Page 1 of 3 PAY, PROFIT AND GROWTH, Part 3 Labor markets delinked from gold
By Henry C K Liu
This is the third article in a series. Part 1: Stagnant wages leading to overcapacity Part 2: Gold shows its true metal
The global gold market, similar to other key commodity markets, is denominated
in fiat United States dollars or derivative currencies of the dollar, while
global labor markets are denominated only in local fiat currencies.
The Law of One Price says that identical goods should sell for the same price
in different markets after adjusting for transaction costs such as
transportation costs, tariffs and taxes applied in different markets and
currency exchange rates. While the Law of
One Price applies to gold and many other key commodities such as oil, it does
not apply to the price of labor around the world.
Cross-border wage arbitrage is inversely linked to cross-border price arbitrage
in that producers seek to maximize profit by making their goods in the
lowest-wage locations and selling their goods in the highest-price markets.
This is the structural incentive behind cross-border outsourcing, which does
not seek to sell locally products produced locally at prices adjusted for
purchasing power parity (PPP) between the currencies of the two markets.
PPP is a theory of equilibrium in currency exchange rates as adjusted by
relative price levels in local currencies in two economies. When comparing the
gross domestic product (GDP) of two countries measured in one reserve currency,
such as the US dollar, the GDP differential as expressed in the reserved
currency, converted at its exchange rate to the local currency, needs to be
adjusted by the disparity in purchasing power of the local currency in its home
market.
If one exchange equivalent unit of the local currency buys four times as such
in its local market as the dollar does in the US, say yielding a purchasing
power disparity of four times, the nominal local GDP needs to be adjusted by a
factor of four to achieve purchasing power parity to reflect its true size as
compared to US GDP.
The purchasing power parity idea originated in the 16th century from concepts
rooted in the intellectual and pedagogical work of Francisco de Vitoria
(1492-1546), a French-educated Spanish Dominican theologian of Jewish converso
ancestry at the School of Salamanca in Spain, in response to critical challenge
from Protestant theologists of the Reformation to the orthodox Catholic
conception of man's relationship to God in the context of an evolving secular
world.
The juridical doctrine of the School of Salamanca put an end to medieval
concepts of law. It accomplished that Herculean task with a vindication of
personal liberty that had been suppressed in medieval theology. The Salamanca
juridical doctrine resurrected personal liberty as one of the God-endowed
natural rights of man that include right to life as a corporeal being, economic
rights as owner of property and right to freedom of thought and human dignity
as a spiritual being after the image of God.
The Salamanca juridical doctrine distinguishes the natural (or civil) realm of
power from the supernatural (or spiritual) realm of authority. This distinction
sets new limits on both the conflated medieval doctrines of the Divine Right of
Kings and of the Temporal Powers of the Pope. A direct consequence of the
separation of realms of secular power from spiritual authority is the
proposition that there are subscribed limits to the legitimate powers of civil
government and to the spiritual authority of ecclesiastical church.
From this distinction between secular power and spiritual authority spouts the
theory of ius gentium (rights of peoples). The common good of the
Christian world is then deemed categorically superior to the individual good of
each secular monarchial state in it. The extension of the theory means that
relations between sovereign states ought to be conducted within the bounds of
commonly recognized (ie Christian) values, and disputes ought to be settled not
by force or the threat of force but by international law and universal justice.
Positive law is man-made, through which a society bestows or denies specific
civil rights and privileges and provides protection to individuals or groups to
enjoy such rights and privileges or to impose penalties upon those who abuse
the rights and privileges of others. In contrast, natural law safeguards
inherent human rights and dignity, without the need for conferral by acts of
civil legislation.
The concept of ius gentium is further subdivided into ius inter gentes
(law between peoples) from ius intra gentes (law within peoples). Ius
inter gentes (which corresponds to international law) is something
common to all subscribing countries, although being positive law and not
natural law is not necessarily universally observed. On the other hand, ius
intra gentes, or civil law, is specific to each nation, and not to
others.
In his History of Economic Analysis (1954), Joseph Schumpeter traces
scholastic doctrine in general and Spanish scholastic doctrine in particular to
highlight the sophisticated level of economic thought in Spain in the 16th
century. He argues that the School of Salamanca deserves to be credited as
being among the founders of economics as a social science. Even though it did
not elaborate a complete general theory of economics, the School of Salamanca
did establish the first modern economic theories to address new secular
problems that had emerged with the evolution of the medieval spiritual
socioeconomic order toward the humanist material socio-economic order of the
Renaissance.
Francisco de Vitoria, a younger contemporary of Erasmus (1466-1536), promoted
Scholasticism, a method of investigation developed by Thomas Aquinas
(1225-1274), which places strong emphasis on disciplined dialectical reasoning
to extend knowledge and understanding by inference, and to resolve conceptual
contradictions within a comprehensive truth. Scholastic thought is also known
for its rigorous conceptual analysis and exacting precision in drawing
distinctions.
Dialectics is conducted through orderly dialogue between parties who may hold
differing views, yet wish to pursue truth by seeking agreement based on
commonly accepted fundamentals. This is in contrast to debate, in which parties
hold opposite views and wish to prevail by proving opposing views wrong as
judged by a persuaded audience. Dialectics leads to evolutionary synthesis
while debate leads to revolutionary displacement. Dialectics also contrasts
with rhetoric, which takes the form of an extensive polemic conducted by a
single party, a method of persuasion favored by Sophists.
The Law of One Price was developed in its modern form by Gustav Cassel
(1866-1945) in 1918, in a series of post-World War I memoranda for the League
of Nations on currency exchange rates and purchasing power parity. Cassel's
contribution is acknowledged by John Maynard Keynes in his Tract on Monetary
Reform (1923).
The purchasing power parity concept is a prerequisite extension of the Law of
One Price which states that before adding both hard and soft transaction costs,
identical goods will have the same price in different interconnected markets.
The best-known and most-used benchmark to calculate currency purchasing power
parity based on exchange rate is the Geary-Khamis dollar, proposed by Roy C
Geary in 1958 and developed by Salem Hana Kham between 1970-72, known generally
as the international dollar, a hypothetical unit of currency that has the same
purchasing power that the US dollar has in the United States at a given point
in time. Data expressed in international dollars cannot be converted to another
country's currency using current market exchange rates; instead they must be
converted using the country's PPP adjustment in exchange rate.
The Big Mac index
An example of one measurement of PPP is the Big Mac index popularized by The
Economist, which compares prices of a Big Mac burger in McDonald's restaurants
in different countries. The index is pragmatically useful because it is based
on a modern-day well-known product whose final price, easily tracked in many
countries, includes cost input from a wide range of sectors in the local
economy, such as capital (exchange rate, interest rate) agricultural
commodities (beef, bread, lettuce, cheese), labor (productivity, service and
managerial), advertising, transportation, rent and real estate value, and so
forth.
In July 2010, the price of a Big Mac in the United States of America was
US$3.73 and in China 13.2 yuan ($1.99 at concurrent exchange rate). The price
difference mostly reflects wage differentials between China and the US, as
other cost factors of production, such as rent and energy, have been converging
between urban centers in the two economies.
However, in many emerging economies, US fast food meals represent an expensive
niche product priced well above equivalent traditional meals. In emerging
economies, the Big Mac is not a mainstream "cheap" meal as it is in the US and
other advanced economies, but a luxury fad import enjoyed by the rising local
middle class. The price of 13.2 yuan represents a high portion of Chinese
hourly wage than $3.73 represents in the US hourly wage.
According to the 2009 China Statistical Yearbook, Chinese wages in
different fields and locations vary greatly. Rural or migrant manufacturing
average hourly wage was only $0.40 an hour at concurrent exchange rate. A Big
Mac would cost a rural or migrant manufacturing worker five hours' earning in
wages.
The middle fifth quintile of US household in 2009 had an annual income of
$34,738, which comes to $17.4 an hour based on a 50-week, five-day, 40-hour
work load. A Big Mac at $3.73 would cost an US worker 12 minutes' earning in
wages.
Chinese wages have been rising since 2008 as a result of government policy. The
US national average wage index for 2009 is 40,711.61, dropping by 1.51% from
the index for 2008.
For China, despite the global financial crisis in 2008, the pace of growth in
average wage and living standards has remained positive, albeit at a slower
rate. According to the 2009 China Statistical Yearbook, the annual
growth rate of the national average wage remained at 17.23% in 2008, similar to
its pre-crisis level. Significant growth in the average salary level in the
financial industry continued in 2008, with Beijing leading with an impressive
37.19% increase compare to 2007. The top two sectors with the highest-paying
salary and the fastest growth in China were the financial and the information
technology (IT) sectors.
In 2008, the Chinese national average annual salary for the financial industry
was $61,841 compared with $22,457 in 2003. The average salary in this category
is still increasing by 22.46% per year. The national average salary for the IT
industry was $56,642 in 2008, up from $32,244 in 2003. The average salary in
this category is increasing by 11.93% per year. Adjusted for PPP, $56,542 in
China commands the equivalent purchasing power of $226,568 in the US.
The fastest-growing sector in China is the security sector in the financial
industry. In 2008, it was $172,123, compare with $42,582 in 2003. The average
salary in this sub-category is increasing at a rate of 32.23% per year.
Adjusted for PPP, $172,123 in China commands the equivalent purchasing power of
$688,492 in the US.
Deflation in emerging economies
PPP, as an adjustment index on comparative GDP as measured in dollars, is
closely monitored by economists concerned with international macroeconomics.
PPP adjusts GDP measurements in dollars by taking into account the difference
in prices of similar goods or substitutes denominated in local currencies
between national economies, as calculated by currency exchange rates to the
dollar, generally using the dollar as a benchmark.
In other words, PPP adjustments reflect the real domestic purchasing power of a
unit of national currencies as compared with the purchasing power of its
exchange rate equivalent in dollars in the US.
What is not generally noticed is that price deflation in an emerging economy
increases the purchasing power of its currency, in that the same local currency
buys more goods after price deflation, provided that there is enough money
available to buy goods.
Thus, price deflation in the local economy drives up the PPP adjustment needed
in its GDP to achieve purchasing power parity between the local currency in the
local economy with the dollar in the US. A positive PPP adjustment between the
local currencies and the dollar enlarges the local GDP as measured in dollars
at concurrent exchange rate.
However, price deflation is generally the result of a decrease in the quantity
and/or velocity of money in the economy, causing a market condition of less
available money chasing after a given amount of goods to drive market prices
down. Yet a decrease in the supply and/or velocity of money is generally
accompanied by dampened economic activities that will lead to a rise in
unemployment and to a fall in wages.
Thus, workers in emerging economies may not benefit from price deflation even
when the local currency buys more goods to adjust nominal GDP figures upwards,
if unemployment rises and wages fall from a decrease in economic activities to
yield a lower real GDP. Under such conditions, a rise in GDP may cause a fall
in wages.
Furthermore, for a number of complex reasons, including market inefficiency,
consumer confidence, political intervention and cultural fixations, the
cross-border Law of One Price applies only to certain commodities, such as oil,
and not to many other goods with less universal characteristics and market
accessibility.
Thus for China, with a PPP adjustment of four times on its GDP as measured
against the purchasing power of the dollar in the US, meaning that a given
amount of Chinese yuan as defined by current exchange rate between the yuan and
the dollar, buys four times more in China than its dollar equivalent does in
the US.
A rise in oil world prices denominated in dollars will cost the Chinese economy
four times the equivalent in other goods not affected by the Law of One Price,
or in lost purchasing power of Chinese wages for oil than equivalent dollar
wages in the US economy.
Should the Chinese economy be hit with deflation-driven falling wages because
of a slowdown of the export sector, the PPP adjusted GDP of China may rise
while Chinese wages shrink with rising unemployment. The larger the PPP
differential between a local currency and the dollar benchmark, the more severe
is the tyranny of dollar hegemony in widening purchasing power disparity
between dollar wages in the US economy and yuan wages in the Chinese economy,
both nominally and in purchasing power for dollar denominated commodities.
PPP adjusted Chinese economy larger
than US economy by 2012
The Conference Board, a US-based global, independent business membership and
research association founded in 1916 to work in the public interest, in a
report published on November 10, 2010, projected that China could have a larger
economy in GDP terms than the US by 2012 when adjusted by purchasing-power
parity.
This trend may be accelerated if China yields to US political pressure to let
the yuan rise in exchange value against the dollar.
The Conference Board report sees the US economy slowing by almost 1.5
percentage points from 2.7% in 2010 to 1.2% in 2011 due to slower spending by
consumers, companies and state and local governments. At only 1.2%, US growth
rate would be lower than those of both Japan and Western Europe, which are
expected to grow by 1.5% in 2011. However, strong growth in emerging economies
like China and India at near double-digit will push growth in the global
economy to 4.2% in 2011.
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