Personal Finance for Inflationary Times - Chapter 5: Labor Income and Markets

Chapter 5: Labor Income and Markets

Labor in the first stage of inflation

When prices are relatively stable, it is possible to save money without having to worry about inflation. People save and invest in the tools of their trade, in savings accounts, and even long-term government bonds. But as inflation picks up, prices begin to rise. It becomes more difficult to make ends meet. Couples fight over money problems—divorce rates go up. Some people moonlight. Others have their spouse find a job (maybe even their children). Still others try to cut corners by working in the underground economy and evading taxes. Everyone watches their spending through comparative shopping. Gambling, lotteries, and speculation become more popular. Many employees get angry with their employers for not paying them more. Forced labor unions (unions sanctioned with government force) gain in popularity. Envy is preached by politicians and clergy alike. Ultimately, governments are called upon to “do something.” Minimum wage legislation is passed, unemployment compensation laws are promulgated, a social security and disability system is established, government grants are made readily available, disaster relief is dispersed, and taxes on the rich are raised. The stage is set for the second stage of inflation.

Labor in the second stage of inflation

Because inflation is a gradual phenomenon (at first), those who spend newly created money first benefit the most. Those who are farther down the line receive cheaper money. Governments obviously get the first crack at spending the money they print, so they get the highest possible value for their money; therefore, the question becomes, “What is government spending its newly created money on?” Is it military equipment, medical benefits for the elderly, or education, for example? Thus, during the early stages of inflation, the ind ustry in which you work begins to take on new significance. Is it a government-favored ind ustry, and how long will it stay that way? In time, more government spending means more government jobs and jobs in industries that benefit from government spending. Consider the signing-bonuses paid by the U.S. military in 2007!

As inflation gradually accelerates, commodity prices tend to rise, calling out more production. At this point, the natural resources ind ustry tends to grow. More jobs become available and wages rise as industry tries to meet the new demand. To the extent that commodity prices rise faster than their cost of production, profits rise, encouraging new capital investment and yet higher productivity. Unfortunately, many capital intensive industries, such as oil and mining, take a long time for new capacity to be realized. In the meantime, prices continue to rise.

Of course, as commodity prices rise, consumers begin to notice higher prices at the gas pump, in the grocery store, and at Wal-Mart (some people even scale down their spending habits!). Others begin to hoard goods in anticipation of ever higher prices. Governments also notice the higher prices and print even more money to buy the goods they want. Budgets increase. Taxes go up. Net incomes go down. Standards of living decline. An inflationary spiral begins. It’s a vicious cycle.

Labor markets during the third stage of inflation

According to the BBC, in July, 2007, Zimbabwe was experiencing hyper-inflation (with an annual rate of inflation at 5,000%). Some of the symptoms included widespread joblessness (80%), an exodus of millions of people (half the population, of which 70% are professionals), empty store shelves, skyrocketing and accelerating price increases, dependence on foreign relatives for money to buy food and shelter. People spend their paper money as quickly as possible to avoid losing the value that they lose if they hold their paper money. Hoarding is common. Stampedes occur when shops obtain essentials. Barter is common with shortages in all commodities. Black markets abound. Everybody moonlights. Limits on foreign currency movement and other imports have been imposed. Price and labor controls have also been instituted. Arrests are on the rise for pricing goods at levels the government defines as profiteering. Nationalization of foreign-owned business is on the horizon. And according to Robert Mugabe, president of Zimbabwe , more money will be printed if the government needs it. He also claims that all Zimbabwe ’s problems arise from sabotage by the West. Click here for the complete story.

Is it any wonder that the unemployment rate is 80% and that millions of people are leaving the country? It is virtually impossible to purchase anything or to survive without breaking some sort of law. Just buying food is a struggle. What kinds of jobs are there, other than government jobs (which don’t produce anything)? And how long can they last when the local currency is becoming worth less daily? At some point, the currency will become worthless, and then, even the soldiers won’t want the money. Obviously, this is an extreme example because Zimbabwe has hyper-inflation. Most places don’t have hyper-inflation, but still, you can see what the third stage of inflation is like.

Competition in today’s world

In today’s world, there is an additional factor to consider. China, India, and much of the rest of the Far East and Eastern Europe are encouraging more capitalistic methods. At the same time, they have added billions of highly competitive and hungry people to the world labor markets. Consequently, world labor prices have become much more competitive, depressing labor wages in higher wage countries, where the lower wages counteract some inflationary tendencies. (Not something people in the United States , for example, want to hear.)

Larger firms move to cheaper labor markets

Larger firms often invest their capital in production facilities in lower labor-cost countries, thus raising the productivity and wages in those countries. To see the effects of this move in China, click here. Individuals and smaller firms tend to invest more capital at home in the tools of their trade and education. Ultimately, if capital is free to move, it becomes a race to see who can/will invest the most capital in a particular job/industry/country, thus raising wage rates in that job/industry/country. Unfortunately, not all countries realize the correlation between capital invested and productivity. The countries that ignore or deny this correlation continue to raise taxes, increase bureaucratic red tape, promote welfare and other social programs, and fight costly wars, thus consuming the capital that would otherwise make its citizens more productive. (Many of the same countries that deny this correlation, also deny their responsibility for creating inflation with their printing presses and credit policies.) In the long run, the countries that ignore or deny this correlation will become poorer until they change their ways.

Cheap labor moves to higher wage markets

At the same time, there is a tendency for labor to migrate to higher wage-paying areas (see China and/or the Mexican migration to the U.S. ). Most people want to improve their lots in life, and they believe that this can only be done by working, increasing their labor income, saving and investing. Consequently, people seek out friendly labor markets; i.e. places where they can earn more and save more money than in their native lands. Because of this migration, there is a tendency for labor rates, capital investment, interest rates, and standards of living to equalize world-wide in the long run. To the extent that countries try to avoid this result by government edict (including the use of inflation and immigration laws), there will be maladjustments, misinvestment, shortages, and a misallocation of labor and other resources in the short run. On the other hand, countries with a stable currency and friendly labor and immigration laws will benefit from the inflow of motivated, hard-working individuals looking to better their circumstances.

New consumers

In the short run, the Far East is adding new consumers as standards of living rise, thus developing a middle class that demands ever more commodities and consumer goods. What’s more is that they aren’t afraid to work for those goods, and save a large percentage of their incomes to get what they want. This added demand, in turn, is pushing all prices higher. See the following article. In countries where there are higher rates of inflation (cheaper purchasing power), goods will become more expensive to purchase and standards of living will decline.

How to survive in the short run

In the short run, you can resort to theft, voting in politicians who will take more money from others (as long as there is still money to be taken), vote in a labor union that forces wage increases on your employer (or strikes), sue someone, collect unemployment compensation or social security, obtain a government grant,oryou can prepare for the long run…

How to compete in the long run

Labor is subject to the laws of supply and demand, just like everything else. At different times and in different places, there is more demand for some skills/talents than there is for others. At one time in the United States , there was tremendous demand for railroad workers. Today, there is more demand for computer technicians. Things change. And with these changes comes progress. People must adjust to these changes and learn the skills that are currently in demand in their area or move somewhere else. The more flexible one is, the better.

Regardless of whether you are willing to learn what is in vogue, or move someplace where your skills are appreciated, there are two ways to compete in the long run: 1. lower the price of your labor and work longer hours (no one wants to know more about this choice), or 2. increase the productivity of your labor. Productivity can be increased through a combination of more knowledge/skills, and more capital invested in your job/work.

Cheap labor vs. capital

I’m reminded of something that occurred during the summer of 1990. I had a college student from Peru working for me for the summer. At that time, the city was digging up the water and sewer lines in the streets, replacing the old lines with newer, more reliable ones. City engineers inspected each property that was hooked up to the main water and sewer lines, and recommended that some of the property owners dig up their lines and replace them while the main lines were still easily accessible. It would cost them less to replace the old worn-out lines and hook up the new lines at that time than it would to dig up the water and sewer lines a second time later. So most of the people who were “advised” to replace their lines went ahead and did so.

Our business building occupied one of the property lots that the engineers marked for re-installation. I delegated the task to my Peruvian employee, and handed him a pick and a shovel to dig up the old water and sewage lines (the total cost for these tools was around $30). I asked him to dig up the lines from the street to the building. At that time I was paying him $5 an hour for his labor. After two days, I realized that this task could easily take him all summer and turn cheap labor into expensive labor. So instead of keeping him on the job, I found a fellow who owned a backhoe. Now the backhoe cost around $45,000 to purchase (not to mention the thousands of dollars spent on development or the training that went into learning how to operate it properly)—that's a piece of capital! The more capital invested (the $45,000 backhoe vs. the $30 pick and shovel) in the job, the more productive a person can be. I had the backhoe operator come and use his backhoe to dig up the water line; he accomplished this task in an hour and a half. He charged me $125, a fraction of what it would have cost to pay my Peruvian employee to dig up the lines all summer at $5 an hour, and it took him a fraction of the time. This was only possible because the backhoe operator had more capital (and skill) invested in the job.

Given enough time and training, I’m sure my Peruvian college student could have learned how to operate the backhoe just as skillfully as the fellow I hired. I’m equally sure my student would not have been willing to dig the ditch for $125 with a shovel and pick. Most people prefer to improve their productivity by learning more, rather than lowering their wages and working longer hours (when given the choice) to remain competitive. When there is no choice, most people will do whatever is necessary to pay their bills and eat.

So the key to increased labor income is increased productivity through an increased investment of capital in one’s job/profession. Unfortunately, during inflationary times, (as we saw in Chapter 2) capital tends to go elsewhere, where it is safe from a loss of value. This means that it leaves places with high taxes, large lawsuits, and government corruption. But then, inflation, itself, is caused by government malfeasance. Do you live in such a place during these inflationary times?

Inflation’s impact on labor in the United States today

As a result of the sub-prime debacle and the tightening of credit markets, the Fed is frightened that the United States will slip into a depression like the one it suffered in the 1930s. To avoid this, the Fed will print more money, and lower interest rates in the hopes that more people will borrow more money and stimulate the economy. The federal government is even cooperating by paying a tax rebate in 2008 to help stimulate the economy. Unfortunately, the Fed’s printing policies and interest rate manipulation will make each U.S. dollar worth less, raising goods prices, thus lowering everyone’s purchasing power and standards of living. As goods prices rise, more money is spent on goods leaving less money for labor. See graph. Unemployment will rise. Moonlighting will rise. Hoarding will begin in earnest. Shortages will occur. Standards of living will decline. This will make it clear that the United States is in the second stage of inflation (with the rest of the world following closely behind).