Page 4 of 5 CHINA'S DOLLAR MILLSTONE, Part 5 Restoring China's national destiny
By Henry C K Liu
is not easily checked and would quickly outstrip economic growth and cause
increasing misery all around. Accepting that, Ricardo modified Smith's theory
of economic growth by including diminishing returns on land.
Output growth requires growth of factor inputs, which are goods and services
used in the process of production, such as land, labor, capital and enterprise.
But unlike labor, land is "variable in quality and fixed in supply". This means
that as economic growth proceeds, more land must be brought into use. But land
cannot be increased without conquest, which led economic growth
inevitably to the age of imperialism and empire.
Self-neutralizing effect of growth
Prior to that imperialist stage, there were two self-neutralizing effects from
economic growth: firstly, rising landowner rents over time cut into the profits
of capitalists from above; secondly, the rising price of wage goods over time
cuts into profits from below, as workers need higher wages for subsistence.
This introduces a quicker limit to economic growth than Smith allowed, but
Ricardo also claimed that this decline can be happily checked by technological
improvements in machinery and the specialization brought by trade. Wage
arbitrage has always been a key factor in international trade.
However, in the third edition of his Principles, Ricardo modified his
position on mechanization, observing that when mechanization displaces labor,
the labor thus "set free" may not be reabsorbed elsewhere in the economy
because capital is not simultaneously "set free". This creates downward
pressure on wages and lowers aggregate labor income, with the difference
absorbed by the high investment cost of capital goods. It is true that capital
goods also require labor to produce, but the productive lifespan of capital
goods after their initial labor input is very long, which brings about the need
for finance. Capital goods need decades of reduced labor cost to pay for them,
and their financing cost, that is interest, requires additional reduced labor
cost to service over the life span of the financing.
In order to reabsorb labor displaced by mechanization, the rate of capital
accumulation must continuously increase. But there is no obvious mechanism for
this to happen - particularly given the tendency for profits and thus savings
to decline over time from over investment. In a high-tech economy, which
Ricardo did not have the opportunity to observe in his life time, technological
obsolescence tends to require an even higher and more frequently recurring
level of mental labor input, rescuing high-tech workers from Ricardo's Iron Law
of Wages. The wage differential then falls even more heavily on production
workers.
Ricardo did not deal with the problem of uneven market demand on different
grades of labor created by mechanization, between educated
scientists/engineers, creative workers, and factory production workers. Until
the introduction of universal education, a non-market social program, unskilled
or low-skilled labor simply could not afford education for their children, thus
condemning them to the ranks of the unemployable for life generation after
generation. This created a shortage of educated workers and an oversupply of
unskilled labor, resulting in drastic income disparity.
As rises in income come to depend on education level, the cost of education
also requires financing over longer periods of schooling and more sophisticated
teaching and research facilities and institutions, limiting access by the poor.
The unequal access to education is the fundamental factor behind the rise of a
class society.
To Ricardo, rent is a result and not a cause of price. Rent has two different
meanings for economists. The first is the commonplace definition: the income
from hiring out an asset, such as money, land or other durable goods. The
second, known as economic rent, is a measure of market power: the difference
between what a factor of production costs and how much it would need to be paid
to remain in its current use.
A star entertainer may be paid $10 million a year when he/she would be willing
to perform for only $1 million under different circumstances, so his economic
rent is $9 million a year. In perfect competition, there are no economic rents,
as new entertainers are attracted by a high rent market and compete until
economic rent falls to near zero. Reducing rent does not change production
decisions, so economic rent can be taxed to reduce income disparity without any
adverse impact on the real economy.
Upon these concepts, Ricardo propounded his Iron Law of Wages and a labor
theory of value. The Iron Law of Wages asserts that wages naturally drift
towards minimum levels and cannot rise above subsistence levels. The theory of
value maintains that in exchange, the value, though not the market price, of
goods is measured by the amount of labor expended in their production. When the
market price differs from value, it causes either inflation or deflation,
producing drags on economic growth. Central banking was then invented to
maintain price stability via monetary elasticity and to control wage rises
through unemployment.
The national wealth of China is dragged down by low wages. All economic and
development policies should be focused on raising wages as a primary objective.
In recent decades, foreign direct investment has reinforced the Ricardo Iron
Law of Wages on the Chinese economy through the country's dependence on
exports. The Chinese export sector competes on its advantage in cross-border
wage arbitrage. This strategy depresses Chinese national wealth.
Until China realizes that export based on low wages is a self-diminishing
strategy, Chinese national wealth will remain underdeveloped no matter how much
foreign exchange reserves the country holds. National income denominated in a
nation's own currency is the only way to increase national wealth. And for a
large population country such as China, wages are the main source of national
income.
On interest, Ricardo had little to say. He observed that money, by which he
meant gold-backed specie money, not fiat money, "is subject to incessant
variations from its being a commodity obtained from a foreign country, from its
being the general medium of exchange between all civilized countries, and from
its being also distributed among those countries in proportions which are ever
changing with every improvement in commerce and machinery, and with every
increasing difficulty of obtaining food and necessaries for an increasing
population. In stating the principles which regulate exchangeable value and
price, we should carefully distinguish between those variations which belong to
the commodity itself, and those which are occasioned by a variation in the
medium in which value is estimated, or price expressed."
Ricardo asserted that a rise in wages due to inflation produces no real effect
on profits, known in modern times as cost-of-living increases, or indexation,
as prices of products also rise. A rise in real wages ahead of inflation has a
direct effect in lowering profits. Labor, when purchased and sold as a
commodity, may increase or diminish quantitatively in supply and has a natural
price and a market price. The natural price of labor is that price which is
necessary to enable laborers to subsist and "to perpetuate their race without
either increase or diminution".
Artificial price of labor
But there is nothing "natural" about Ricardo's natural price of labor. What
Ricardo called natural was actually an artificial socio-political regime. In
that regime, as then existed in England, population grew naturally without
intervention and the growth tended to be concentrated on the laboring poor, who
had the least capacity to intervene on their fate in society. Ricardo's natural
price of labor depends on the price of the food, necessaries, and conveniences
required for the subsistent support of the laborer and his family. Ricardo's
Iron Law of Wages is derived from his view that population is a liability
rather than an asset to the economy. The lower wages fall without starving
workers to death, the higher the profit capital can realize to produce a rich
economy.
Yet over-investment will lead to overcapacity unless wages rise to sustain more
consumption. To solve this problem of insufficient demand, neoclassical
economics resorted to foreign trade to earn gold to enrich the nation. In the
21st century, emerging economies, led by China, were seduced into dependence on
export. But under dollar hegemony, the exporting economies do not earn gold or
even gold-backed money. They earn dollars, which cannot be used in the domestic
economies without first converting the dollars back into local currencies.
This, however, will cause inflation because the wealth behind this local
currency has been shipped to foreign markets for dollars. The emerging
economies cannot shift towards domestic consumption because domestic wages have
been kept too low and the profit from low wages has gone to foreign capital
denominated in dollars.
In a functioning economy, the natural price of labor should be based on workers
being able to purchase the goods their labor produces. It should also be based
on society's concept of a good life, which includes good provision for family,
ample leisure to cultivate the body and spirit, occupational safety, health
care, continuing education, affordable housing and dignified retirement
benefits.
Subsistence has taken on different, more equitable and humane meanings since
the early days of the Industrial Revolution. Ricardo granted that with
technological and social progress, the natural price of labor always has a
tendency to rise, while the natural price of commodities, excepting raw
material and labor, has a tendency to fall because of innovation that improves
productivity.
When the market price of labor is determined by supply and demand, unemployment
is needed to depress the market price of labor. This can only be achieved by
increasing labor supply to saturate labor demand. When the market price of
labor exceeds its natural price, the condition of the laborer is flourishing
and happy. By the encouragement that high wages give to the increase of
population, the number of laborers will increase and wages will again fall to
their natural price level, and indeed from an overshoot reaction sometimes fall
below it. So goes the argument for population control for the good of the
laboring class, or as Ricardo put it, "the laboring race". The Christian
church, having for most of its history allied itself with establishment
interests, opposes birth control in modern times for more than religious and
moral reasons.
When the market price of labor is below its natural price, the condition of the
laborers is wretched and poverty results. It is only after their privations
have reduced population increase, or the demand for labor has increased through
economic growth, that the market price of labor can be raised to its natural
price, and that the laborer will have the moderate comforts which the natural
rate of wages will afford.
Notwithstanding the tendency of wages to conform to their natural rate, their
market rate may be constantly above it in an improving and progressive society
for an indefinite period. Thus, with every improvement of society, with every
increase in capital, the market wages of labor will rise; but the permanence of
their rise will depend on whether the natural price of labor has also risen;
and this again will depend on the rise in the natural price of those
necessaries on which the wages of labor are expended.
As population increases, these necessaries will be constantly rising in price,
because more labor will be necessary to produce them and more people are
consuming them. If the money wages of labor should fall, while every commodity
on which the wages of labor were expended rose, workers would be doubly
affected, and would be soon totally deprived of subsistence. Instead of the
money wages of labor falling, they would rise; but they would not rise
sufficiently to enable the laborer to purchase as many comforts and necessaries
as he did before the rise in the price of those commodities.
Ricardo concluded that these are the iron laws by which wages are regulated and
by which the happiness of far the greatest part of every community is governed.
Labor then has a self interest in assuring the profitability of employers. This
has been a self-regulating attitude since adopted by the labor union movement,
putting labor at a constant disadvantage in contract negotiations.
Thus according to Ricardo, emerging economies with an underdeveloped labor
force such as China cannot expect to escape incomes disparity because capital
formation depends on keeping workers poor.
China and the labor market
Unless and until policymakers in China realize that labor is not a commodity
and that a labor market should not exist any more
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