The fallacy of cheap labour: Debunking the belief that rich countries need poor countries to sustain wealth – Ivo Vegter

The idea that rich countries and people rely on poor countries and people for their wealth is a misconception. Ivo Vegter argues that cheap labor is a benefit to businesses and that profit is simply the difference between market prices and production costs. Companies keep costs down by negotiating for better capital and raw material prices or recruiting cheaper labour. While there are many companies that pay their staff well, workers with less experience or skills are easily replaceable and therefore less expensive. However, profitable companies contribute to a thriving economy that raises living standards, and as standards rise, so do wage levels. Read more below.


Do the rich require the poor to stay poor?

By Ivo Vegter*

The belief that rich people, and rich countries, require poor people, and poor countries, in order to sustain their wealth on the back of cheap labour, is a fallacy.

Cheap labour is a boon. Let’s not be coy about it. The lower the price of any of your inputs, be it raw materials, labour or capital, the more competitive and profitable your company is going to be.

Free-market capitalism operates by directing capital to those uses that create the most value. Value is determined by subtracting the cost of the factors of production from the revenue generated by the goods or services produced.

Revenue is dependent on the prices a company can charge. Price is entirely unrelated to cost. If a company cannot charge a price high enough to cover their costs, their only rational option is to quit producing what they were trying to produce. Price is determined entirely by what the market will pay.

There is no such thing as a ‘fair’ profit margin. Profit is simply the difference between the price the market will pay, and the cost of producing what the market wants.

The market consists of a multitude of individual customers, each making subjective value choices about how to spend their limited money. This is how a decentralised price mechanism signals to producers what goods or services are needed, where they are needed, and how resource allocation ought to be prioritised to serve the wants and needs of society.

Competition

In an uncompetitive market, companies could raise prices until too many customers decide they don’t need their product that badly. High prices produce excess profits, which invariably attracts competition. In a competitive market, there is constant downward pressure upon prices, so those excess profits are soon eroded away.

(This is why it is so harmful when a government protects companies from competition by raising import tariffs, issuing limited numbers of licences, or raising high regulatory barriers to entry. Customers always have to carry the burden by paying higher prices than they otherwise would have. Excess profits can only persist when competition is artificially restricted.)

The control that companies have over their pricing is limited by having to be higher than their costs, and no higher than what the market will bear.

This is why the other side of business is going to great lengths to curtail costs.

Whether it is negotiating better terms on capital, seeking out better prices for raw materials, or recruiting cheaper labour, keeping costs down is often key to a company’s profitability. As we’ve seen, profitability is the key measure of how efficiently a company is able to satisfy the wants and needs of society.

There are, of course, many companies that do pay their staff well, especially when the staff are skilled and are required to bring creativity, ingenuity and drive to the workplace. This is also a function of market demand, however: the rarer such combinations of skills and personality traits, the more employees can charge for their time and labour. The more common they are, the cheaper their labour becomes.

So there is no mystery to why companies pay low wages to low-skilled or unskilled workers. There is, almost always, an oversupply of them and they are easily replaceable.

Read more: Greenpeace: An elitist movement from rich countries? – Andrew Kenny

Rising living standards

However, profitable companies create a thriving economy, which produces a greater variety of products of increasing quality at increasingly competitive prices, which raises the living standards for everyone in society.

The poor might still feel poor by comparison to their wealthier compatriots, but in absolute terms, they, too, become richer as economies grow.

Standard of living isn’t limited to income, of course. In rich countries, even those earning a minimum wage can expect to live in a residence of reasonable quality, with many modern conveniences that would have been considered luxuries 50 years ago. Budget vehicles are far safer, far more economical, far cleaner running, and feature more mod-cons than many high-end cars did in the past. Medical care has, generally speaking, improved over time. Shops contain a wider variety of goods, giving consumers greater choice and more opportunity to satisfy their exact wants and needs. Today’s computers and smartphones are light-years ahead of what was available even 10 or 20 years ago.

Higher standards of living also raise wage levels. That means that companies need to pay more, even for low-skilled labour. And what does the market do when the cost of labour rises? It looks for less expensive labour.

Japan, China

At first, it wasn’t so much companies moving to low-wage jurisdictions as it was customers in rich countries importing goods from countries where workers (and hence products) were cheaper. In the 1970s and 1980s, the preferred country was Japan. It had a hard-working and inexpensive labour force, and produced goods – especially electronics, but also cars and other goods – at highly competitive prices.

The problem was that Japan’s success also raised the general standard of living there, which caused labour prices to rise, just as it had done in the rich countries of Europe and North America.

By the 1990s, Japan had lost the competitive advantage in cheap labour, but was far wealthier, had a far better-educated workforce, and now produces high-quality goods targeted at wealthier market segments. At the time, it sported the second-largest economy in the world.

The new kid on the block was China, which had shed some of its doctrinaire communism to establish a competitive, quasi-capitalist industrial sector. Here, wages were lower than in Japan. It became a mass-exporter of inexpensive goods, and many companies began to move to, or outsource manufacturing to, China.

India became big in call centres and software development work. Some smaller countries succeeded in attracting business in niche sectors, as Vietnam did with clothing and textiles.

These are also the countries that are leading the entire world in real wage growth today. As the economic activity attracted by inexpensive labour raises living standards, wages rise, and their once-cheap labour isn’t so cheap anymore.

Africa could be the next destination for companies seeking the least expensive labour, although it has huge disadvantages in poor education, weak institutions, corrupt and socialist governments, and, at last count, 24 ongoing wars and insurgencies.

Rising wages

Those countries that do succeed in attracting foreign employers will follow the same path as all other countries that grew if not rich, at least noticeably more prosperous, thanks to the ability to sell inexpensive labour to international buyers.

Initially, workers will earn low wages, but as general living conditions improve, so will wages, until they match those in the countries that went before them.

Anti-capitalists insist that rich countries must keep poor countries poor to exploit their cheap labour. However, the evidence is that they’re not doing that: the use of inexpensive labour actually raises both wages and living conditions in poor countries.

What happens when there are no more poor countries left?

Nothing. Remember that companies are simply seeking out the lowest possible costs for their input factors, labour being one of them. If lower-priced labour is not available to their competitors, there will be no problem with hiring the least expensive labour that remains, even if that means hiring at substantially higher wages than are available around the world today.

Remember that free-market capitalism makes everyone, including the poor, richer. (Countries where the poor have not become richer are invariably poorly governed, corrupt, socialist or at war.)

There is no reason to believe that once there is no labour left that is inexpensive by today’s standards (except in the aforementioned countries where it is hard or impossible to do business), the buyers of the products that rely on that labour won’t be able to afford the higher prices that would pay for higher wages.

As long as no competitor can undercut them, it doesn’t really matter to a company exactly how cheap labour is. If everyone pays the higher wages, no competitive edge is lost.

Read more: How the wealthiest became wealthy: Risky investments, not inheritance

Medellín

An episode of NPR’s Planet Money podcast (from 4:33 to 12:32) had a great story about a woman in Medellín, Colombia, who sews clothing in a factory contracted to the Jockey brand. It highlighted how important this work is for the people who do it, even if they are paid low wages.

It also explained what happened when the general standard of living rose in Colombia. A country that once offered low costs, ended up costing 20% to 30% more than rival countries, so Jockey pulled their contract.

Faced with a crisis, the factory pivoted to producing its own successful clothing brands for the domestic and export market, moving up the value chain in the process. At the time of the report, they had already opened 160 stores across Latin America, with plans for more. It had to cut some factory jobs, but added more higher-paid retail jobs.

So, much as agriculture employment once shifted towards manufacturing jobs, factory jobs began to give way to service-sector jobs in Colombia.

The woman the story followed will find it hard to adjust. She has no education, and sewing is all she knows. But her son went to college to study graphic design.

Meanwhile, Jockey moved their business to four or five lower-cost countries, repeating this largely virtuous cycle.

Exploitation or employment?

This process is disruptive, certainly, but on balance, and without exception, it improves the economies and general standard of living both of the rich country whose companies outsource work, and of the poor countries in which low-cost workers are employed.

The notion that rich countries are ‘exploiting’ workers in poor countries, and that they need poor countries in order to stay rich, is a fallacy. Their employment of low-cost labour is extremely beneficial to those workers, as well as to the economies of their countries.

Moreover, this rising standard of living also expands consumer markets for companies, domestic and foreign. You can’t make much money from people who have nothing.

Business is much better when everyone involved is relatively wealthier, so rising standards of living in once-poor countries is ultimately as beneficial to rich countries as much as it is to the countries lifting themselves out of poverty.

Read more: Best of 2022: SA no country for rich people – Heystek vs Gore

Companies don’t necessarily need cheap labour; they only need to find the least expensive labour to remain competitive. Wherever the least expensive labour can be found will be next on the list of countries where the general standard of living will be improved by foreign employers looking for inexpensive labour, provided it is open for business and conducting business is easy.

South Africa is not open for business. It falls short in a number of areas, from corruption, to high taxation, to inflexible and relatively expensive labour, to burdensome regulation, to poor security.

We could easily take advantage of the benefits of global trade and global business if only our policies were more conducive to doing business here.

Inexpensive labour is a boon to profit-seeking companies, sure. But being a seller of inexpensive labour is also great for living standards in poor countries.

*Ivo Vegter is a freelance journalist, columnist and speaker who loves debunking myths and misconceptions, and addresses topics from the perspective of individual liberty and free markets. Follow him on Twitter, @IvoVegter.

This article was first published by Daily Friend and is republished with permission

The views of the writer are not necessarily the views of the Daily Friend or the IRR

Copyright of The Daily Friend 2023