More Socially Desirable Firms gain strength from Normalization of Monetary Policy
If the Fed raises interest rates and marginal companies are pushed into struggling for survival, is this a bad thing? Won’t we lose jobs? Won’t wages be hurt? Well, the question is… Are the healthier companies (those that can better survive a higher Fed rate) willing to make employees happier?
Well, we now have a study that supports the view that healthier companies are more likely to have happier employees. And I safely assume for the moment that happier relates to better pay. What did the study find?
“Companies that employees report to be a good place to work have significantly outperformed the S&P 500 over the past six years… Since 2008, the S&P 500 has returned 121%, but the companies that employees rate well have returned 218.5%.” (source WSJ)
These more profitable companies are the ones that would easily survive a normalization process of monetary policy… And the employees are much more satisfied.
Even though the source article from the WSJ offered some explanations for this condition, labor economists have been aware of this condition for a long time. Beatrice Webb and her husband wrote about it over a hundred years ago. Here is a quote from a paper by Bruce Kaufman.
“Apropos labels today are “low road” vs. “high road” employment systems.”
“This duality comes from a combination of technological, institutional and human features. A consequence of assuming heterogeneity in factor inputs and production sets is that firms have different cost curves and, given a uniform market price for the good, different levels of profit. As a useful generalization, some firms are very technologically advanced, have efficient managements, and operate at a larger minimum efficient scale. These firms earn above normal profits and, for human motivational reasons, share some of their rents with workers. On the other end of the same product market are undercapitalized, small-scale, and poorly managed firms with higher cost curves that put them in a constant struggle to stay in business. Here, instead of sharing rents, these firms stay in business by taking it out of workers in the form of wages and conditions below the competitive social cost level. The Webbs characterize the worst of these firms as sweatshops and note, “the bottom of the industrial army…. suffers not from great capitalists but from small masters”.” (Kaufman 2013)
These “high-road” firms are more likely to pay better wages. And the implication is that accommodative policy to keep marginal firms alive has put a drag on wage increases. This is why I say that a properly-timed raise in the Fed rate is efficient for the economy and allows better wages in the medium-term. Recent accommodative monetary policy has kept “low-road” firms in business.
More from Bruce Kaufman on the dual structure between “high-road” and “low-road” firms…
“Institutional factors also encourage a dual structure. The larger and better managed firms often develop internal labor markets (Doeringer and Piore 1971). This term was not invented when the Webbs wrote but they observed that certain large employers in the late 19th century were already using various devices to create a long–term employment relationship on the belief it increases productivity and profit (1897: 661 – 62). Smaller–scale and less efficiently managed firms, on the other hand, gain cost advantage by relying on the external labor market with low wages, high turnover, and bare bones training and conditions. Other institutional factors creating a dual structure are sectional collective bargaining, gendered social norms, and labor laws specific to occupations and industries.” (Kaufman 2010)
Edward
in a word: Wal-Mart.
i guess the only thing worse than statistics is “studies,” or maybe “theoretical models.”
I don’t mean to be a pain, you could still be right about all of this, but the arguments you give are not very convincing to me at least.
Coberly,
Yes, I had Walmart in my mind when I wrote the above. Keep in mind that Walmart stock has only risen 60% since its low after the crisis from about 50 to 80 now. The stocks of companies where employees are satisfied rose 218%.
I realize Walmart is a big company but that does not mean that it is a profitable company. Walmart falls into the category of a low-road firm even though the Webbs long ago implied that large firms were high-road firms.
If you put the screws to Walmart with normalized monetary policy, you make Walmart more vulnerable and you open the doors to its more socially desirable competition. Walmart will be forced to play the game and be more socially beneficial. Tell me that is not a good thing.
You provide evidence that “high-road” and “low-road” firms exist but do not show any further evidence that tighter monetary policy will lead to an increased percentage of the population becoming employed by “high-road” firms.
No evidence is given that “surviving firms are more likely to raise wages and make their employees happier”.
Further, it seems like a large minimum wage hike could work quite well to “weed out the “low-road” firms” while guaranteeing wage increases outright.
Edward
I can’t tell you that is not a good thing. I can tell you I don’t understand it.
Walmart is big and should be able to absorb whatever comes in the way of interest changes. I don’t know who their more efficient competition is.
What I wish you would do is what I have always wished you would do: Explain it in cause and effect terms and real examples that a simple peasant like me can understand.
Otherwise I keep thinking you are thinking in terms of imaginary constructs.
I think this theory fits well with the US experience over time. The “low road” firms are like slow-growing tumors on the economy. During the Golden Age , tumors were excised periodically by recessions ( a relatively benign , in-patient procedure ) allowing sustained overall health. During the Great Moderation , tumors were allowed to spread. Now we need major , and potentially disabling , surgery.
With perpetual QE , or Sumner’s NGDP targeting , it will be all-cancer , all-the-time.
Edward,
I kinda agree with Coberly that there is not enough there to draw the premise that you are making.
Wal-Mart may be a low margin business that makes its money through volume, but their absence from the market place would not create a vacuum whereby better companies fill it. Besides, Wal-Mart never fears marketwide changes in the cost of doing business since a general increase across the market would leave them in the same relative position, which is why they often support min wage increases. A bigger impact by the change would most likely be felt by mom-and-pop’s and mid-size firms. Are those the low road firms to which you are referring?
K
Coberly & Kai HK
Low road firms have taken on the name of zombie firms recently. Here is a link where Bill Gross talks about low interest rates keeping zombie firms alive….
http://globaleconomicanalysis.blogspot.com/2015/03/bill-gross-too-much-debt-too-many.html
“[Low interest rates] keeps zombie corporations alive because they can borrow at 3 and 4 percent, as opposed to the 8 or 9 percent. It destroys business models. It’s destroying the pension industry and in the insurance industry.”
Edward
thank you. what this tells me is that you and i are thinking about completely different things when we talk about “efficient” companies.
that’s the kind of thing that makes discussion futile and politics effective.
Coberly,
Low/road firms and zombie firms together hold down productivity, wages and economic growth.
In the desire for quantity, monetary policy has sided with entrepreneurs and sacrificed quality. The Fed knows that it is time to discipline. There are ranks inside the Fed research teams beating this drum.
Edward
this would be easier for me to understand if i knew who you meant by low road and zombie, and why Fed policy is not just going to help the efficient Home Depot drive out the friendly mom and pop. I need cause and effect and real examples. I spent too much of my life believing fairy tales about abstractions and “logic.”
Coberly,
The mom and pop’s are already desseminted. Monetary policy seems almost powerless to counteract that. Local savings are channeled off to New York to be not invested in local communities.at whatever interest rate. Big national firms have previleged access to those channeled funds.
Amongst the big national firms there are firms on the margin. Of course there are always firms on the margin, but low interest rates loosen the margin. At what point is it not socially beneficial to loosen the margin. That can be a judgement call in the eye of the beholder.
You may want the marginal firms to stay in business as much as possible.because you do not want to lose any jobs. But that is the logic against raising the minimum wage too. And it doesn’t hold. You can raise the costs of capital and labor and gain net social benefits for society.
My research tells.me that interest rates are too low and reducing net social benefits.
thanks, Edward
I may gradually come to see things your way when I know what you know.
meanwhile i am looking at a farmer who has been destroyed by the Big Recession and the West Coast dock strike and maybe by some predatory lenders so I am not really a great fan of the way America does business.
Edward,
cross section studies tell you nothing about dynamics. Increasing interest rates will only make some good firms bad, and people are happier having a lousy job rather than none at all. Firms aren’t good and bad immutably, they change. Ask people who worked for IBM and Hewlett-Packard.
Reason,
Then why ever raise the nominal rate? Just keep it at zero for ever and ever and never think about raising it.
Edward
that is a very disappointing answer to Reason. I personally don’t know why the Fed “ever” raises or lowers rates. I thought it had something to do with managing inflation versus recession, but I have not been convinced that the policy actually works (times of high inflation might cause people to borrow at high rates as likely, or almost as likely, as to stop borrowing (investing) because interest is too high.
on the other hand, i thought a free market would “set” interest rates according to the demand/supply of money. and that doesn’t seem to be the whole story either.
meanwhile the kind of cause and effect argument for (or against) raising rates that i was hoping for would go something like this (something like, i really don’t know anything):
a farmer (or retailer or manufacturer) has to borrow money to start a business. he pays interest on that money. normally he hopes that by the end of the year he has made enough money to pay the interest on his loan as well as his other expenses and leave something for himself. if rates go up he may not be able to pay the interest as well as his other expenses as well as his “profit.” this would mean he was “inefficient” by your standards, and would go broke and become homeless, while some larger, more efficient, farmer retailer manufacturer would not go broke and take over the business of the now-failed firm. this might mean economic progress. or it might mean that we have an economy with one person out of 15 unemployed, perhaps literally starving and homeless. and as everyone knows, once the big company has driven out all the little inefficient companies, their prices go up, and their wages go down.
of course in the famous long run all those out of work former businessmen find better jobs in data processing, so it works out for the best. for the bankers.
something like that?
Coberly,
Reason used the word “only” which implied that raising interest rates never has a good affect, so why do it at all… but it is important to remember that raising rates has a beneficial function to stabilize growth at full employment.
After a recession, nominal and short term real rates need to be low in order to give the economy momentum to return to full employment. But then when you reach full employment, you need nominal rates at a level that will stabilize full employment. Otherwise all kinds of excess overheating will destabilize the economy.
In the case of your farmer, he needed to borrow when the rates were low in the business cycle and store cash in case of cash flow trouble.
Agricultural economics is a different ball of wax too. I was involved in the futures market for some years, especially soybeans. It is important for farmers to know when to lock in their profits using the futures market. The big farmers know how to do this. The smaller farmers sometimes are too hesitant to get involved which puts them in peril. They get more scared of the futures market. I do not know the specifics of your farmer friend, but there are many ways for small farmers to fail by not handling their money well.
Lambert
thanks. i missed the “only.” generally i think it not best practice to let a discussion fall on the basis of one word. far too easy to misunderstand each other.
my farmer friend did a number of things i wouldn’t have done… mortgaged his house to pay farm debts being the worst.
i don’t think a farmer should be expected to play the futures market to be a good farmer. if that’s what it takes to provide insurance against bad days in farming, i’d rather see the government handle it.
otherwise i think i understand, sort of, what you are saying. still think it opens the way to bad outcomes that economists hide from themselves by talking always in terms of abstractions. i know you can’t avoid abstractions, but to the extent they allow you to ignore the human cases, they are destructive.
I didn’t mean “never” when I said “only”.
oops in this case that should be
I didn’t mean “always” when I said “only”. What I meant was that that would be the consequence in the current circumstances (because as Coberly pointed out, nominal growth is too slow to repay loans at higher interest rates. Nominal growth won’t magically increase when you increase interest rates – actually you only increase SHORT term non risky interest rates – in the current circumstances long term non interest rates might actually fall, but the risk premium will increase – that is the problem with only talking about THE interest rate as though there was only one).