point that wage abritrage is now a factor in China's growth as well.

Albert makes repeated mention of labor union strikes in Europe--especially those in transport. Municipal labor unions have plenty of leverage over public transport and services, as we all know. Subway/train and garbage strikes are usually quickly resolved in the unions' favor.

But as Albert points out, what happens on a macro level when cities and public agencies go bankrupt? As readers know, I have been forecasting just such a tidal wave of public bankruptcies for several years.

The problem for public unions is they don't control or even influence the revenue side of public agencies' ledgers. The basic model for the past 25 years of union contracts has been this: when unions strike, the easiest way to lower the pain (public outcry at the disruptions, etc.) for agency managers has been to cave in and agree to higher wages/benefits. Then the agency raises ticket prices or taxes. The public has grumbled but never revolted.

That will change once people find they can't afford food by the third week of the month. Their sympathy for well-paid transit and public union workers will vanish, and they may, for the first time, refuse to pay the higher ticket prices or higher property taxes.

If politicians start losing elections for trying to raise taxes, then agency heads will also roll. Bottom line: it's the politicians who control the revenue stream, and the public has the ultimate leverage on them.

If we wander back down memory lane, we can recall that President Reagan was faced by what appeared to be a union with tremendous leverage: the air traffic controllers. Now the air traffic control system is in dire need of a complete (and costly) overhaul, and I am not knowledgeable enough to say whether the union being busted was a good thing for the nation or not.

My point is simply this: public officials can stand up to public unions when pushed beyond a certain point--and when the public supports the officials. Europe and the U.S. have a different mix of public and private labor. About 40% of the French workforce is public or semi-public employees. That's a high enough percentage that they can practically control elections and vote in tax increases as a policy of self-interest.

But at some point, the private corporations and businesses who are paying the high taxes may rebel, and either close down (in the case of cafes and small businesses) or leave for more hospitable climes--wage and tax arbitrage, another issue Albert raised so preciently.

If public revenue (taxes) cannot keep pace with public union demands, then something will have to give. I would anticipate a situation in which transit/rail workers go on strike, demanding higher wages. This is a strategy which has worked exceedingly well for 60 years (since 1945). But alas, they will be told by bankrupt public authorities there simply is no more money. The unions will have a difficult time grasping this strangulation of the public revenue stream. But can't you raise taxes on someone, somewhere? No; all the productive businesses have left, exploiting global wage and tax arbitrage.

Many observers in California have noted the flow of jobs from California to other states--that is, wage and tax arbitrage within the U.S. Businesses and jobs leave California for lower-cost states. At an even finer-grained level, businesses leave high-cost San Francisco for lower cost suburbs. Like water flowing to the lowest level, businesses flow to the areas with the lowest wages and taxes. In many cases, they really have no choice; their competitors are already reaping the benefits of lower wages and taxes, and they can cut prices and increase profits as a result.

So the question for each of us becomes: how much leverage do we really have?

Readers Journal has been updated! An important new essay and many excellent comments on Can a Fragmented Culture Find Common Ground? and inflation/deflation.

Readers commentaries

Thoughts on a Common Culture (Chuck D.)


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