Wages and productivity

This article is a fine read. It begins:

Much ink has been spilled over the last few weeks about the Obama and Clinton campaigns’ flagging commitment to free trade. Seeking to shore up support in the industrial Midwest, both candidates have decried trade agreements that allegedly expose American workers to cheap labor from outside our borders.

So while cheap foreign labor is conveniently fingered as the root cause of economic decline in the Midwest, an essential economic reality is being ignored. Ohio and Michigan aren’t ailing due to low overseas wages, but instead they’re suffering because cheap labor is very expensive, while expensive labor is very cheap.

Indeed, if specific locales or regions were truly weakened by high levels of pay, Silicon Valley and New York City would be ghost towns. But as evidenced by the high cost of living in both areas, salaries and wages are at nosebleed levels commensurate with those costs.

In other words: The wage rate and cost per unit of output are not synonymous. The U.S. has on average the best trained, best education, most productive workers in the world. We also have more capital per worker than lower-wage nations. All of this makes U.S. workers more productive than workers in low-wage countries.

So, in a capital-intensive industry, one might witness a worker in the U.S. earn $15 per hour and a worker in Mexico earn $4 per hour. On the surface, it would appear the U.S. could not compete. Not so. Thanks to our greater productivity, we might fair quite well. Let’s say the worker in Mexico could produce one unit of output per hour, or eight units in an eight hour day, yielding a wage cost of $32 for that day and a cost per unit of output of $4 ($32/output). The American worker, as long as he is very productive, could produce the output for less on a per unit basis. For instance, say the American worker is four times for productive than the Mexican worker, which would not be unreasonable in some capital-intensive industries. With this information, we can calculate total daily wages of $120, but the cost per unit of output would be $3.75 ($120/output), which is less than the cost per unit of output for the foreign worker.

Productivity matters! This is why more labor intensive work tends to flow to low-wage nations and more capital- intensive work flows to capital-rich, high-wage nations.

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