By Cristian Alonso, Siddharth Kothari, and Sidra Rehman New technologies like artificial intelligence, machine learning, robotics, big data, and networks are expected to revolutionize production processes, but they could also have a major impact on developing economies. The opportunities and potential sources of growth that, for example, the United States and China enjoyed during their […]
In a recent blog post, I wrote:
Aside for non-economists: Why would reductions in income tax rates on corporations and on high-income individuals even be expected, at a theoretical level, to increase real wages? By increasing the incentive to invest in capital. The greater the capital to labor ratio, the higher are real wages.
Commenter Robert asked:
Could someone expand on this a bit for me? Does investing in capital, mean investing in capital goods (i.e., land, machinery, tools, etc)? I don’t understand why that would necessarily lead to higher real wages.
Commenter Laron gave a nice succinct answer:
The capital goods like machinery increase labor’s productivity, which increases wages. Others can chime in with more detail or to correct me tho.
Here’s what the article on “Capital Gains Taxes” in The Concise Encyclopedia of Economics says about the issue:
Between 1900 and 2000, real wages in the United States quintupled from around fifteen cents an hour (worth three dollars in 2000 dollars) to more than fifteen dollars an hour. In other words, a worker in 2000 earned as much, adjusted for inflation, in twelve minutes as a worker in 1900 earned in an hour. That surge in the living standard of the American worker is explained, in part, by the increase in capital over that period. The main reason U.S. farmers and manufacturing workers are more productive, and their real wages higher, than those of most other industrial nations is that America has one of the highest ratios of capital to worker in the world. Even Americans working in the service sector are highly paid relative to workers in other nations as a result of the capital they work with. In their textbook, Nobel laureate Paul Samuelson and William D. Nordhaus noted: “Because each worker has more capital to work with, his or her marginal product rises. Therefore, the competitive real wage rises as workers become worth more to capitalists and meet with spirited bidding up of their market wage rates.” The capital-to-labor ratio explains roughly 95 percent of the fluctuation in wages over the past forty years. When the ratio rises, wages rise; when the ratio stays constant, wages stagnate.
The quintupling in the above is certainly an underestimate because the Consumer Price Index, used to adjust for inflation, overstates inflation.
A way to think about it is with a person on a desert island catching fish. If he does it with his bare hands, he can catch, say 2 fish a day, enough to keep from starving. But if he fashions a stick that can spear the fish, he can catch, say 4 fish a day. So that one piece of capital, the spear, has doubled his productivity. His real wage has doubled.
Then Robert followed up:
Thanks Laron. That was kind of what I was assuming was meant in the quote. I don’t know if I fully trust a business to return higher productivity back to workers in the form of higher salaries, but I can see how and why that could happen.
Here’s why it would happen. A worker becomes more productive, not just with his current employer but also with other potential employers. So if an employer does not pay the employee an increased wage for increased productivity, another employer will offer more than the current employer. That will happen until the marginal revenue product (the marginal revenue produced by the employee’s marginal product) equals the wage.
Honor laborers by letting them work
On this Labor Day, it’s fitting to appreciate and defend people’s right to engage in labor. That right has been under attack since March as state and local governments have threatened force to stop waiters and waitresses, bartenders, hairdressers, manicurists, gym trainers, and Pilates instructors, to name a few, from practicing their trade.
And it’s not as if the politicians defending those rules think that they themselves should be subject to them. Nancy Pelosi’s only apology for breaking a rule in San Francisco by getting her hair done was for being set up (i.e., caught on camera), not for breaking the rule. Chicago major Lori Lightfoot thought that she should be able to her hair done even though the commoners are not. The difference, you see, is that she was “in the public eye.” Government workers in San Francisco are allowed to go to government-run gyms while the government keeps private gyms closed.
As I said in a recent talk I gave on Zoom to an audience in Nashville on August 13:
Classical liberals and libertarians have often been charged with not caring about the working class. That charge never stood up to scrutiny. But it is especially clear now that we who advocate the right to make a living are the true defenders of the working class.