THE BEAR'S
LAIR Fast-food theory
undercooked By Martin
Hutchinson
Bloomberg Businessweek of May
29 had a fascinating article propounding a "Big
Mac" labor value theory, and using it to suggest
that all restrictions to international migration
were economically damaging.
I have
disagreed strongly with that conclusion from time
to time in this column beginning in 2004, but yet
found the basic data evidence compelling. I thus
thought it worth deconstructing the article's
logic to see where its reasoning was in error and
what economically sound conclusions could be drawn
from the data presented.
The earnings
evidence is clear. In the United States, an
employee of McDonald's earns an average of US$7.22
per hour, compared with a Big Mac cost of $3.04;
thus the employee earns 2.38 Big Macs per hour. In
India, the average employee earns 46 cents per
hour while the Big Mac
costs $1.29, so the employee earns 0.36 Big Macs
per hour. According to Bloomberg Businessweek,
both employees do the same work; thus the US
employee earns 6.6 times as much as the Indian
employee, simply for living in the United States.
The article then goes on to recount the
fate of employees of one of the big Indian
software companies, who earn far more when
transferred to the United States than they do in
India, and are then back on Indian pay scales when
they return to India. The article draws from these
examples the highly questionable conclusion that
world welfare would be maximized if all
immigration barriers were removed, so that Indian
McDonald's employees and software engineers could
flood to the United States and earn the juicy
remunerations available in the Land of
Opportunity.
It requires a little
deconstruction to determine why this conclusion is
rubbish. Is the differential between Indian and US
McDonald's employees purely a matter of location,
and would Indians be able to pick up the higher US
living standards by mass migration to the US?
One factor glaringly left out of the
Bloomberg Businessweek calculation is that of
productivity. Its glib assumption that the job of
McDonald's employees in India and the United
States is identical is almost certainly wrong. For
one thing, a Big Mac occupies a different market
position in the relatively impoverished India to
that in the United States.
Even when I
lived in Zagreb, Croatia, a country considerably
richer than India, McDonald's had a very different
social position from that in the US. Being
American, McDonald's was where the relatively
affluent young Zagrebacki hung out on a Friday
evening. For families, being taken to McDonald's
was more of a treat than in the US, and children's
birthday parties were held at McDonald's even by
the affluent and sophisticated.
The
"product", defined to include the ancillary
services and overall experience, was different
too. You were much more likely in Zagreb to have
the food brought to your table when it was ready,
and the outlet was spotlessly clean, far more so
than most McDonald's in the United States.
For the less affluent in Zagreb, there was
an alternative to McDonald's in the cevapi houses,
which served the local delicacy of meat on a
skewer, accompanied by a little salad in a pita
bread half. Those outlets were "faster" than
McDonald's - and more crowded, with rushed service
and tables that weren't spotless. While the cevapi
were delicious, they doubtless involved less
McDonald's-style quality control.
Given
that the product and its market position were
different in Zagreb from the United States, I'm
quite sure staffing levels and the jobs involved
were also different, as they would be in Mumbai.
For one thing, far more man-hours must have been
devoted to keeping the place clean and providing
modest service to its upscale clientele. It makes
sense; if labor costs only 0.36 product units per
hour instead of 2.38, then the optimal production
and service mix will use considerably more of it.
Thus productivity, in terms of the number
of Big Macs served per employee, will be lower in
a poor country even if the employees themselves
work equally hard. I would also guess that the
training involved for a McDonald's employee in
Mumbai is more substantial than for one in New
York, since the disciplines of hygiene and
regimentation needed to succeed are less ingrained
in the local society as a whole.
The
Indian software example is more difficult, until
you consider what function the software engineer
fulfils within the Indian company. For the
company, it is much costlier to have software
written in the United States than in India, unless
the productivity of the US workforce is much
greater than that of its Indian staff. However,
the company employs software engineers in the
United States because it needs them to be in the
same time zone as its customers, and if necessary
be able to visit them, in order to provide
marketing, customer service and support
activities.
The two jobs are not
identical, even if the engineers are the same
people, and the company would lose huge amounts of
money if it transferred all its Indian workforce
to the US since its employees' wages would be
raised by competition from local employment
opportunities.
In a theoretical economic
model, welfare might be optimized by eliminating
immigration restrictions. But that could not
happen by moving the Indian, Chinese and African
population to the United States and raising their
wages to US levels because they would not be
sufficiently more efficient in a US setting to
support the higher wages.
Instead, while
the overall global average wage might be somewhat
higher, most of the differential would be
eliminated by US wages falling to emerging market
levels. US politicians, responsible for the
welfare only of the US electorate, would be
betraying their voters if they contemplated any
such move.
In reality, any such mass
migration would incur such huge assimilation costs
that the theoretical benefits of leveling the
playing field would be largely wiped out. However,
that is not a counsel of despair. Free trade is
not the same thing as free migration; the case for
it is very much stronger. In particular, the
"globalization" caused by the Internet and modern
telecommunications has hugely increased economic
welfare for the citizens of poorer countries,
provided those countries are even moderately
competently run. (The recent economic histories of
India and China, both badly run countries by any
Western standards outside Greece, are good
examples of this.)
It is now clear however
that globalization has also depressed living
standards for the less able citizens of rich
countries, raising their unemployment rate as
wages are to a certain extent "sticky" on the
downside. That does not mean that globalization
should be rejected by Western politicians; having
been an artifact of technology rather than policy,
it would almost certainly have been impossible to
stop, and any attempt to do so would have left the
country attempting it both poorer and more
isolated than when it began.
In any case,
there is every sign that the initial effect of the
Internet revolution is approaching completion; the
rapid increase in Chinese wage rates and
disappearance of the Chinese balance of payments
surplus certainly suggests that a new equilibrium
is being reached.
To improve the living
standards of Western countries' citizens in this
new equilibrium, and reduce their debilitatingly
high unemployment, new policies are necessary.
Increasing mass immigration increases the pressure
on domestic living standards, especially at the
bottom; it should thus be avoided.
Education, so often touted as the panacea
for facing the increase in international
competition, is clearly no such thing, because it
is of mediocre quality and excessive cost. In any
case at all but the most exclusive levels it can
easily be copied overseas (as the recent Indian
successes in the software business have
demonstrated). Instead, interest rates must be
raised to levels that rebuild the capital base in
rich countries, rather than decimating it as has
been the case with the Alan Greenspan and Ben
Bernanke polices at the US Federal Reserve.
By increasing the incentives to save, and
the returns from it, policymakers can increase the
rich countries' natural advantage in capital
availability, and reduce their pension and medical
expenses by providing citizens with higher
investment returns.
The other need is for
policymakers to reduce the level of waste in the
public sector, most of which produces "output"
that is laughably overvalued in GDP statistics.
Especially in Europe, living standards, already
under threat, have been reduced further by the
exactions of oversized and unproductive public
sectors. Cutting this waste will leave more money
in citizens' pockets, and improve their living
standards thereby.
Wage differentials
between rich and poor countries are natural,
caused by differentials in those countries'
capital endowments, infrastructure and
institutional effectiveness. Their natural level
has been reduced by the Internet, and will
doubtless be reduced further by future
technological advances. But as far as possible,
responsible Western policymakers should work to
ensure that this reduction in differentials
produces only improvements in emerging markets'
living standards, without allowing it to
immiserate their own people.
Martin
Hutchinson is the author of Great
Conservatives (Academica Press, 2005) - details
can be found on the website
www.greatconservatives.com - and co-author with
Professor Kevin Dowd of Alchemists of Loss
(Wiley, 2010). Both are now available on
Amazon.com, Great Conservatives only in a
Kindle edition, Alchemists of Loss in both
Kindle and print editions.
(Republished
with permission from PrudentBear.com.
Copyright 2005-12 David W Tice &
Associates.)
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