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Using Game Theory to Optimize the Pace of New Technology Adoption
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US Unemployment Data

The Changing Nature of the Labor-Capital Game

The Labor-Capital Game

V.1: Pre-1980s

V.2: 1980s – 2000s

V.3: 2000s -

Job Mismatches

The Job Mismatch Issue

The Changing Nature of the Demand for Labor

The Changing Nature of the Supply of Labor

Government Policies Impacting Unemployment

The Future of Labor

 

US Unemployment Data

The following three figures present US unemployment rates

Figure 1

Figure 2

Figure 3

The data indicate that the portion of the population most in need of jobs are young, unskilled workers without a college degree.

The changing nature of the global economic environment and its impact on the US economy suggests that a large portion of the jobs lost by unskilled workers during the past several years (if not longer) are never coming back, even when the economy recovers from its current stagnation. That is, a large part of the unemployment problem is not a temporary problem, but rather, a structural one.

 

The Changing Nature of the Labor-Capital Game

At its most basic level, economic production theory posits that companies use a combination of three types factors of production to transform raw materials into final products, Y:

Y = f(K, L, H), where

  • Capital (Equipment/Machinery/Infrastructure), K is limited by the current state (availability) of technology, tech, and the cost of capital, k.

K = K(tech, k)

  • Unskilled Labor, L, is limited by the costs of coordination/communication comm, transportation, t, the prevailing local and offshore wages, w and w’, and the costs of complying with government regulations regarding worker health, safety, taxes, etc., reg.

L = L(comm, t, w, w’, reg)

  • Skilled Labor (Human Capital), H, is limited by the current state (availability) of knowledge/information, info, the costs of coordination/communication comm, transportation, t, the prevailing local and offshore wages, W andW’, and the costs of complying with government regulations regarding worker health, safety, taxes, etc., reg.

H = H(info, comm, t, W, W’, reg)

Of course, there is also semi-skilled labor, but to simplify the analysis, I exclude them from the analysis.

Companies can usually substitute one factor for another, to a greater or lesser extent. Most commonly, unskilled labor and capital substitute for one another. In particular, in the US, capital is relatively cheap compared with labor, whereas in China, labor is cheap relative to capital. So many US companies use machinery to do the same types of tasks (e.g., production line) that China uses labor to accomplish.

As for costs to employers associated with government regulations (reg and reg), OSHA was established in 1970, Social Security payroll taxes were established in 1937 (see Figure 4), and Medicare payroll taxes were established in 1966 (see Figures 4). Payroll taxes totaled 4.8% in 1970, 6.13% in 1980, and 7.65% starting in 1990 and continuing through the present.

Figure 4

As a proxy for the state of technology, we can use Moore’s Law (see Figure 5 (taken from Wikipedia)).  Moore’s law indicates that the state of technology has grown exponentially over time since the 1970s.

Figure 5

 

The Labor-Capital Game

The dynamics of the battle between business managers, skilled and unskilled workers, and makers of technology is a game: each player’s payoff (profits) is affected by the actions taken by the other players. In particular, business owners can substitute capital (technology) for skilled or unskilled labor, and it can substitute offshore labor for local labor, depending on the costs of communication/coordination (comm) and transportation (t), the state and cost of technology (tech, k), the state of knowledge (info), local labor regulations (reg), and the price of labor, both locally (w, W) and offshore (w’, W’).

Figure 6 provides an illustration of the game, where each (set of) player(s) is represented by a node and the dotted black lines show which factors can potentially substitute for other factors.

Figure 6

 

The game has evolved over time as the state and price of technology, the state of knowledge, and the supply and price of labor, both locally and offshore, have changed.

 

V.1: Pre-1980s

US companies were unable to cost-effectively coordinate the outsourcing of labor to lower wage countries until transportation and communication costs became low enough, during the 1980s and 1990s. Prior to then, US companies were forced to use local labor.

The Labor-Capital Game for this period is displayed in Figure 7.

The decision facing business owners/managers was to choose among unskilled labor, skilled labor, and capital so as to maximize the profits of the company.

Since communication/coordination (comm, comm) and transportation (t, t) costs were relatively high at that time, outsourcing was prohibitively expensive, so management was forced to use local (US) labor.

At the same time, while labor was being replaced by automation to some extent, the state of technology was relatively primitive, as compared with the state of technology today.

These restrictions against using outsourcing or automation to substitute for much labor provided unskilled labor in particular with a lot of leverage to negotiate relatively high wages. It was during this period that blue collar workers with no more than a high school diploma ascended into the middle class (see, for example, Louis Uchitelle, “The Wage That Meant Middle Class”).

Figure 7

 

V.2: 1980s – 2000s

During the 1980s and especially the 1990s, new technology innovations induced dramatic reductions in transportation and communication costs, which, in turn, drove large expansions in globalization, and with it increases in the intensity of competition. It was during this period that many companies started outsourcing large portions of their back-end and/or non-core operations to India and China (see Figure 8) so as to be able to compete more effectively with rivals. While both skilled and unskilled labor fell victim to outsourcing, the hardest hit by far was unskilled labor. According to Sourcing Line,

The modern services offshoring trend was first enabled by progress in telecommunications in the second half of the 20th century. Prior to low cost telecommunications and the internet, managing services in distant locations was too costly, difficult, and risky. Well trained low-cost workers were available in the global market, but western managers did not have the tools to effectively tap into the resources. During the 1980s it began to change. Modern conveniences such as inexpensive telecommunications and air travel, and rise of the personal computer and internet completely transformed the cost-benefit equation.

Figure 8

 

As the trend in outsourcing labor started to gain traction, the labor unions were endangering their livelihoods by continuing to press management for high wages and benefits. The unions seemed to be considering only their relative positions – their past and current wages and benefits relative to their hoped-for increases in future wages and benefits -- rather than their absolute positions – their past and current wages and benefits relative to the new possibilities of offshoring.

The threat of outsourcing facing union labor and big labor’s reaction to it was akin to the record label’s reaction to the advent of massive downloading of music on the Internet. Neither big labor nor the record labels seemed to understand that they were facing a permanent change in the structures of the respective industries. The caustic reaction of both – pressing harder for higher wages and benefits on the part of the unions, and suing downloaders (lost customers) for piracy – seemed only to hasten the transition to the new realities -- the increasing tendencies both to offshore (or go bankrupt) on the part of business management and to download digital music on the part of music listeners.

 

V.3: 2000s -

During the 2000s and into the 2010s, technological advances in the form of software (and robotics) automation introduced the possibility of substituting automation for labor (see Figure 9).

Figure 9

In particular, the financial crisis of 2008 and the recession that it subsequently induced have caused consumer demand to plummet. To survive the “new normal” (decreases in consumer demand, together with increases in global competition), businesses have been forced to seek out greater efficiency. As such, many businesses have turned to (software) automation as a less expensive substitute for labor. Examples in which automation has replaced labor include: self-scanning checkouts, automated bank tellers, computerized technical support systems, airline ticket purchasing and check-in, and legal discovery and document review.

The tremendous pace of development in both India and China over the past few decades have led to significant increases in the cost of labor in these countries. At the same time, as fuel prices have increased over the past several years, so have transportation costs. Finally, businesses have experienced coordination problems associated with international supply chains. These three factors together have led some businesses to bring back some previously offshored labor to the US.

Nonetheless, the continued weakness in the economy, along with ongoing increases in global competition, mean that businesses will continue to transition to sources of automation in lieu of hiring new workers.

Despite the harsh nature of the current economic environment, labor unions seem unwilling to accept the new reality. They continue to fight business management for higher wages and benefits. Some more recent casualties of unyielding unions include airlines, state and local governments, schools, and Hostess Bakeries.

 

Job Mismatches

Remarkably enough, I found a single article that just appeared in the WSJ that pretty much covered all the major issues surrounding the alleged job mismatch problem: Mark Peters and David Wessel, “A Jobless Dilemma: What’s Wrong with Fort Wayne?” In this section I quote heavily from this article.

 

The Job Mismatch Issue

The article perfectly describes the job mismatch issue:

That mismatch between skills and applicants, available and desired pay is a big conundrum in today's labor market. Most economists conclude that the bulk of today's unemployment, there are 3.4 jobless workers for each opening or nearly double the December 2007 level, would disappear if business conditions improved. If they're right, then pumping more fiscal or monetary stimulus into the economy will bring unemployment down; if they're wrong, then short-term measures are useless and the U.S. will be plagued with higher-than-traditional levels of unemployment for a long time.

Unlike “most economists,” I don’t think the jobs problem will be solved as the economy starts to improve. As I detailed in the previous section, The Changing Nature of the Labor-Capital Game, I believe that changes in the economic environment have created a problem for many unskilled and skilled workers, in particular, those whose jobs can either be offshored or automated. I believe these workers will continue to have a difficult time gaining employment, even as the economy starts to improve, due to the changing natures of both demand and supply in the labor markets.

 

The Changing Nature of the Demand for Labor

The nature of demand in US markets has changed over time: technology has enabled labor to do more with less. In particular,

Industries that undergo this transformation [increasing use of automation and information technology] don’t disappear, but the number of jobs that they support changes drastically. Consider the business of farming, which employed half the population in the early 1900s but now provides just 3% of all jobs. The United States is still a huge exporter of food; it is simply a far more efficient food producer now in terms of total output per farm worker…

Since 1970, manufacturing jobs as a percentage of total employment have declined from a quarter of payrolls to less than 10%. Some of this decline is from outsourcing, some is a result of othersourcing. Those looking for a rebound in manufacturing jobs will likely be disappointed. These jobs will probably not be replaced—not in the United States and possibly not overseas, either.

  • Increases in the stock of knowledge and the reliance on technology over time have increased the skill requirements of workers. From “A Jobless Dilemma”

…[Y]ears of improving productivity, or output per hour, have made each individual worker more important and, thus, tend to make employers pickier... “The toughest part is you don't just need an individual, but the skill set to go with them” …

  • Increases in worker productivity has increased the value to company and cost of replacement of each employee, which has increased the pickiness of employers. From “A Jobless Dilemma”

Such versatile workers are hard to find, he said. "Are we being too picky? No, we're not because every time we hire someone we're making a million-dollar decision," he said, factoring in the long-run cost of pay, benefits and training.

There has been a change in the nature of new job openings. Specifically, new jobs being added to the Service sector jobs tend to require different worker skill sets than manufacturing jobs.

Figure 10

  • Due to the high rates of unemployment, there is currently a large pool of applicants (excess supply of labor) for each job opening. Such an excess supply of labor means
    • Employers can be choosy.
    • Employers can shift the burden of training, or otherwise obtaining the appropriate skills, onto workers. This may take the form of unpaid apprenticeships.

 

The Changing Nature of the Supply of Labor

At the same time as the changing nature of demand in US markets, the nature of supply has also changed. In particular,

  • The availability of unemployment benefits provided by government to address the downturn in the economy has deterred workers from taking available jobs. Unemployment benefits provide unemployed workers with an alternative to seeking new employment. This is particularly a problem for unskilled workers. From “A Jobless Dilemma”

At the other end of the spectrum, employers are having trouble hiring for jobs that require little more than high school education, a clean drug test and a steady work history. Some here say the availability of unemployment benefits, between $50 and $390 a week depending on past wages for up to 63 weeks, makes workers picky.

"Individuals who are on unemployment, some...feel they can make more money that way than actually working, and some of them probably are," said Kathy Carr, hiring manager for the local school district.

  • The newer generation that has grown up with the digital economy tends to lack formal communication skills. From “A Jobless Dilemma”

The second qualification, communications, is the challenge. One warning sign, he said, are job applications filled out like text messages with abbreviations, slang and smiley faces.

And finally, unskilled workers in particular are having a hard time re-adjusting their expectations in the new global environment. More specifically, as globalization has led to a vast increase in the supply of unskilled labor, there has been downward pressure on wages in the US for jobs that can be outsourced (or automated) to lower-wage nations. While economic theory would suggest that rational workers would immediately adjust their expectations as the economic environment changed, in reality, it’s not so easy. It is tremendously psychologically difficult for people to accept the fact that they are no longer as valuable to employers as they used to be. As long as workers can cling to the idea that the unemployment situation is temporary – and they are aided in this delusion by the generous unemployment benefits being made available by the government – they can refuse to accept the new reality that the jobs they are qualified to fulfill simply pay less now than they used to.

 

Government Policies Impacting Unemployment

Government has undertaken a few policies to specific address the unemployment and job-mismatch problem. Specifically, it has provided funding for job (re-)training through the American Recovery and Reinvestment Act (ARRA):

The major ARRA provisions that will beef up training include:

    • $1.25 billion for dislocated adult workers, such as those laid off or who have received advanced notice of a factory closing.

    • $1.2 billion for dislocated youth workers.

    • $500 million in state grants for employment services, mainly for low-income adults.

  • $500 million to fund training for sustainable energy jobs.

Government studies indicate that the funding for retraining has had a positive impact on employment; however the funding is also expected to increase budget deficits “by about $833 billion over the 2009–2019 period”, as per the August 2012 CBO report.

At the same time, however, government policies have also worked against the unemployment problem. The government’s policy of keeping interest rates low to help stimulate business development will have a negative impact on job creation, especially in labor-intensive industries, through two venues in particular. First, since low interest rates decrease the cost of capital, they encourage business managers to substitute technology (automation) for labor. And second, low interest rates increase the cost of labor by increasing the burden of pensions. With low interest rates, pension funds will expect lower returns on investments, thereby requiring higher contributions for any given eventual payout.

Government’s policy of continually extending unemployment benefits is also having a negative impact on employment. By providing unemployed workers with a viable alternative to seeking new employment or job training, government is prolonging the unemployment problem.

And then there’s the impending fiscal cliff. If the government does not come to an agreement, then payroll taxes will increase as of the beginning of the year. Higher payroll taxes increase the burden of labor, thereby decreasing the demand for labor.

 

The Future of Labor

in “Hard at Work in the Jobless Future”, James H. Lee notes (emphasis mine):

Fixed hours, fixed location, and fixed jobs are quickly becoming a thing of the past for many industries, as opportunities become more fluid and transient. The 40-hour workweek is becoming less relevant as we see more subcontractors, temps, freelancers, and self-employed. The U.S. Government Accountability Office estimates that these “contingent workers” now make up a third of the workforce. Uncertain economics make long-term employment contracts less realistic, while improvements in communications make it easier to subcontract even complex jobs to knowledge workers who log in from airports, home offices, and coffee shops…

The career path for younger generations more closely resembles a patchwork quilt, as people attempt to stitch together multiple jobs into something that is flexible and works for them. In today’s environment, they sometimes can’t find a single job that is big enough to cover all of their expenses, so … they find themselves working multiple jobs simultaneously. Some of these jobs might match and be complementary to existing skills, while others may be completely unrelated.

The continuing trends toward globalization and automation will continue to put downward pressure on wages of jobs at risk of being offshored or automated. In particular, there will continue to be decreases in relative wages and/or demand for labor of unskilled workers and there will continue to be increases in relative wages and/or demand for labor of skilled and/or adaptable workers.

The continuing trends toward increasing productivity in the manufacture of goods with increases in the states of knowledge and technology suggest that there will continue to be increases in employment in services (that are less subject to automation) relative to manufacturing.

The increasing connectedness of global players suggests there will continue to be increases in the complexity of the global environment. As such, the trend towards flexible employment arrangements will continue (as noted by Lee). At the same time trends towards outsourcing non-core tasks (de-integration of businesses) will continue, leaving businesses smaller (with less fixed overhead) and more flexible. This also suggests that businesses will rely more on market transactions, as opposed to intra-company transactions. The implication here is that any product or service that will enhance the speed or ease of market transactions or decrease their risk will continue to be of value.

Finally, increases in regulations and taxes on labor (e.g., payroll taxes, OSHA requirements, Obamacare) will continue to push businesses toward more offshoring and/or automation.

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