Central bankers must be circumspect in their public expression, lest they roil the markets, and some take this to the point of being mealy-mouthed.
So Neel Kashkari, president of the Minneapolis Federal Reserve, is seen often a breath of fresh air for his candor — as in a recent speech in Sioux Falls, S.D. In an economy where we hear increasingly frequent references to “labor shortages,” Kashkari puts it bluntly: “If you’re not raising wages, then it just sounds like whining.” Amen Brother!
This strikes at the core of a market economy. If, at some given market price, buyers are not able to buy as much of an item they would like or need, then the price needs to rise. If the item is labor, then the higher “price” is the wage rate. And, if some employers won’t be able to make it financially if they must pay more for labor, that is the market’s way of demonstrating that society does not value the product or service they are offering enough for it to be produced. These are simple realities of how markets allocate resources efficiently.
In the wake of our own district Fed president explaining the obvious, Target’s announcement last week that, starting this month, it is raising its starting wage to $11 an hour is also welcome. Even more welcome is that this is scheduled to rise to $15 by 2020. This shows that managers of at least one large corporation understand market economics.
Moreover, in his announcement of the increase, Target CEO Brian Cornell demonstrated he is as sharp as that legendary U.S. CEO Henry Ford. Cornell stated that one objective of the wage bump is “making sure we are attracting and maintaining great talent.” That mirrors Ford’s 1914 decision to raise his company’s basic wage from $2.34 to $5 per day while also cutting weekly hours from the 60 then common.
Ford’s own analysts warned him it would “bust the company.” Business pundits echoed them. But Ford owned the company himself and did not have to humor outside shareholders. And, like Target’s Cornell, Ford understood that there is more to the equation than the simple wage rate.
For one thing, labor is not a “homogeneous commodity,” like 87 octane gasoline, #2 yellow corn or 85 percent lean ground beef. There are myriad variations between workers in terms of skills, motivation and what we now euphemistically call “work readiness,” the ability to consistently show up for work on time, follow instructions and take pride in doing a good job.
Ford was not altruistic. He knew that by making a big wage jump over all his competitors, he would be able to attract the most skilled and hardest working workers in Detroit. He would be able to demand a lot from them. And factory floor discipline would be easy, because the prospect of getting kicked off the gravy train to be replaced by one of many others waiting eagerly in line for a Ford job was a powerful incentive not to anger the foreman.
Modern CEOs like Cornell are smoother in their phrasing. But for the same reasons he is exactly right. By paying more than the bare minimum needed to get warm bodies to fill out applications, Target will get more productive, better-motivated employees. That was a winning strategy for Ford a century ago in the age of steel and steam. And in the contemporary information economy, it is even more correct.
After Ford’s new wage went into effect, turnover at his plants dropped dramatically. Even for low-skill assembly-line jobs, money spent on hiring and training fell markedly. Productivity increased as did quality, even on the low-tech Model T.
Economists would describe this as an example of “transaction” costs. Hiring a new worker is not as simple as buying 10 gallons of gas. It takes time and HR workers to sift through applications, check references and qualifications and, nowadays, do background checks and drug tests. Moreover, once an individual is identified and hired, he or she must be trained to do necessary tasks. Initial weeks and months will require more coaching and monitoring by supervisors.
These costs of hiring new persons and getting them up to speed are fixed costs, up-front expenditures that have to be paid off over time, just as for a new machine like a drill press. There is a key difference, however. New employee transaction costs are “sunk costs.” There is no salvage value, no way to recover them if the employee quits or doesn’t work out. You can always sell a drill press on the used machinery market and get some of your investment back, but if new workers abruptly move to greener pastures, whatever resources went into hiring and training them are down the drain. They are like the concrete floor under the drill press. This was true for Ford in 1914 and it is even more true for Target and its competitors 103 years later.
Kudos to Kashkari for emphasizing what should be obvious. When an economy grows after a prolonged recession, wage rates rise. If employers want to succeed, they have to pay market prices for inputs. Labor is not an exception. You can bellyache all you want about labor shortages, but those basic realities won’t change.
And kudos to Target management for understanding these ABCs of free enterprise and choosing to get ahead of the curve. Yes, there are some sectors where labor skills and motivation are not all that important relative to wage rates themselves. But these situations are far rarer than people think. Modern retailing is not one of them. This is an intensely competitive sector undergoing structural change. Target is making a bet that quality of labor is more important than absolute lowest labor cost if they are to survive and prosper. I think they are right on target, but the next few years will be the test.