PEN-L message, Re: [Pen-l] The fundamental crisis response. was Ecologicalcre

On Oct 31, 2008, at 5:09 PM, David B. Shemano wrote:

Michael Perelman writes:

Making labor more expensive can spur technological innovation, which can
potentially make things better for both classes. The consequences of
making labor cheap are less uncertain: cheap labor means less
innovation, less productivity, and, in the long run, fewer potential
profits.

Of course, making labor too expensive can make a market economy unable
to function. I don't know example where that has happened, although this
outcome is often claimed. claim is common.

I think I am asking a different question. I am not asking whether increasing labor expense will increase unemployment, affect growth, or any macro question, What I want to know is the allocation of enterpise wealth between labor and the owner with respect to the enterprises that continue to operate after the change in labor costs. My intuition is that there is, let's call it, a "natural rate of profit" below which owners/entrepeneurs say it is not worth it and they close up shop to retire, become consultants or government employees. Therefore, assuming that enterprises continue to exist after the labor cost shock, my intuition is that those that survive after the initial shock will ultimately have profit margins that provide a return to the owners that is consistent with the "natural rate of profit" that existed before the shock. I want to know whether my intuition is right and whether any notion of permanently decreasing the share of enterrpise wealth that goes to the !
owners is a fool's errand.

David Shemano

Shemano thinks of an economy with an owner deciding between running a business and working at the Post Office. That is not the US economy, and thus his frame could us off in the wrong direction. I'm not going there tonight.

There will be large changes in the economy as industries with relatively small shares of labor costs do better than those where labor is a large share. It has been remarked already on this list that labor is not a large share of manufacturing cost. Day care centers, where labor is a significant cost will be hit harder. With extra time off for parents, furthermore, the demand for day care could drop, so that service might suffer doubly. We can say that the economy will change. We can say that the economy will drastically change.

But Shemano asks the wrong question. The biggest impact on owners of shares will be not from a one time drop in profits but from facing an economy growing more slowly -- never mind not at all. We know that the value of a share depends on the estimate of the rate of growth of profits along with the level of profits. A simplified statement of the cost of capital is:

k = F(D1, P0) + g where k is the cost of capital, D1 is the Dividend expected in period one and P0 is the current price of a share. g is the growth rate of dividends expected by investors. We see in the equation that the cost of capital, k, depends in part on the rate of growth, g. It is geneally accepted in finance theory that k is an increasing function of the rate of growth. (Sabri, where are you when I need you?) Conversely, the lower g is, the lower the cost of capital, so David Shemano's investor may continue to invest, though dreams of compounding beyond Midas' hopes diminish. It will take a decade or two to see how things evolve.

All that having been said, I do think a relentless reduction in working time, year after year, is a sine qua non for the survival of full employment in a most sub-prime world. More importantly, that same relentless reduction in working time is the only real hope for dealing with global warming. Carbon tax, Cap & Evade, technological miracles are all chimeras.

Re: [Pen-l] The fundamental crisis response. was Ecologicalcreditcrunch