CHAPTER SIX

Low Wages: No Longer a Competitive Edge

WAGE LEVELS FOR BLUE-COLLAR workers are becoming increasingly irrelevant in world competition. Productivity still matters—indeed it matters increasingly more. Quality, design, service, innovation, marketing, all are becoming more important. But blue-collar wages as a direct cost are rapidly becoming a minor factor.

The reason is, blue-collar labor no longer accounts for enough of total costs to give low wages much competitive advantage. A well-tested rule says offshore production must be at least 5 percent, and probably 7½ percent, cheaper than production nearby to compensate for the considerable costs of distance: transportation, communications, travel, insurance, finance. And if wage costs fall below 15 percent of total cost, it takes a 50 percent wage differential—at the same labor productivity—to offset the costs of distance. That is practically unheard of, certainly in developed countries.

Blue-collar costs in U.S. manufacturing account for 18 percent of total costs. But they are down from 23 percent only a few years ago. And they are dropping fast as productivity is rising at a good clip. An industry or company that today operates at a blue-collar cost of more than 15 percent is already way behind. GM still has blue-collar costs of nearly 30 percent—in part because of the restrictive work rules in its union contracts. But Toyota and Honda in their U.S. plants, paying the same wage rates, operate at labor costs of less than 20 percent and expect to reduce this to 15 percent within a decade, as does Ford.

Competing Neck-to-Neck

Integrated steel mills still have blue-collar costs of 25 percent. But the “minimills” operate at blue-collar costs of 10 percent or less—and they now produce a fifth of all steel made in the U.S. and are likely to produce well over half in another 10 years. The textile industry says it’s been killed by imports from low-wage countries. But about half the industry actually operates at costs fully competitive with the lowest-wage producer anywhere—Malaysia, for instance, or Indonesia. These companies—mostly the large ones—have brought their labor costs down to 10 percent or 12 percent of the total—and not only in making commodity products, such as sheeting, but in many cases for finished goods as well, e.g., blue jeans and housedresses.

In this restructuring in which blue-collar wages cease to be the dominant factor in competitive strength—and almost cease to be a factor altogether—American and Japanese industry are neck-to-neck. The Japanese are ahead in reducing labor-cost content in traditional industries, e.g., autos and tires; what helps them, of course, is that they are largely unhampered by union restrictions. In the new, fast-growing industries—pharmaceuticals, specialty chemicals, biotechnology, communications, computers—and in some old industries such as paper or turbines, the U.S. is ahead. Europe, by and large, has barely begun; but it is waking up.

One result of this is that American manufacturers are slowly beginning to bring back to the U.S. operations they had moved offshore—precisely because they do not have to restore the blue-collar jobs they abolished when they moved offshore 10 years ago. Another result—a paradoxical one—is that manufacturing employment has not gone down in the U.S., contrary to union claims. Because unit labor costs have been falling steadily, U.S. manufacturing has been able to expand total production fast enough to maintain blue-collar employment in absolute figures. This is in glaring contrast to Western Europe, where blue-collar manufacturing employment is about 5 million lower than 10 years ago, and a little better than the Japanese record. What has been happening is a shift from industries with yesterday’s wage costs, e.g., autos and steel, to those with tomorrow’s labor costs, e.g., telecommunications and pharmaceuticals.

The shrinking importance of blue-collar costs as a decisive competitive factor also underlies the rapid movement of manufacturers to their markets all over the developed world. American industry made this shift in the 1960s and ’70s—in part through the multinationals’ buying European companies or building in Europe, in part through joint ventures in Japan. Even so, U.S. manufacturers, despite the dollar’s greatly reduced purchasing power abroad, are now increasing their direct investments abroad—and contrary to what almost everybody believes, at about the same rate at which foreigners are increasing their direct investments in the U.S.

Now it is Europe and Japan that are moving production offshore into developed countries where their markets are—the Europeans mainly into the U.S., the Japanese into the U.S. and Western Europe. The official Japanese reason, especially for building or buying plants in the U.S., is “fear of protectionism.” But that is mainly PR for domestic Japanese consumption. The real reason is blue-collar wages are becoming relatively insignificant as a competitive factor, so that costs of the distance to the market are becoming more onerous.

These trends spell greatly increased competition among manufacturers in developed countries. It will not be competition based on wage differentials but on managerial competence—productivity of knowledge work and of money, process technology, management of foreign-exchange risks, quality, design, innovation, service, marketing. Increasingly, concentration rather than conglomeration or diversification will be needed, with growing emphasis on knowing one’s technology, market, and customers.

In the developed countries these trends will mostly intensify the integration that has been going on for quite some time—at least since American business started “multinationalization” 30 years ago. But for the developing countries the trend threatens to close the broadest avenue toward rapid economic development: export-led development based on low-wage but productive labor.

Some of the development of the postwar period, notably Brazil’s, has been based on the classical nineteenth-century recipe: export-led development based on selling foodstuffs and raw materials to the developed countries—exemplified by the U.S. during the nineteenth century with its exports to Europe of pork bellies, lard, beef, cotton, corn, tobacco, and copper.

But the far more spectacular development of the postwar period was that of Japan, followed by the “four tigers” of Southeast Asia: South Korea, Taiwan, Hong Kong, and Singapore (about to be joined by a fifth tiger, Thailand). What these countries did was quite new. They took an American invention of World War II—it was called “training” and it enabled the U.S. during the war years to change pre-industrial, unskilled people into efficient, high-productivity workers—and turned their unskilled and low-wage people rapidly into highly productive but still low-wage workers whose output could then compete in the developed markets.

Neither development route is likely to be open in the future. There are few food importers left. Among developed countries, only Japan still has a food deficit; all the other developed non-Communist countries have food surpluses. Industrial production is rapidly becoming less raw-material intensive. The typical product of the 1920s, the auto, has a raw-material content of almost 60 percent; the typical product of the 1980s, the semiconductor, has one of 1 percent. The raw-material and energy content of a glass-fiber cable is about 12 percent; the copper cable that it replaces has a raw-material and energy content of nearly 50 percent, and so on.

The Last Nineteenth-Century Model?

Brazil may thus have been the last country to finance its development the nineteenth-century way, by paying for capital imports with food and raw-material exports. And today’s crisis of the Brazilian economy is largely the result of the collapse of world-market prices for raw materials and foods brought about by the shift from food shortages to food surpluses and from raw-material-intensity in manufacturing to knowledge-intensity.

But the access to economic development through exports based on the productivity of low-cost labor may become blocked, too, when wages are no longer a major factor in total costs. The managerial contributions that then count are precisely in the areas in which a poor, developing country finds it hardest to compete. For manufacturers in developed countries the shift means heightened demands in areas in which they should excel anyhow. The Third World may, however, have to find new development strategies based probably on the domestic market, that is on freedom and market incentives for farmers and for small, local (and tax-aversive) entrepreneurs. Northern Italy, rather than Japan, may become tomorrow’s development model.

[1988]