Bloomberg Businessweek of May 29 had a fascinating article propounding a “Big Mac” labor value theory, and using it to suggest that all restrictions to international migration were economically damaging. I have disagreed strongly with that conclusion from time to time in this column beginning in 2004, but yet found the basic data evidence compelling. I thus thought it worth deconstructing the article’s logic to see where its reasoning was in error and what economically sound conclusions could be drawn from the data presented.
The earnings evidence is clear. In the United States, a McDonald’s employee earns an average of $7.22 per hour, compared to a Big Mac cost of $3.04; thus the employee earns 2.38 Big Macs per hour. In India, the average employee earns 46 cents per hour while the Big Mac costs $1.29, so the employee earns 0.36 Big Macs per hour. According to Bloomberg Businessweek, both employees do the same work; thus the U.S. employee earns 6.6 times as much as the Indian employee, simply for living in the United States.
The article then goes on to recount the fate of employees of one of the big Indian software companies, who earn far more when transferred to the United States than they do in India, and are then back on Indian pay scales when they return to India. The article draws from these examples the highly questionable conclusion that world welfare would be maximized if all immigration barriers were removed, so that Indian McDonalds employees and software engineers could flood to the United States and earn the juicy remunerations available in the Land of Opportunity.
It requires a little deconstruction to determine why this conclusion is rubbish. Is the differential between Indian and U.S. McDonalds employees purely a matter of location, and would Indians be able to pick up the higher U.S. living standards by mass migration to the U.S.?
One factor glaringly left out of the Bloomberg Businessweek calculation is that of productivity. Its glib assumption that the job of McDonalds employees in India and the United States is identical is almost certainly wrong. For one thing, a Big Mac occupies a different market position in the relatively impoverished India to that in the United States.
Even when I lived in Zagreb, Croatia, a country considerably richer than India, McDonalds had a very different social position from that in the U.S. Being American, McDonalds was where the relatively affluent young Zagrebacki hung out on a Friday evening. For families, being taken to McDonalds was more of a treat than in the U.S., and children’s birthday parties were held at McDonalds even by the affluent and sophisticated. The “product,” defined to include the ancillary services and overall experience, was different too. You were much more likely in Zagreb to have the food brought to your table when it was ready, and the outlet was spotlessly clean, far more so than most McDonalds in the United States.
For the less affluent in Zagreb, there was an alternative to McDonalds in the cevapi houses, which served the local delicacy of meat on a skewer, accompanied by a little salad in a pita bread half. Those outlets were “faster” than McDonalds – more crowded, with rushed service and tables that weren’t spotless. While the cevapi were delicious, they doubtless involved less McDonalds-style quality control.
Given that the product and its market position were different in Zagreb from the United States, I’m quite sure staffing levels and the jobs involved were also different, as they would be in Mumbai. For one thing, far more man-hours must have been devoted to keeping the place clean and providing modest service to its upscale clientele. It makes sense; if labor costs only 0.36 product units per hour instead of 2.38, then the optimal production and service mix will use considerably more of it. Thus productivity, in terms of the number of Big Macs served per employee, will be lower in a poor country even if the employees themselves work equally hard. I would also guess that the training involved for a McDonalds employee in Mumbai is more substantial than for one in New York, since the disciplines of hygiene and regimentation needed to succeed are less ingrained in the local society as a whole.
The Indian software example is more difficult, until you consider what function the software engineer fulfils within the Indian company. For the company, it is much costlier to have software written in the United States than in India, unless the productivity of the U.S. workforce is much greater than that of its Indian staff. However, the company employs software engineers in the United States because it needs them to be in the same timezone as its customers, and if necessary able to visit them, in order to provide marketing, customer service and support activities. The two jobs are not identical, even if the engineers are the same people, and the company would lose huge amounts of money if it transferred all its Indian workforce to the U.S. since its employees’ wages would be raised by competition from local employment opportunities.
In a theoretical economic model, welfare might be optimized by eliminating immigration restrictions. But that could not happen by moving the Indian, Chinese and African population to the United States and raising their wages to U.S. levels, because they would not be sufficiently more efficient in a U.S. setting to support the higher wages. Instead, while the overall global average wage might be somewhat higher, most of the differential would be eliminated by U.S. wages falling to emerging market levels. U.S. politicians, responsible for the welfare only of the U.S. electorate, would be betraying their voters if they contemplated any such move.
In reality, any such mass migration would incur such huge assimilation costs that the theoretical benefits of leveling the playing field would be largely wiped out. However, that is not a counsel of despair. Free trade is not the same thing as free migration; the case for it is very much stronger. In particular, the “globalization” caused by the Internet and modern telecommunications has hugely increased economic welfare for the citizens of poorer countries, provided those countries are even moderately competently run. (The recent economic histories of India and China, both badly run countries by any Western standards outside Greece, are good examples of this.)
It is now clear however that globalization has also depressed living standards for the less able citizens of rich countries, raising their unemployment rate as wages are to a certain extent “sticky” on the downside. That does not mean that globalization should be rejected by Western politicians; having been an artifact of technology rather than policy, it would almost certainly have been impossible to stop, and any attempt to do so would have left the country attempting it both poorer and more isolated than when it began. In any case, there is every sign that the initial effect of the Internet revolution is approaching completion; the rapid increase in Chinese wage rates and disappearance of the Chinese balance of payments surplus certainly suggests that a new equilibrium is being reached.
To improve the living standards of Western countries’ citizens in this new equilibrium, and reduce their debilitatingly high unemployment, new policies are necessary. Increasing mass immigration increases the pressure on domestic living standards, especially at the bottom; it should thus be avoided. Education, so often touted as the panacea for facing the increase in international competition, is clearly no such thing, because it is of mediocre quality and excessive cost. In any case at all but the most exclusive levels it can easily be copied overseas (as the recent Indian successes in the software business have demonstrated). Instead, interest rates must be raised to levels that rebuild the capital base in rich countries, rather than decimating it as has been the case with the Greenspan/Bernanke polices. By increasing the incentives to saving, and the returns from it, policymakers can increase the rich countries’ natural advantage in capital availability, and reduce their pension and medical expenses by providing citizens with higher investment returns.
The other need is for policymakers to reduce the level of waste in the public sector, most of which produces “output” that is laughably overvalued in GDP statistics. Especially in Europe, living standards, already under threat, have been reduced further by the exactions of oversized and unproductive public sectors. Cutting this waste will leave more money in citizens’ pockets, and improve their living standards thereby.
Wage differentials between rich and poor countries are natural, caused by differentials in those countries’ capital endowments, infrastructure and institutional effectiveness. Their natural level has been reduced by the Internet, and will doubtless be reduced further by future technological advances. But as far as possible, responsible Western policymakers should work to ensure that this reduction in differentials produces only improvements in emerging markets’ living standards, without allowing it to immiserate their own people.
(Originally appeared in The Bear's Lair.)
Martin Hutchinson is the author of "Great Conservatives" (Academica Press, 2005)—details can be found on the Web site —and co-author with Professor Kevin Dowd of “Alchemists of Loss” (Wiley – 2010). Both now available on Amazon.com, “Great Conservatives” only in a Kindle edition, “Alchemists of Loss” in both Kindle and print editions.