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What Employers Buy

Here’s a letter to a high-school student in Nevada:

Mr. D__:

Thanks very much for your e-mail and for reading my blog. I’m delighted that you find it useful.

You write that you think your economics teacher is “wrong when she teaches us that very low wages paid manufacturing workers in poor countries don’t give unfair advantages to our foreign competitors over in those countries.”

In fact your teacher is correct. But can you tell me the argument she used to justify that correct conclusion? I’m curious.

Here’s my way of explaining this reality. It’s best to think of employers not as buying workers, or workers’ time, but instead as buying the outputs that workers produce. Thinking of the employment of workers in this way makes clear that if Jones can produce (say) two automobile tires per hour while Smith can produce 20 tires per hour, a tire producer would be willing to pay Smith ten times more per hour than it’s willing to pay Jones.

Looked at a bit differently, suppose Jones’s employer pays him $2 per hour and that Smith’s employer pays her $20 per hour. While superficially it appears that Jones employer is paying less for labor than is Smith’s employer, this conclusion is very misleading. The reason is that each employer is paying $1 per tire (and tires are ultimately what tire manufacturers buy when employing workers). That is say, to produce each tire costs Jones’ employer $1, and to produce each tire costs Smith’s employer the identical amount: $1.

Let me quote from page 210 of the 2018 edition of one of the best introductory economics textbooks ever written, Universal Economics, by Armen Alchian and William Allen (my emphasis):

Cost is the value of output given up per unit of product. American wages of $20 per hour reflect the productivity of labor; they do not measure cost, which involves labor productivity per unit of output. At 10 units of output per hour, cost is $2.00 per unit of output. Foreign labor with wages of $5 per hour may produce only 1 unit of output per hour. In this case, higher-wage, more productive American labor is a lower-cost producer than the low-wage, less productive foreign labor.

In other words, in this example, American factories paying workers an hourly wage of $20 are paying less for labor per unit of output than is being paid for labor per unit of output by the foreign manufacturer that pays its workers an hourly wage of $5. What looks like a bargain for the foreign manufacturer is, in fact, no such thing.

Don’t feel bad about not seeing this economic reality immediately. It’s not the most obvious thing in the world. And be thankful that you have what seems to be an excellent economics teacher.

Keep me posted!

Donald J. Boudreaux
Professor of Economics
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA 22030

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