Why is labor so cheap in poor countries?

[softwareNerd]

In a discussion on "4AynRandFans", someone asked why some things -- like food from a street vendor -- are so cheap in poor countries (e.g. in Thailand). I posted this example there, and decided to post it here too.

This example is in response to the original question of the topic.

Situation 1: Suppose a Thai person who has two employment options:

• Either, he tills the soil, producing 20MT (20,000kg) of rice each year; or,
  
• is a street-hawker selling 20,000 servings of food per year
  

Clearly, as a street-hawker, he must price his wares so that each serving contains a labor cost equivalent to 1 kg of rice.

Situation 2: Instead, suppose he was able work on a farm that was more capital-intensive. Suppose the capital enabled better irrigation, fertilizer, pesticides, harvesting equipment, and storage facilities. Suppose, by doing this, he could double his output to 40 MT of grain.

We should also assume that the provider of capital requires a return. Assume that the provider of capital takes the equivalent of 15MT of grain, and pays his labor the equivalent of 25MT of grain (to coax the street hawkers to come work for him). Over time, street-hawking becomes less attractive, unless the hawker can price in the equivalent of (25MT/20,000=) 1.25kg. of grain per food-serving.

Summary: Raising the productiveness of a unit of labor in one industry will draw labor to that industry until the wage rates for similar labor are similar across industries. The higher productiveness in one industry does not raise the wages in that industry alone, but in other industries as well.

The effect of money: Using money, instead of "kgs. of rice" shows the same effect. Suppose Thai rice is about $300/MT. So, 20 MT is $6,000. To get $6,000 from selling food, one has to price in a labor cost of ($6000/20000=) $0.30 per serving. The capitalist-farmer in the second example pays his labor ($300/MT x 25MT=) $7,500. Soon enough, street-hawkers need ($7,500/20,000=) $0.38 per serving, to make it worth their while.

[~Sophia~]

One of the significant factors which affects the value of labor is the rate of unemployment. The higher the rate of unemployment the lower the value of labor in that country (I am assuming free market structure - not fixed value of labor).

Why services and goods are cheaper?

Cheap labor, fewer or no environmental costs, lower levies/taxes.

Edited September 27, 2007 by ~Sophia~

[y_feldblum]

Because the productivity of labor in such countries is far lower.

[softwareNerd]

Because the productivity of labor in such countries is far lower.

Yes. Thanks for the one-line summary of my examples

Actually, I avoided using the term "labor productivity", because a lot of people who are not familiar with economics misunderstand it. Many people think it means that this productivity is an attribute of the labor, as such. Some of it is; but -- particularly in street-hawker type situations -- it is really an attribute of the context within which labor operates. Transplanting low-productivity low-end Thai labor to an equivalent job in the US will result in a highly-productive laborer, because of the productive context in which the person now works. The productivity comes from the tools and knowledge made available to the low-end labor.

[~Sophia~]

Isn't China highly productive (due to foreign technology) yet the value of labor is low?

Edited September 27, 2007 by ~Sophia~

[KendallJ]

Isn't China highly productive (due to foreign technology) yet the value of labor is low?

Nope. I think the productivity assumption is incorrect.

China's economic boom is primarily based off of assembly operations. High technology is only used to replace workers where they cannot perform the task to the level of accuracy required. Unskilled labor is still the primary component of the cost advantage.

[softwareNerd]

Sophia,

You're right to point to productivity in Chinese factories. While these still don't rise to the levels of automation in the West, the rates don't seem high enough for the levels they do have there.

The important clarification is that the output per worker in the most highly-automatized industry is not the primary determinant of wage-rates in that economy as a whole. One has to look at the wage rates for similar levels across the entire economy. Having a highly-automatized factory raises wage rates, but having many industries that are still labor-intensive keeps them down.

If you go back to the example I gave, the capitalist farmer has to pay more, to entice street-hawkers to come work for him. On the other hand, he does not have to pay that much more. He is able to pay less because of the fewer alternatives available. This ties in to your previous comment about unemployment. Unemployment is an extreme form of "low labor productivity" !

So, the level of automation across the economy as a whole, is the prime determinant of the productiveness of labor across the economy as a whole, and this sets the wage rates for the economy as a whole. Then, within this framework, some industries, that can afford it because of their better productivity, may see higher wage rates. [Theoretically, even these industries aren't paying "higher" wages, because they are able to entice better workers. So, they're paying more, because they can afford to, but also because they're getting more. Nevertheless, the effect is to raise average wage-levels.]

[~Sophia~]

If you go back to the example I gave, the capitalist farmer has to pay more, to entice street-hawkers to come work for him. On the other hand, he does not have to pay that much more. He is able to pay less because of the fewer alternatives available. This ties in to your previous comment about unemployment. Unemployment is an extreme form of "low labor productivity" !

Right. Labor force = employed + want-to-be employed. Overall labor productivity (and value of labor) is thus affected by both the productive output of employed and the level of competition for work.

Edited September 27, 2007 by ~Sophia~