Tag Archives: capital

Effect of Interest Rates on Economic Returns to Labor v. Capital

A friend recently sent me a video titled “Wealth Inequality in America“, asking for my take on the matter. Unable to quickly demonstrate the Austrian view, I responded briefly and included links to several extant posts here.

Normally, I would walk someone through conceptual scenarios with different mixtures of labor and capital spend while varying interest rates to show how relatively lower rates “make early stage production activities more profitable” (Mises Daily, 4/21/2007). Instead, with Excel 2013 and the St. Louis Federal Reserve Economic Data (FRED) repository, I went looking for a few data series that showed my view of the relationship between interest rates and factors of production.

Using Wages + Salaries as a stand-in for economic returns to labor and Corporate Profits (after taxes) as a proxy for returns to non-labor (ie capital), I created the chart below.

In response to growing wealth inequality, I contend that two decades of relatively low interest rates are largely responsible for the increase in economic returns to capital versus labor. Because the vast majority do not hold claims against returns to capital, wealth inequality will grow until real time preferences are expressed in financial markets.

Effective Fed Funds Rate v. Ratio of Corporate Profits to Wages+Salaries
(1960 – 2012)

Interest Rates and Returns to Labor v Capital

Graph Summary: When the orange line is increasing, gains accruing to capital (in the form of corporate profits) are increasing faster than gains accruing to labor (in the form of wages and salaries). When interest rates (blue) fall, more economic gains accrue to capital than to labor.

The unfortunate irony is that while failing to achieve the case for interest rate manipulation (increased employment), it also transfers a greater proportion of economic returns to capital owners.

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Information Technology Spending, Interest and Unemployment

Over all, people will spend $3.6 trillion on information technology in 2012, the research firm said. This represents a 3 percent increase from 2011, when $3.5 trillion was spent…The increase, while modest, is notable because it is happening in the face of a financial crisis in Europe, slow growth in the United States, and a slowdown in China’s economic growth. – NYT Blog [emphasis added]

To the extent that interest rates are set below the natural interest rate, unemployment will increase as lower rates favor capital investment projects that directly replace labor. Information technology is THE modern form of capital. Like a building with a lifespan of 50 years, an IT project can produce systems/algorithms that will continue functioning (at high speed) for decades.

In theory, there is nothing wrong with capital replacing labor. The Austrian view is that technological advances (in early stages) increase interest rates as firms compete for capital to participate, allocating gains to savers (providers of capital). However, the our economy does not work this way.

An artificially low rate of interest, which might prevail for some time if the Federal Reserve is targeting a low federal funds rate, translates into the business world as longer planning horizons than are justified by people’s actual willingness to save. The policy-induced mismatch between production and consumption activities creates the illusion of prosperity but sets the stage for an eventual market correction, which takes the form of an economy-wide downturn. – Mises.org

Regardless of whether rates are below an unknowable natural rate; gains from these technology projects are not accruing to average, individual savers. Instead, three primary groups are capturing the gains given the current environment (where the Fed has used tools (QE, Twist) beyond simply targeting a low Fed funds rate to satisfy the Taylor rule):

  1. Highly consolidated firms with the scale to profit from high-technology projects and the ability to fund them (via access to cheap credit/equity markets)
  2. Large financial firms participating in quantitative easing and profiting on excess reserves held with the Federal Reserve
  3. Workers (labor) skilled in creating technological capital

The Phillips curve and other similar analyses are insufficient because they focus on the relationship between unemployment and wage inflation instead of the underlying monetary cause that directly effects capital costs and indirectly effects labor costs.

My contention is that an extended duration of below-natural interest rates has resulted in a rate of technological change and adoption that is a major factor in the high structural unemployment visible in the labor force participation rate and the mean duration of unemployment.

Bill Gross, manager of the world’s largest mutual fund, said U.S. unemployment is now a structural, and not cyclical, problem stemming from technology advances and the lack of retraining.

Rather than reducing unemployment, monetary stimulus leads to further substitution of capital for labor while allowing politicians to capture votes from those closest to the ‘spigot’.

Sources and Additional Reading

CNBC: More Jobs Predicted for Machines, Not People (Oct 24, 2011)
NYT Blog: Information Technology Spending to Hit $3.6 Trillion in 2012, Report Says (Jul 9, 2012)
Mises.org: Natural and Neutral Rates of Interest in Theory and Policy Formulation
Wikipedia: Phillips curve, Public choice theory, Rent-seeking, Quantitative Easing, Operation Twist
St. Louis Fed: Excess Reserves of Depository Institutions, Effective Federal Funds Rate, Labor Force Participation, Mean Duration of Unemployment, Unit Labor Cost
Econlib: Phillips Curve

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Is America, a Cowardly Nation?

Through a fundamental discomfort with certain kinds of inequality within our society, we created the economic realities that made international labor arbitrage a necessary factor of production of many if not most goods enjoyed in American households. Illegal immigrants are simply another component of this labor arbitrage; filling the void for local, low-cost labor – often in industries where government intervention has created the need for it. (They work on our subsidized farms, and beside unionized labor in construction, etc.)

There are transaction, transportation, and other costs associated with this worldsourcing, which increases the overall price level. The terrible irony is that it is now virtually impossible to be truly poor, and live in America. Take this excerpt from the Wikipedia article

Poverty in the United States:

A typical American categorized as poor has good condition housing. Most have at least two rooms per person and more space than middle-class people in Paris, London, Vienna, Athens, and other cities throughout Europe. Over three quarters have a car and a third of poor Americans have two cars. Poor Americans have air conditioning, a refrigerator, a stove, a clothes washer and dryer, and a microwave oven, two color televisions, cable or satellite TV reception, a VCR or DVD player, and a stereo. Most poor Americans report zero financial or material problems.

Two categories of people would otherwise be employed locally with this arbitraged labor: those with fewer gifts/abilities, and those born to a low station. However, we are uncomfortable with members of these sets living among us (although Democrats sometimes assert that Republicans, without access to education and living in lower cost areas of the country compose most of the first category). The concept that through public education we pay enough to eliminate or reduce the probability of inequality brought about by birth to a low station holds enough weight to support the endurance of that institution. The reality is that many people know it doesn’t, but while still trapped by that hope, instead argue for greater funding and perhaps changing the rules. Again, the affect is an increase in labor cost, outsourcing, and the general price level.

We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness. – Declaration of Independence

A friend recently posted this humorous article from NY Magazine, What the Hotness of Your Waitress Says About the Economy. In summary, attractiveness has elastic demand, and duration a recession, those possessing attractive qualities must meet other demands, such as waiting tables. But there is another economic metric, ‘What the Whiteness of Your Fast Food Worker Says About the Economy’. Based on my observations, white people who formerly might have had other job prospects have settled for lower wages working at jobs formerly filled by immigrant workers. Perhaps some of you have had similar observations?

I suggest that America is a cowardly nation because we lack the courage to both accept and endure the unpleasant truths about society, ability, station, and equality. The most explicit form of this cowardice exists in minimum wage laws, which are simply (legal) labor price floors – through these we increase the market for illegal workers, while tacitly acknowledging the high level of general prices. The irony here is that the largest employers often have greater access to capital, and are able to replace higher cost labor with capital. As an example, consider grocery store checkouts – as many as four self-service checkout stations are now monitored by one employee where the previous standard was one or two employees per register (one to work the register, and one to bag groceries).

Finally, I’d like to be clear to avoid potential offense or misdirection. I’m not contending that education is irrelevant, that immigration is bad, or that people can and should improve themselves unaided. The material implication I’m making is that the prevailing theology has been insufficient to accept a broad enough understanding of God’s sovereignty that would allow us to accept certain inequalities and simultaneously work to change them.

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