Labor and Energy Costs

Posted by PITHOCRATES - July 1st, 2013

Economics 101

If you want to Destroy an Industry and Kill Jobs all you have to do is Raise the Cost of Labor

What happened to American manufacturing?  The Industrial Revolution swept through the United States and made America an industrial superpower.  By the beginning of the 20th century the United States became the world’s number one economic power.  Immigrants poured into this country for those manufacturing jobs.  Even though some of these jobs may have come out of a Dickens novel.  Because being able to eat had it all over starving to death.  And in America, with a good factory job, you could put food on your family’s table.

Most of those manufacturing jobs are gone now.  Why?  What happened to the once booming textile industry?  The once booming steel industry?  The once booming automotive industry?  Unions happened to them.  That’s what.  These jobs were so horrible and unfit for humans that unions stepped in and organized them.  But the jobs never got better.  Based on the ever more generous union contracts they kept demanding.  Increasing the cost of labor more and more.  Which chased the textile industry out of the country.  And much of the steel and automotive industries as well.

Is there anything we can learn from this?  Yes.  If you want to destroy an industry, if you want to kill jobs, if you want to damage the economy, all you have to do is raise the cost of labor.  The largest cost to most businesses.  Which is why many businesses have been replacing people with machines.  Advanced machines.  Computer-controlled machines.  Robots.  Because they can work 24/7.  They’re never late.  Never hung over.  Never out sick.  They don’t take lunch.  And they will work as fast as possible without ever complaining.  This is why businesses like machines.  For they let them lower their costs.  Making them competitive.  So they can sell at prices lower than their competitors.  Allowing them to remain in business.

Uncompetitive American Manufacturers go to Emerging Economies where they can be Competitive

Labor is a big cost of business.  Especially in an advanced economy.  With a high standard of living.  Where people own houses and cars.  Where those houses have central heat, air conditioning, televisions, sound systems, kitchen appliances, washers and dryers, etc.  These things cost money.  Requiring paychecks that can afford these things.  As well as pay for clothes, groceries, gasoline, utilities, etc.  Common things in an advanced economies.  But not all that common in an emerging economy.  Where factory workers aren’t accustomed to those things yet.  And don’t demand paychecks that can pay for those things.  Yet.

Still, people in developing economies flock to the new factories.  For even though they are paid far less than their counterparts in advanced economies these factory jobs are often the highest paying jobs in their countries.  And those who have these jobs have a higher standard of living than those who don’t.  Even when the occasional factory burns to the ground or collapses killing everyone inside.  As sad as that is.  But if you want to eat and provide for your family these factories often offer the best opportunity.

So this is where American manufacturing jobs go to.  Where labor costs are lower.  Allowing business to stay competitive.  Because if they can’t be competitive no one will buy what they are selling.  And without any revenue they won’t be able to pay their suppliers.  Their employees.  Or their energy costs.  Another large cost of business.  Especially for manufacturers.

Unions and Regulatory Costs haven’t made Emerging Economies Uncompetitive Yet

A lot of houses today come with a 200-amp electric service.  Assuming a house uses about 100 amps on average that comes to 24,000 watts (100 amps X 240 volts).  Now consider a large manufacturing plant.  Like an automotive assembly plant.  That can have anywhere around 8 double-ended unit substations.  Which are pieces of electrical distribution equipment to feed all of the electrical loads inside the plant.  Each substation has two 13,800 volt 3-phase primary electrical services.  If you’re looking at one you will see the following from left to right.  A 600-amp, 15,000 volt switch, a transformer to step down the 13,800 voltage to 480 voltage, a 480-volt main switch, a bunch of 480-volt switches to feed the electrical loads in the plant, a ‘tie’ switch, another bunch of 480-volt switches, another 480-volt main switch another transformer and another 600-amp switch.

The key to a double-ended unit substation are the two 480-volt main switches and the tie switch.  Which normally distributes the connected electric load over the two primary services.  With both 480-volt main switches closed.  And the tie switch open.  If one service fails because a car knocks down a cable pole these switches will sense the loss of that service.  The 480-volt switch on the side of the failed service will open.  And the tie switch will close.  Feeding both sides of the unit substation on the one live primary service.  So each primary service carries half of the connected load.  Or one primary service carries the full connected load.  Assuming each unit substation uses 600 amps on average (2 services at 300 amps or 1 service at X 600 amps) that comes to approximately 13,194,070 watts (600 amps X 13,800 volts X √3 X .92 PF).  Where we multiply by the square-root of 3 because it is three phase.  And assume a 0.92 power factor.  If a plant has 8 unit substations that comes to 105,552,562 watts.  Which equals approximately 4,398 houses with a 200 amp service.  Now to further our crude mathematical approximations let’s take a typical electric bill for a house.  Say $175 on average per month.  If we multiply this by 4,398 that comes to a monthly electric bill for this manufacturer of about $769,654.  Or $9,235,849 per year.

So here is another way to destroy an industry, kill jobs and damage the economy.  By increasing the cost of electric power.  Which is already a very large cost of business.  And ‘going green’ will make it even more costly.  As the Obama administration wants to do.  With their war on coal.  The cheapest source of electric power we have.  By increasing regulations on coal-fired power plants.  Even implementing some kind of a carbon tax.  To punish these carbon emitters.  And to subsidize far more costly green energies.  Such as solar.  And wind.  Going from the least costly to the most costly electric power will greatly increase a business’ electric utility costs.  Easily adding 15%.  30%.  40%.  Or more.  A 40% increase in our example would increase the electric utility cost by $3,694,340 each year.  If a plant has 1,200 workers that’s like adding another $3,000 per worker.  And we’ve seen what higher labor costs have done to companies like General Motors.  Chrysler.  And the textile industry.  By the time you add up all of these new regulatory costs (Obamacare, green energy, etc.) businesses will be so uncompetitive that they will have to follow the textile industry.  Out of the country.  To a country that will let them be competitive.  Such as an emerging economy.  Where unions and regulatory costs haven’t made them uncompetitive.  Yet.

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Versailles Treaty, Marshall Plan, Post-War Japan, MITI, Asian Tigers, Japan Inc., Asset Bubbles, Deflationary Spiral and Lost Decade

Posted by PITHOCRATES - February 21st, 2012

History 101

Douglas MacArthur brought some American Institutions into Japan and unleashed a lot of Human Capital

At the end of World War I the allies really screwed the Germans.  The Treaty of Versailles made for an impossible peace.  In a war that had no innocents the Allies heaped all blame onto Germany in the end.  And the bankrupt Allies wanted Germany to pay.  Placing impossible demands on the Germans.  Which could do nothing but bankrupt Germany.  Because, of course, to the victors go the spoils.  But such a policy doesn’t necessarily lead to a lasting peace.  And the peace following the war to end all wars wasn’t all that long lasting.  Worse, the peace was ended by a war that was worse than the war to end all wars.  World War II.  All because some corporal with delusions of grandeur held a grudge.

The Americans wouldn’t repeat the same mistake the Allies made after World War II.  Instead of another Versailles Treaty there was the Marshal Plan.  Instead of punishing the vanquished the Americans helped rebuild them.  The peace was so easy in Japan that the Japanese grew to admire their conqueror.  General Douglas MacArthur.  The easy peace proved to be a long lasting peace.  In fact the two big enemies of World War II became good friends and allies of the United States.  And strong industrial powers.  Their resulting economic prosperity fostered peace and stability in their countries.  And their surrounding regions.

MacArthur changed Japan.  Where once the people served the military the nation now served the people.  With a strong emphasis on education.  And not just for the boys.  For girls, too.  And men AND women got the right to vote in a representative government.   This was new.  It unleashed a lot of human capital.  Throw in a disciplined work force, low wages and a high domestic savings rate and this country was going places.  It quickly rebuilt its war-torn industries.  And produced a booming export market.  Helped in part by some protectionist policies.  And a lot of U.S. investment.  Especially during the Korean War.  Japan was back.  The Fifties were good.  And the Sixties were even better. 

By the End of the Seventies the Miracle was Over and Japan was just another First World Economy 

Helping along the way was the Ministry of International Trade and Industry (MITI).  The government agency that partnered with business.  Shut out imports.  Except the high-tech stuff.  Played with exchange rates.  Built up the old heavy industries (shipbuilding, electric power, coal, steel, chemicals, etc.).  And built a lot of infrastructure.  Sound familiar?  It’s very similar to the Chinese economic explosion.  All made possible by, of course, a disciplined workforce and low wages.

Things went very well in Japan (and in China) during this emerging-economy phase.  But it is always easy to play catch-up.  For crony capitalism can work when playing catch-up.  When you’re not trying to reinvent the wheel.  But just trying to duplicate what others have already proven to work.  You can post remarkable GDP growth.  Especially when you have low wages for a strong export market.  But wages don’t always stay low, do they?  Because there is always another economy to emerge.  First it was the Japanese who worked for less than American workers.  Then it was the Mexicans.  Then the South Koreans.  The three other Asian Tigers (Hong Kong, Singapore and Taiwan).  China.  India.  Brazil.  Vietnam.  It just doesn’t end.  Which proves to be a problem for crony capitalism.  Which can work when economic systems are frozen in time.  But fails miserably in a dynamic economy.

But, alas, all emerging economies eventually emerge.  And mature.  By the end of the Seventies Japan had added automobiles and electronics to the mix.  But it couldn’t prevent the inevitable.  The miracle was over.  It was just another first world economy.  Competing with other first world economies.  Number two behind the Americans.  Very impressive.  But being more like the Americans meant the record growth days were over.  And it was time to settle for okay growth instead of fantastic growth.  But the Japanese government was tighter with business than it ever was.  In fact, corporate Japan was rather incestuous.  Corporations invested in other corporations.  Creating large vertical and horizontal conglomerates.  And the banks were right there, too.  Making questionable loans to corporations.  To feed Japan Inc.  To prop up this vast government/business machine.  With the government right behind the banks to bail them out if anyone got in trouble.    

Low Interest Rates caused Irrational Exuberance in the Stock and Real Estate Markets

As the Eighties dawned the service-oriented sector (wholesaling, retailing, finance, insurance, real estate, transportation, communications, etc.) grew.  As did government.  With a mature economy and loads of new jobs for highly educated college graduates consumption took off.  And led the economy in the Eighties.  Everyone was buying.  And investing.  Businesses were borrowing money at cheap rates and expanding capacity.  And buying stocks.  As was everyone.  Banks were approving just about any loan regardless of risk.  All that cheap money led to a boom in housing.  Stock and house prices soared.  As did debt.  It was Keynesian economics at its best.  Low interest rates encouraged massive consumption (which Keynesians absolutely love) and high investment.  Government was partnering with business and produced the best of all possible worlds.

But those stock prices were getting way too high.  As were those real estate prices.  And it was all financed with massive amounts of debt.  Massive bubbles financed by massive debt.  A big problem.  For those high prices weren’t based on value.  It was inflation.  Too much money in the economy.  Which raised prices.  And created a lot of irrational exuberance.  Causing people to bid up prices for stocks and real estate into the stratosphere.  Something Alan Greenspan would be saying a decade later during the dot-com boom in the United States.  Bubbles are bombs just waiting to go off.  And this one was a big one.  Before it got too big the government tried to disarm it.  By increasing interest rates. But it was too late.

We call it the business cycle.  The boom-bust cycle between good times and bad.  During the good times prices go up and supply rushes in to fill that demand.  Eventually too many people rush in and supply exceeds demand.  And prices then fall.  The recession part of the business cycle.  All normal and necessary in economics.  And the quicker this happens the less painful the recession will be.  But the higher you inflate prices the farther they must fall.  And the Japanese really inflated those prices.  So they had a long way to fall.  And fall they did.  For a decade.  And counting.  What the Japanese call their Lost Decade.  A deflationary spiral that may still be continuing to this day.

As asset prices fell out of the stratosphere they became worth less than the debt used to buy them.  (Sound familiar?  This is what happened in the Subprime Mortgage Crisis.)  Played hell with balance sheets throughout Japan Inc.  A lot of debt went bad.  And unpaid.  Causing a lot problems for banks.  As they injected capital into businesses too big to fail.  To help them service the debt used for their bad investments.  To keep them from defaulting on their loans.  Consumption fell, too.  Making all that corporate investment nothing but idle excess capacity.  The government tried to stop the deflation by lowering interest rates.  To stimulate some economic activity.  And a lot of inflation.  But the economy was in full freefall.  (Albeit a slow freefall.  Taking two decades and counting.)  Bringing supply and prices back in line with real demand.  Which no amount of cheap money was going to change.  Even loans at zero percent.

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