In microeconomics we also look at the ways that labor and capital (equipment) can substitute for one another. As costs for one input rises, there is an incentive to purchase more of the other input. Decades ago the automotive manufacturers added more and more robotic assembly processes to their production, in part to deal with increasing labor costs. Catherine Rampell wrote an article and a blog post in The New York Times this week, on this topic.

In “Employers Spend on Equipment, Not Workers“, she points out,

Indeed, equipment and software prices have dipped 2.4 percent since the recovery began, thanks largely to foreign manufacturing. Labor costs, on the other hand, have risen 6.7 percent, according to the Labor Department. The rising compensation costs are driven in large part by costlier health care benefits, so those lucky workers who do have jobs do not exactly feel richer.

Labor theory suggests that as workers become more productive, the demand curve for labor shifts to the right, and should raise the equilibrium price (wages). This hasn’t been happening – in part because of high unemployment levels and an excess supply of labor. Rampell also argues that total compensation is rising – but that most of that increase is in benefit costs rather than wages.

In an Economix blog post she explores the health care benefit assertion further.

It may seem strange that the cost of labor is rising so fast. With such a weak economy, it doesn’t seem as if a lot of workers are getting raises. (Are you?)

And technically, employees are not getting much of a raise — at least not in cash. The higher cost of labor is primarily being driven by rising benefits costs and, in particular, rising health insurance costs.

[...]

[T]he benefits cost line is quite steep. Even more daunting to employers, it could get even steeper in the years ahead; health care costs are rising sharply, and their costs a year or two from now are very hard to predict.

Several take away points from this pair of articles. First – as capital equipment (particularly software-driven) improves and gets cheaper, we should expect it to substitute for labor. Second – health care costs drive so much of our economy, including the pace of unemployment changes.

One argument for preserving tax cuts, or lowering them generally is that they will increase incentives to work harder and longer. The Laffer Curve is based on this premise, saying that lower tax rates encourage more work and more investment, which results in more economic activity and growth, which in turn results in higher total tax revenues.

Harvard’s Gregory Mankiw started a gentle and funny conversation about this premise. In this op-ed piece in The New York Times Mankiw notes that when offered additional work opportunities, he often turns them down, because…

In effect, once the entire tax system is taken into account, my family’s marginal tax rate is about 90 percent. Is it any wonder that I turn down most of the money-making opportunities I am offered?

Mankiw’s article focuses on marginal tax rates – an important economic consideration. Rather than looking at a family/worker’s average tax rate, he argues that incremental increases in income are faced with higher tax rates. He goes on to say that these high marginal tax rates discourage him from accepting additional, incremental work – to the detriment of the economy.

This is the essence of what has been called supply side economics – freeing up the production/supply side of the economy will result in economic growth. While there is some strong theory behind these claims, the actual results have been hard to prove.

Stephen Colbert lampooned Mankiw in this piece.

And then a comedy troupe at Mankiw’s Harvard University added their punch.

This article in the March 2, 2009 edition of The New Yorker, by James Surowiecki, does a nice job of explaining both of these phenomena.

A quick excerpt from the the lead…

It’s harder and harder to find and keep a job, but if you’ve got one you may well be making more than you did twelve months ago.

We can think about labor as a market, where workers “supply” their time and expertise, and employers “buy” that time and expertise. If workers become more productive they are more attractive to employers and the demand for labor shifts to the right (increases). If nothing else changes (fat chance of that!) then an increase or shift in demand should result in higher wages. The article explains how, due to a number of factors, worker productivity has been rising at a nice clip – resulting in higher wages.

Now, if we look around us at rising unemployment and laid off workers seeking any kind of employment at almost any wage, it would be reasonable to expect that wages would start falling. After all there is an abundance of available, potential workers, so why wouldn’t wages decrease? They do, over time, but not right away. This is the “sticky wages” phenomenon. Some times there are structural reasons that wages stay the same. This might include a negotiated union contract, or a heavily bureaucratized wage and salary structure (think schools or public government employees, or sometimes hospitals). To add to that is at least some empathy on the part of the employer – trying to do the right thing for their work force in hard times. Surowiecki also notes employer concerns about adverse selection, where the employer fears losing their most productive employees as a result of a wage cut.

Eventually wages do start falling in hard times, along with prices. This change isn’t immediate, but with a prolonged recession it is inevitable.

In his blog in October, Greg Mankiw pointed to a chart from PhDComics.com that is sure to warm the hearts of college instructors: