The cost of production and living standards Saturday, Nov 7 2009 

Updated below

There’s an interesting discussion at the SCSU scholars blog regarding capital and labor (click comments). Classical economic theory tells us that firms are (or at least seek to be) profit-maximizing (whether or not that is true will be ignored here). Profits, remember, are revenues minus (economic) costs. So one way firms can increase profits is by lowering the costs of production. Classical analysis states there are three factors of production: land and natural resources, labor, and capital (sometimes referred to as “the means of production”). It follows, as Dr. Banaian points out, that when the cost of labor relative to the cost of capital goes up, firms will substitute capital for labor when possible. That is, firms will attempt to increase profits by using the cheaper factor of production. (Of course, the decisions a firm can make in the long-term and in the short-term differ, but that will be ignored here. It is also important to note whether the market for labor and capital are perfectly competitive; it’s dubious, but I assume they are here for simplification.) Theoretically, a firm can look at their isocost and isoquant curves to determine the cost-minimizing combination of labor and capital, but we don’t need to get into that level of technical analysis.

Anyway, we might just assume firms will choose to replace capital with labor when it becomes cheaper to do so. Does this make cheap labor a bad thing, as “spencer” posits? He claims the move to labor-saving capital has been the key to rising standards of living (apparently the “liberal” position). Therefore, labor-intensity is a bad thing and high capital-to-labor ratios are a good thing. I don’t think it matters. In my mind, and I’m sure in the firm’s, what matters is what’s cheaper. If the cost of production is lower by increasing capital, then increase capital. If the cost of production is lower by increasing labor, then increase labor. That’s how I see it. That’s how you increase profits, which is assumed to be a good thing. Still others disagree, arguing that labor retention is a higher moral obligation than profit maximization (apparently the “conservative” position). In particular, the “radical perspective” in labor relations sees a conflict between capital and labor wherein organized labor fights against their exploitation by capital. The importance of the mobility of labor and the mobility capital is highlighted here, with the argument that capital is mobile and labor is more immobile (for example, a firm can lower wages just by threatening to move its manufacturing).

What I want to focus on, though, is the point that spencer makes. It reminded me of a passage I read from “Cannibals and Kings” by Marvin Harris (I’ve referenced the book on previous occasions—see here). Here is a somewhat long passage from pages 266-271—the end of Chapter 14 (“The Origin of Capitalism”) and the beginning of Chapter 15:

Capitalism, then, is a system that is committed to an unbounded increase in the production in the name of an unbounded increase in profits. Production, however, cannot be increased in an unbounded way. Freed from the restraints of despots and paupers, capitalist entrepreneurs still have to confront the restraints of nature. The profitability of production cannot expand indefinitely. Any increase in the quantity of soil, water, minerals, or plants put into a particular production process per unit of time constitutes intensification. It has been the burden of this book to show that intensification inevitably leads to declining efficiencies. That declining efficiencies have adverse effects upon the average standard of living cannot be doubted.

What must be made clear is that environmental depletions also lead to declining profits. The relationship is not easily understood because, according to the laws of supply and demand, scarcities lead to higher prices. Higher prices, however, tend to lower consumption per capita (the market symptom of declining living standards). Profits can be sustained temporarily if the drop in per capita consumption is compensated for by an expansion in total sales based on population growth or the conquest of international markets. But sooner or later the curve of rising prices caused by environmental depletions will begin to rise faster than the curve of rising consumption and the rate of profit must begin to fall.

The classic entrepreneurial response to a fall in the rate of profit is exactly the same as under any mode of production that has been overintensified. To compensate for environmental depletions and declining efficiencies (which manifest themselves as falling rates of profit), the entrepreneur seeks to lower the cost of production by introducing labor-saving machines. Although these machines require more capital and hence usually have higher start-up costs, they result in lowering the unit cost of production.

Thus a system that is committed to perpetual intensification can survive only if it is equally committed to perpetual technological change. Its ability to maintain living standards depends on the outcome of a race between technological advance and the relentless deterioration of the conditions of production. Under the present circumstances, technology is about to lose that race.

Chapter 15: The Industrial Bubble

All rapidly intensifying systems of production, whether they be socialist, capitalist, hydraulic, neolithic, or paleolithic, face a common dilemma. The increment in energy invested per unit time in production will inevitably overburden the self-renewing, self-cleansing, self-generating capacities of the ecosystem. Regardless of which mode of production is involved, there is only one means of avoiding the catastrophic consequences of declining efficiencies: to shift to more efficient technologies. For the past 500 years Western scientific technology has been competing against the most rapidly and relentlessly intensifying system of production in the history of our species.

Thanks to science and engineering, the average standard of living in the industrial nations is higher than at any time in the past. This fact, more than any other, bolsters our faith that progress is inevitable—a faith, incidentally, shared as much by the Comintern as by the U.S. Chamber of Commerce. What I want to emphasize here is that the rise in living standards began only 150 years ago, while the race between rapid technological change and intensification has been going on for 500 years. During most of the post-feudal epoch, living standards hovered close to pauperdom and frequently fell to unprecedented depths despite the introduction of an unbroken series of ingenious labor-saving machines.

I’ll leave analysis of the above excerpt up to the reader (keep in mind this was written in 1977).

Update: The Becker-Posner blog has a post about the recent upshoot in production vis-a-vis higher unemployment. Dr. Becker, an economics professor at the University of Chicago, argues that the increase in productivity is, in the long-run, a good thing despite the higher unemployment. His argument is that it will ultimately lead to higher employment, in the same way the advent of the computer, the Internet, biotechnology, or supermarkets have. He is assuming here, like “spencer” does at SCSU Scholars, that technological advances have been the source of the recent spike in productivity.

Posner’s response, however, is that technological innovations have not been the cause of increased productivity over the past two quarters. “More likely they have been due to old-fashioned cost cutting spurred not by technological advances but by economic distress. The only explanations I have seen offered for the productivity surge is cutting wages and working the workers harder. I have found no suggestion of any technological change that might be responsible for such a large, sudden surge in productivity,” he states. The optimism, then, that Dr. Becker displays seems to be unfounded. If firms are merely adapting to the dire economic situation simply by old-fashioned cost-cutting techniques, the spurt in productivity is not likely to last and not likely to result in increased employment.


The state, revisted Wednesday, Jun 10 2009 

One of the books I decided to read this summer (before taking summer courses) is a book called Cannibals and Kings (1977) written by anthropologist Marvin Harris.

The book discusses a whole range of topics relating to the origin of culture (origin of agriculture, origin of warfare, origin of male supremacy, origin of the state, origin of food taboos, origin of hydraulic despotism, origin and consequences of capitalism and the industrial bubble, to name a few). The main theory revolves around the idea that humans react to their natural surroundings. Much of our actions revolve around a cost-benefit analysis based on ecology, intensification, and reproductive pressures. Obviously I cannot do the book justice here, so I suggest you read it, especially if you’re interested in the origin of culture, economic incentives, the effects of statism, and about the current-day modes of production that also influence human behavior. I can guarantee the book will make you look at certain things differently–it certainly did for me.

A refrain one notices later in the book is that the rise of the state has coincided with the abysmal treatment, pauperization, and stratification of human beings (i.e. “the descent of the world from freedom to slavery”). This has been the case for most of human history; only very recently have people begun to gain rights and control their governments (and not in all places). Harris warns his readers that to think the current form of the state is permanent and inevitable is both folly and dangerous.

Last month, I quoted a passage in the book about the rise of the state, which can be read here. There is another paragraph about the state that I would like quote, appearing in the chapter about hydraulic despotism on page 235:

Western observers have always been astonished by the static or “stationary” nature of these ancient dynastic systems. Pharaohs and emperors came and went decade after decade; dynasties rose and fell; the life of the coolies, ryots, and fellahin, however, went on as always, just a notch above barest subsistence. The ancient empires were warrens full of illiterate peasants toiling from morning to night only to earn protein-deficient vegetarian diets. They were little better off than their oxen and were no less subject to the commands of superior beings who knew how to keep records and who alone had the right to manufacture and use weapons of war and coercion. The fact that societies providing such meager rewards endured thousands of years—longer than any other system of statehood in the history of the world—stands as a grim reminder that there is nothing inherent in human affairs to ensure material and moral progress.

The State Monday, May 18 2009 

In his 1977 book Cannibals and Kings, anthropologist Marvin Harris explores human culture and society and their evolution. In it, he devotes a chapter on the origins of the state. One paragraph in the opening discussion on page 102 struck me as a profound and honest statement on the perniciousness of the state:

With the rise of the state all of this [economic and political freedom] was swept away. For the past five or six millennia, nine-tenths of all people who ever lived did so as peasants or as members of some other servile caste or class. With the rise of the state, ordinary men seeking to use nature’s bounty had to get someone else’s permission and had to pay for it with taxes, tribute, or extra labor. The weapons and techniques of war and organized aggression were taken away from them and turned over to specialist-soldiers and policemen controlled by military, religious, and civil bureaucrats. For the first time there appeared on earth kings, dictators, high priests, emperors, prime ministers, presidents, governors, mayors, generals, admirals, police chiefs, judges, lawyers, and jailers, along with dungeons, jails, penitentiaries, and concentration camps. Under the tutelage of the state, human beings learned for the first time how to bow, grovel, kneel, and kowtow. In many ways the rise of the state was the descent of the world from freedom to slavery.