The Wage And Price Disparity

One of the most important factors in the global economy today is the fact that in some countries, both wages and prices are high and in others both are low. I have yet to see a satisfactory answer as to why this is the case because I do not think that it can be due to inflation alone.

Inflation can certainly result in an upward wage-price spiral but when it does, the national currency becomes devalued relative to that of other countries which are not undergoing the same inflation. This means that inflation cannot really account for why wages and prices, in terms of real earnings, are so much higher in some countries in comparison with others.

The reason that these differences in wages and prices from one country to another are so important is very clear. Tens of millions of jobs have been lost in the high wage-high price nations of the west as production work and industry has migrated to those countries where workers are able to live on low wages because prices are also low. Today I would like to give my explanation of why, in our global economy, there is such differences in wages and prices.

First, let's consider why prices tend to be higher in cities than in most small towns and rural areas. The reason is that since land is more scarce in the cities, it's cost will naturally be higher. This means that for a business to buy or rent a building in a city, it will have to pay more than if the same building were in a rural area. The cost of the land that the building lies on finds it's way into the goods or services that the business manufactures or sells.

Since this is true of all the buildings used by all of the businesses in the city, it means that those workers who live and work in the city will have to pay more for things they buy than they would if they lived in rural areas. Thus, in order to keep workers, businesses in the city generally must pay more in wages than those in rural areas. The final result is that both wages and prices tend to be higher in cities than in rural areas.

I find that it is a similar principle which causes the wages and prices to be much higher in some countries in comparison with others. On this blog, there is a posting entitled "The Extreme Inefficiency Of Wealth Production" This details how we have gotten ourselves into a situation in which only about 15% of all workers actually produces any wealth when they go to work. This posting was a continuation of the idea of "fluff" that I introduced in my book "The Patterns Of New Ideas".

The basic purpose of working has always been to create wealth. It does not make much sense to work all day unless it produces something beneficial. But problems begin when technology comes along and makes production more efficient.

Suppose it requires ten workers to accomplish a certain task in the production of goods. Now suppose that a new machine is invented that makes it possible for only two workers to do the work that formerly required ten. Those eight workers that were made redundant will now have no source of income and so will be unable to afford the goods that are being produced. This will mean that it will not make economic sense for the two workers still employed to produce the goods because there will now be few people that are able to afford them.

(You can see that this rationale uses the same logic as the posting "Recessions Made Really Simple" on this blog. When there is an increase in production without a corresponding increase in wages, there is not enough money in circulation to buy all the goods that have been produced and an artificial cutback in production is the result.)

As new technology comes on the scene some of the eight displaced workers find their way into the production of new types of goods, such as making the new machines that the original two workers now use to make their goods. However, a basic problem with our economic system and our society is that while new technology both creates and eliminates jobs, it usually eliminates jobs faster than it creates them. If this were not true, there would be no such thing as unemployment (redundancy).

Basic common sense tells us that it is of no use to create a machine that can enable two workers to do the work that was formerly done by ten if it requires eight workers to build and maintain the new machines. If that were the case, no jobs would be eliminated but the factory owner may as well just leave things the way they were originally, since he would have to pay for the new machine but would not be saving any money on wages. Society could not function if technology put most workers out of work unless it could make a communistic system work without destroying enterprise and initiative.

The result is that the economy tends to create all kinds of work that employs the majority of workers but does not actually produce any wealth. This is what I was referring to in my previous writing on this subject. Without these tens of millions of non-production jobs, the production itself would make no sense because few people would have the money to buy the goods. If the means of production in an economy is too efficient, it will tend to create enough non-production jobs so that it can remain near peak production.

Now, let's move on to the basic economic principle that all of the wages, salaries and, profits in an economy must match all of the prices paid. The vast number of workers whose work does not actually produce any wealth must be paid wages just as do those who do produce wealth. If any workers are not paid enough, the production sector will not be able to operate at peak production because there will not be enough people earning enough money to buy all of the goods. This must mean that the wages of the majority of workers that do not actually produce any wealth when they go to work must "hitch a ride" on the prices of the goods that are produced by a relative few of the workers.

Let's now go back to why there is such wage/price disparities from one country to another that there is a mass movement of industrial work and other jobs from one side of the world to the other, the phenomenon commonly known as "outsourcing". I would like to establish the economic principle that the prices of goods and wages in an economy is determined not by the technical efficiency of production but by the proportion of workers in the economy engaged in non-production tasks.

My hypothesis is that if a high proportion of workers in an economy are engaged in acutal production of wealth both wages and prices will be relatively low, regardless of the inefficiency of that production. In the same way if only a few workers actually produce wealth, even if very efficiently, prices and wages will necessarily be high.

This explains why prices tend to be high in prosperous countries. The wealth production system is so efficient that it requires only a fraction of the total workforce and the wages of the others must "hitch a ride" on the goods that are produced.

Simple logic would seem to dictate that as efficiency of production increases, the price per good should get lower. But we can now see why this is often not the case. We can also see why industry tends to migrate across the world to countries with lower wages.

The great paradox of our global economic system is that if a country manages to increase the efficiency of it's wealth production, it will drive industry away instead of attracting it. A spiral gets started in which some production leaves for offshore locations, meaning that there will be more workers engaged in non-production tasks, meaning that wages and prices will rise, meaning that yet more production work will leave.

This is simply because increased production efficiency will mean more workers who do not actually produce any wealth but whose wages must "hitch a ride" on the prices of the goods that are produced. We can also see why wages and prices were so much lower in the past, many more workers were employed in production.

There is one way around this. I described it in the posting "The Idea Curve" on this blog.

Suppose that in our simple example of the ten workers, there was a never-ending flow of new ideas into the economy. The eight redundant workers would find their way into the new industries that were continuously being born. If we were able to keep in front of the Idea Curve, unemployment would virtually cease to exist. We could also lower the proportion of workers engaged in non-production work so that industry would have less reason to move offshore.

The fact that there is unemployment and a majority of workers employed in non-wealth production means that we are behind maximum efficiency in the Idea Curve. The economy of the western countries is a lot like an airplane (aeroplane). The plane must keep moving to remain aloft. If it tries to stand still, or moves too slowly, it will lose altitude.

The trouble with making production more efficient is that it leaves many workers with no way to earn the money to afford the goods that are produced. One solution is to develop a vast number of jobs that do not actually produce wealth, but that drives up wages and prices and prompts industry to move offshore. A better solution is an increase in the flow of new ideas and new technology in which workers in those industries will be producing actual wealth. This was the reason behind two of my books, "The Patterns of New Ideas" and "The Commoner Syndrome".

All of the facets of my economic theory operate by the same idea of balance. All wages and salaries paid in an economy find their way into the cost of living. In a balanced economy, we invite recession if the wealthy take too much of the wealth for themselves because it will not leave enough money in circulation to buy all of the goods and services that are produced in the economy.

If we try to grow one sector of the economy in a way that outstrips genuine progress, it will just form an artifical bubble that bursts, as I described in the posting on this blog, "Economic Boom And Bust Cycles" . And now we can see that if we make the production of wealth efficient without a corresponding flow of new ideas, we will only drive industry offshore by scaling up wages and prices.