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  • What is labor?

    Posted by TM Lutas on October 14th, 2011 (All posts by )

    There seems to be a lot of oppositional thinking about labor and capital. I’m not sure that this is conducive to clear thinking and wonder if putting them on a continuum would lead to more productive solutions to everybody’s problem, how to make money.

    In the cycle of producing stuff and serving customers, the later you get paid, the more the risk you won’t get paid at all. To take hindmost position, the capitalist takes the greatest risk and consequently reaps the greatest reward. Flipping over the coin, the sooner you get paid, the less you get paid because your payment is a surer thing and thus you don’t get as much in risk compensation. So the common stockholder gets the biggest rewards and is paid last, preferred stockholders get paid earlier, but their payments tend to be less, ditto bondholders.

    Labor is, by definition, made up of people who are paid in advance of sales and regardless of whether there is a profit made of the fruits of their labor. The laborer gets paid first, even more so than the bondholder or the preferred stockholder. But just like the bondholder and the preferred stockholder, getting to the head of the payment line has a price.

    Now if you’ve got no reserves, I can see the need to be paid right away. But after age 30 when you’ve got some money put away and could afford to not be paid immediately, would deferring compensation either in part or in whole make sense? In terms of the enterprise you would be reducing the capital requirements to produce and reducing the risk that the capitalist has to take. Payroll would drastically shrink and payout would be in shares as sales came in. Capitalists would have a shrunken role in the enterprise because they would only have to fund the land and the tools. In terms of worker attitude, you would be strongly aligning worker interests with increasing sales in order for their back end compensation to come through. To some extent, these workers would cease to be labor.

    Labor would become a phase you went through as a kid, if your family couldn’t stake you to a more normal working arrangement, or right after a bankruptcy, because you’d exhausted your reserves and couldn’t afford to wait for your pay anymore. It might also be something you would do if you lost faith in your company’s future but hadn’t found another position at a different company yet. It could also be used as a weapon, punishing management by demanding to be paid on the front end or the back end and driving up costs by shifting quickly from one to the other.

    Would firms accept a lower capital cost and a better incentivized work force in exchange for the risks? I suspect that some would be amenable to it but we’ve gotten so stuck in the rut that labor is paid first and hit with the penalty of not taking part in the risks of the firms that it just hasn’t been considered an option.


    18 Responses to “What is labor?”

    1. Lexington Green Says:

      “…after age 30 when you’ve got some money put away and could afford to not be paid immediately…”

      Who is this “you” whom you refer to here? Not most people in America today.

    2. David Foster Says:

      “But after age 30 when you’ve got some money put away and could afford to not be paid immediately, would deferring compensation either in part or in whole make sense?”….stock option grants in lieu of higher salaries do precisely this; unfortunately, they have become less common in the wake of the FASB ruling on the expensing of option grants. This has definitely had an impact in terms of career choices, for instance investment banking vs a startup.

    3. TM Lutas Says:

      Lexington Green – At that point of the post I’m working from the point of view of somebody coming into the system after it was already established including a “new normal” of worker behavior. Sure, there would be a transition and a lot of shifts in behavior by everybody concerned in a firm. I think that you’re looking at it from the point of view of a worker today, before the transition had been made and the new normal established. You are right that not a lot of people could make the jump immediately. Quick sales cycle items would have workers shift first, with long-cycle, big ticket items retaining the old salary structure the longest.

      David Foster – Stock option grants are not precisely what I’m looking at but rather not turning production into the firm’s undifferentiated property but instead establishing ownership shares that are paid out upon sale. Such arrangements were not practical before the information age. I think we’re starting to get the computing power necessary to get it done now.

    4. David Foster Says:

      If I understand, this would be shares that accrue increasing ownership with length of time working at the firm; ie, basically a periodic stock grant program in lieu of part of one’s salary. What is it about this that requires particularly extensive computing power?

    5. James Bennett Says:

      Are you asking the employee to take the risk of nonpayment? All that would do is make the employee pool more risk-averse. if you’re just asking the employees to finance, in effect, part of the cashflow, it’s not clear why there’s any big reason to re-arrange society to accomplish this. For a company with an established line of product, they finance this need through working capital lines of credit from banks, or similar arrangements. This is pretty cheap capital. Individual workers would in effect be financing this through their individual lines of consumer credit, in reality, which is expensive capital. (If people really had buffers of capital saved up, they’d never buy expensive consumer items on credit. If you do have the buffers saved up, you’d rather have them working in an investment than using them to finance daily cashflow.)

      As for start-ups with uncertain sales prospects, it’s quite common to use something like this model already. If you’re in a startup, you know that postponing one or more pay periods is not uncommon.

    6. Michael Kennedy Says:

      It used to be that banks were eager to loan money to new doctors starting up a practice. It would be interesting to see what has happened to that situation the past few years. Deferred compensation was considered a good risk.

    7. foxmarks Says:

      The way you frame it, the several parties bring to the table different tolerances for risk. It isn’t just the time value of money or the greater risk in delaying gratification that leads the “capitalist” to his greater share of ultimate proceeds. Willingness to put capital at risk is more scarce than desire/necessity to work for food. The capitalist end of the spectrum gets greater return for multiple causes. Some peoples’ preferences may never allow them to be very “capitalist” even when they are 30+ and secure on paper.

      That there are so many willing to work for food that labor gets a lesser return strikes some as unfair. Such people are not economic thinkers.

    8. David Foster Says:

      MK…banks lending money to docs for new practices….I’d be really curious whether this had dried up….certainly a lot of small and midsized businesses have had great difficulty obtaining funding from banks. I think the dysfunctionality of banking is creating considerable opportunity for Business Development Companies, which are nonbank entities in the business of making business loans, sometimes coupled with warrants or other equity stakes. (Disclosure: shareholder in several of these)

    9. sol Says:

      By adopting the Marxist viewpoint of land, labor, capital you chain yourself to a Marxist outcome. In the Soviet Union collectivized farms (land) used peasants (labor) and tools/seed (capital) to grow crops for the masses. Sadly these collectives failed to meet production targets because of bad weather, bad seed, bad tools, bad transportation and anti-socialist plots by international capitalists.

      However, every peasant family had a small garden where they grew stuff for their personal uses. These peasants sold this produce in local farmers markets and prevented starvation among the masses. The Russian Peasant has always done this since the invasions of the Rus.

      Workers tend to be more productive when they can sell the fruits of their labors. Thus we have arts and crafts on Ebay and self-publishing at Amazon; we have farmer’s markets, souks, bazaars and flea markets. Obamacare has caused many doctors to close private practices and sign on as salaried hospital employees. Will they work the same long hours for the hospitals that they did in private practice. Recent atudies show they will work 8 hour days and go home. Soon, we will have a serious shortage of doctors.

      Marxists see workers as people imitating mindless macines. But successful entrepreurs see workers as team members who continuously react to the ever-changing needs of the marketplace to produce a useful and needed product or service. Marxism is static; free market economies are dynamic.

      “Capitalism” is a Marxist term that cannot describe a free marke economy.

    10. Joseph Fouche Says:

      The problem with the current forms of joint-stock corporations companies in this country is:

      1. Too much focus on creating value through share price appreciation rather than creating value by increasing the payout per share through dividends. Following the shift in stock market metrics from the beginning of value investor Benjamin Graham’s career as an investor in the 1910s to his death in 1976 is telling. At the beginning of his career he could find value stocks primarily by looking at dividend yield. By the end, he was having to get increasingly creative with his metrics.

      2. Fractional ownership and share dilution to the point where ownership is meaningless. If you own 1/13,000,000th of Microsoft, are you really an “owner” of Microsoft? Share dilution to the point where ownership is as real as Bigfoot or the abominable snowman is not an effective way to incentivize “owners” to keep tabs on management and whether they’re running the company into the ground.
      3. Divorce of ego from management and management from ego. If I’d put my money where this notion was back in 1997, I’d have more money in the bank now. I remember when the late Stephen Paul Jobs was a failure and also ran. Prior to the release of “Toy Story” in 1995, Steve Jobs was better known for being a washed up former wunderkind like Mitch Kapor or Dan Bricklin than a new colossus of American industry. The week “Toy Story” came out, one of the major weekly magazines featured Jobs in its regular column entitled “Whatever Happened To…”

      My thought at the time, which I think is accurate in retrospect, was that Jobs had a Godzilla-sized chip on his shoulder and, while money is nice, Jobs wasn’t looking for profit as much as he was looking for vindication in the eyes of history. He would make his story one of personal death and resurrection. He would prove that he was not just another lucky tech company founder whose company had outgrown him and thrown him overboard in favor of more seasoned and adult leadership. Jobs’ immediate predecessors, Michael Spindler (known to hide under his desk on occasion) and Gil Amelio (known as Jobs’ fall guy), were simply managers seeking standard managerial compensation. They had no self-image in the game. The force of disgraceful failure on a mass scale is not a good spur to good management if you have a golden parachute to waft you to your second act as a consultant and board member.

      The remedy to much that ails modern American joint-stock companies is fewer and more real chunks of ownership with real power, real responsibility, and real risk for both management and labor that pay out real cash flows. The current system of fractional joint-stock ownership that dilutes shares to the point of meaninglessness, puts too much emphasis on puffing up share prices at the cost of generating concrete cash flows, and hands out meaningless securities like options that lack real life or death stakes in success or failure is little more than a casino funded by unlimited cheap money shoveled out by Uncle Sugar.

    11. Bill Waddell Says:

      All you would be doing is borrowing money to finance inventory from workers instead of banks. In terms of risk, workers are already taking on considerable risk in betting their careers on the success of the business, often with little upside reward when the business succeeds beyond keeping their jobs.

    12. Jonathan Says:

      Bill makes a good point. For most employees in most businesses, deferring pay would be like investing discretionary income in their company’s ESOP, with higher pay in exchange for deferring compensation but without the leverage an ESOP provides in the form of the possibility of unbounded capital appreciation. You might defer pay in a startup in exchange for large upside potential in the form of shares/options, or in the unusual case of a failing business where keeping the business alive is the priority for the employees (e.g., it’s the only employer in town). Otherwise, deferred pay may not be attractive to employees unless they’re getting a substantial premium in salary, and in that case the employer would probably be overpaying for the marginal capital he raised via this practice, so doing this makes little sense. Also, to get back to the ESOP paradigm, for most employees in non-startup businesses, investing discretionary income in their employer’s business is a bad idea for personal risk-management reasons.

    13. TM Lutas Says:

      David Foster – You make a car with VIN XXXX and that car is sold. You get your compensation at sale. It’s not fractional ownership in the firm I’m talking about but fractional ownership in the production.

      James Bennett – The idea is that labor and capital are misaligned, at least in part because labor feels disconnected from the risk of production without sales. Aligning their interests, somehow, would make for a more efficient and productive economy. You’re assuming that labor is always going to be a paycheck-to-paycheck affair. I think that this is not going to be the case over the next century. The distortions that made such a strategy pay are disappearing and they are unlikely to return.

      Michael Kennedy – The banks are still providing such loans though the mania to push them on doctors has reduced. We get fewer mailings these days.

      Sol – Neither Capitalism nor Capitalist originated with Marx. You are simply in error. Look here and you will find that Marx was beaten to the punch by over a decade for both capitalist and capitalism. He did massively popularize the term but that in no way makes it necessarily marxist.

      Joseph Fouche – While ownership of the firm is hopelessly diluted, ownership of the production itself might be reclaimed by a scheme similar to what I am saying. I think the idea obviously needs work before implementation.

      Bill Waddell – In terms of upside reward, the labor force would capture the banker’s portion of the profits under this system. In terms of risk, the practice would seem to push shaky, poorly run firms into bankruptcy quicker as the labor force will likely pull financing quicker. Killing off the walking dead is an important function of capitalism.

    14. David Foster Says:

      Fractional ownership in the production…but no one individual makes a car with VIN xxxx, of course. You could allocate a fraction of the car’s selling price to each individual…based on any combination of factors, I guess: hours worked, skill level, etc…in effect, this is a deferred piecework arrangement, with the delay being a function of the firm’s work-in-process and finished-goods inventory levels. For even a not-very-lean American auto company, I doubt if the typical interval between the work and the sale/payment would be more than 6 months or a year….for companies building ships or chemical plants, it might be a few years.

      Is this basically the idea?

    15. ArtD0dger Says:

      I have often had thoughts along these lines. Most of us would say we want to foster economic dynamism and innovation, but the unavoidable flip side is variability of economic outcomes. Social and legal institutions such as wages and salaries that shield workers from this uncertainty have the perverse effect of lowering their equilibrium share of productivity.

      Say I am a would-be entrepreneur and my model of a proposed venture has expected revenues of mu, with standard deviation sigma. I simply will not pursue that venture if fixed costs (most notably including labor) exceed some level where the probability of loss is acceptably small, say mu minus sigma. But that means that when revenues come in at mu (as they will on average), then the profit of sigma will accrue solely to me and any other risk-holders.

      I think this mechanism goes a long way toward explaining the widening income gaps incessantly bemoaned (and admittedly, greatly exaggerated) by the left. In their halcyon 50’s, the big three automakers could afford to bargain fixed costs up to 97% of revenue because sigma was only a couple percent of mu, but no more. The left’s solution to the new situation is to use redistribution to keep labor in its beholden, infantilized state. Mine, like TM Lutas’s, would involve evolving institutions and norms so that average people can share the risks, reap the rewards, and achieve the independence of holding their own chunk of capital.

    16. TM Lutas Says:

      David Foster – You’ve reached the heart of it, other than the fact that it would be voluntarily chosen. You could take all your wages in advance or take profit from what you make (a fraction of the sale price) or some combination of the two. To choose one system or the other is to create an injustice but to offer both and let the computers sort it all out allows for flexibility.

      ArtD0dger – You can, today, invest in the company’s stock, or not. But there’s something of a doughnut hole in the risk/reward scale between. My proposal, with the details worked out, would fill the doughnut hole.

    17. david foster Says:

      Note that sales compensation plans encompass the characteristics of risk-sharing and deferred payment. Someone may work on a prospective sale for months or even years (in the case of large capital equipment and software sales, project sales, etc) and not get paid until the sale is closed…in some cases, where the sale is for a service, payments may be further deferred after the sale until periodic service payments are actually received.

    18. TMLutas Says:

      David Foster – Yes, and they get frustrated and upset when the hourly and salary people in charge of executing the orders foul it up. Imagine an enterprise where every department had people like that insisting on a tight focus of quality production and real value.