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The Low-Wage Strategy in the South: Is It the Future for Your State?

I commend to your attention an article from the Washington Post published on December 2 titled "A Grim Bargain: Once a weakness, low-skilled workers who earn little have become the South's strength."  It tells the tale of James Deschler, a young man living in ironically named Sunny South, Alabama, a very low-income community that has been down on its luck for a long time.  Five years ago, Deschler, now 29, left a job with Hyundai in Montgomery that paid $25 an hour.  He thought he could do better than that if he had higher skills and he had always wanted to be a machinist, so he enrolled in a community college program with his savings from his Hyundai job and graduated as a certified machinist. 

But there were no jobs, so he went to work at his parent's convenience store, splitting one minimum wage job there with another family member, making $3.70 an hour, just barely getting by.  That's when he saw the trucks going down the road to a new construction site.  That site belonged to the Golden Dragon Company, a Chinese firm that makes copper tubing for air conditioning and similar applications.  Golden Dragon wanted access to the American market, but they found that they could not compete if they had to pay the tariffs on goods imported from China.  The only way to get around that was to manufacture in the United States.

Everyone that Golden Dragon had talked with said that they should look at locations in the American South.  There, they were told, they could find very cheap labor, no unions, cheap land and a lot of concessions from the state and local governments.  Golden Dragon did not need highly skilled labor, and the promise of low wages would enable them to make a profit according to their business plan.  Their advisors set up a competition among southern American states for the Chinese business.  Five states submitted bids.  Alabama won by offering to levy not one penny in taxes for 20 years, free land, free roads to their plant and, believe it or not, a cash payment to Golden Dragon reimbursing the firm to the tune of $20 million for the tariffs it had paid to the United States government for several prior years. All told, the various subsidies paid to Golden Dragon were worth $200 million.

Deschler was among the first to be employed by Golden Dragon.  He thought his problems were over.  They were only beginning.  Though the average machinist in Alabama was making $19 an hour, Golden Dragon paid only $11.  He worked really hard at his job and was eventually offered a job running a whole machine shop.  Once again, he thought he was over the hump.  He thought he'd be offered maybe $16 an hour.  It did not happen.  His pay was bumped up to $11.75 an hour.  He still could not cover his mortgage, insurance, light bills and baby food.  "Literally," he said, "going to Dairy Queen is like a mini-vacation."  His Dad opined that Deschler "might as well be working at Wall-Mart."

Why are wages so low?  When K. C. Pang, Golden Dragon's human resources director, was asked that question, he said that wages were determined on the basis of market value and skill set and "...the quality of workers is not very good."

When Deschler realized that his prospects at Golden Dragon were severely limited and always would be, he joined with several other workers to start a union.  The workers divided evenly on the proposition.  That is because many workers realized that, even though wages were very low and were likely to be for a long time, low wages were better than no wages.  No wages were a very real prospect in a community where one in five workers could not get any kind of job.

Economists describe economies of this kind as being in a "low-skill equilibrium."  Because the prevailing skill levels are very low, the only businesses interested in locating there are businesses that employ low-skilled people. But companies that can only survive if they are competing on the basis of the cost, not the quality, of their labor, can only pay low wages.  If their wages go up, they cannot compete. 

viciouscircle.jpg

Such companies can afford to pay very little not just for their labor, but for everything else, too.  So they look for places that offer to forgive state and local tax payments.  States with poorly performing education systems work hard to outbid each other to get firms employing low skill labor to locate in their state, because they don't have a highly skilled workforce to offer. 

After they grant these abatements and "win" the competition, the governments are obliged to provide the services the taxes were supposed to pay for, without the additional tax revenues to pay for them.  Public schooling typically takes up about half the state budget.  So this means that 'winning' these competitions for low-skill firms results in lowering the quality of education even further.  State governments using this kind of strategy for economic 'development' cannot make the investments in education that are their only hope for raising the skill levels of their citizens.  They are on a treadmill to nowhere.

It is a vicious circle. With each turn of the screw, there is less money to educate and train students in school and adults in the workforce. The lower the skills, the more unemployment there is, which leads to even lower tax revenues and even less money for the schools.  Alabama will never recover in taxes the $200 million it invested in Golden Dragon.  Bringing low-skill, low-wage employers to Alabama is a formula for further impoverishing the state and its people.

But surely, you will tell me, this corner of the Deep South is not typical of the United States, does not foretell a nationwide disaster, and has nothing to do with me.  Recall that five states competed for the favor of Golden Dragon.  That may have been all that were invited to bid.  It is certainly not all that would have been interested in bidding.  The fact is that large swaths of the United States are dominated by businesses that believe they can compete only by keeping their labor costs and their taxes as low as possible.  Those businesses believe they can get by with low-skill labor and they know that labor markets dominated by people with low skills are a good place to get the cheap labor they think of as their key to decent profits.  That way lies Sunny South, Alabama.

Singapore shows us a very different way of thinking about competitive advantage.  That country started out in the early1960s selling a low-skilled workforce to global firms looking for cheap labor.  But, almost as soon as Singapore succeeded in bringing those firms to Singapore, they invested heavily in the education and job training of their people.  It was as if, instead of forgiving $200 million in taxes for low-wage, low-skill employers like Golden Dragon willing to come to Singapore, the government had instead invested that $200 million in the education and training of the people of the county in which Golden Dragon is now located.  Two hundred million dollars is a lot of money.  Do that over and over again, and it becomes possible to turn a down and out, impoverished county, state or even small country into a powerhouse. 

That is exactly what Singapore did.  It was not long before they kicked out the firms that had come there for cheap labor and attracted firms looking to add more value to the products they made and the services they were selling, firms that were willing to pay well for more highly skilled labor.  Year in and year out, Singapore has been ratcheting up the skills of its people and year after year, it has upgraded the firms that are located there.  At each turn of the screw, they have gone after firms that would pay higher and higher wages for ever more skilled workers.  Both the companies and the workers pay high taxes, which the companies are willing to do because they get highly competent workers and use those workers to make very healthy profits. The individuals are willing to do so as well because they are earning the high wages they need to pay those taxes.  That is a virtuous circle, the exact opposite of what the Washington Post article described.

Some states in the United States are investing heavily and wisely in the knowledge and skills of their people.  Others, not all of them in the South by any means, are going down the Alabama road.  This is the great American divide.  You can see the results of this educational divide now in our politics.  It will not be long before you can see it in dramatically different economic outcomes and levels of social stability.  Which kind of state do you want to live in?

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