iPhone Production and the Sweatshop Solution

I want to discuss a recent bit of news and the economics of sweatshops. I'll touch on what causes economic growth, what doesn't, and how sweatshop conditions can be eliminated.

There's been a recent report from a journalist working for the Shanghai Evening Post, who spent a week working undercover as an employee at a Chinese Foxconn factory producing the new iPhone 5.

Foxconn production line. (Photo credit: micgadget.com)

Here's a quote from day 8, when he actually starts his work at Foxconn after 7 days of training:

1. We have reached the entrance of the production floor with a warning sign that says: "TOP SECURITY AREA". We are told that if anyone enter or exit the metal detector door and found carrying any metallic stuff on your body such as belt buckle, ear rings, cameras, handset, mp3 players, the alarm will sound and you will be fired on the spot. One of my room mate told me that his friend has been fired because he carried an USB charging cable. When I walked into the production floor after passing through the metal detector door, I heard loud sounds of machinery engines and a very dense of plastic smell. Our supervisor warned us: "Once you sit down, you only do what you are told". The supervisor finally present us the back of the iPhone 5 and shows it to all of us and said: "This is the new unleashed iPhone 5 back plate, you should be honored having the chance to produce it"

Foxconn has been in the news many times because of worker suicides and poor working conditions. Some have called it a sweatshop. But who's really at fault here?

The economics of a Sweatshop

No economy starts out rich and advanced. Everyone has to start somewhere, and in countries that have for centuries been hampered by onerous government regulations or backward traditions, economic progress comes slower.

A lot of anti-market types will suggest that regulations, or price fixing, such as raising the minimum wage of workers and enforcing various health & safety regulations, will solve the sweatshop problem.

Nothing could be further from the truth. By imposing minimum wages (which to be effective have to be a wage floor above the current wage rate), the government would only squeeze the profit margins of the producers, which usually means that someone is going to get fired, or that corners will be cut elsewhere.

Likewise, regulations are just more red tape to raise the costs of doing business. None of these things help to create economic growth, which is the only lasting and sustainable solution to the problem of sweatshops.

So where does economic growth come from?

The build-up of capital. Economic growth comes from capital accumulation.

Capital is a name given to the various labor-saving tools and devices used by people to increase their productivity. For example, a worker using a chainsaw will have greater success felling a tree than someone using an axe.

Capital accumulation, the accumulation of such labor-saving tools, allows people to improve their productivity, and hence increase the amount of value that they create for others.

Thus, a laborer using a chainsaw can fetch a higher wage for his labor than someone who uses an axe.

Capital, insofar as it signifies labor-saving or productivity-improving devices, encompasses many things. Education and skills fall under the category of human capital. Organisational efficiency improvements could also be classified as capital.

Imagine a simplistic model in which an unskilled person with minimal ability has a base output unit of 'x' per hour. Everyone is a little different, so the 'x' will vary. In order to determine his output, 'x' is multiplied by the capital he uses, 'c'.

Thus, someone who uses no capital will create cx = 1x = x units per hour.

That same person using a capital multiplier of 10, would create 10x. Such a more productive person would obviously earn a higher wage through the bidding process by which competing companies raise wages to attract labor.

So who's at fault here for the Sweatshop conditions? Is it Foxconn?

Foxconn do what they need to do to remain competitive in the market. If they operate in a free market (they obviously don't), and if the other companies can't offer their employees any better working conditions or wages, then Foxconn would be operating their factory at the best possible level given current economic conditions.

There are two limitations here. Two factors that reduce working conditions beyond their optimum, whatever that may be:

Laws, regulations, and taxes

The more artificial restrictions are imposed on a company or its employees, and the more they are plundered through taxation, the less is left for the company and its employees.

In the same vein, the more anti-competitive regulations exist, such as business licenses, corruption, patent laws, etc., the less competition there is between companies to raise the wages of their workers.

For instance, a company working in a tightly regulated market with great political influence can raise artificial barriers to entry that reduce their competition. They then no longer have to offer the best wages possible to their employees, because their employees have fewer employers to choose from.

While we could blame the various companies that use political favors to gain an unfair edge, the fact is that without a government that has these powers, there is nothing they could do.

Moreover, in such a politicized economy, any company that chooses to be noble and not participate in the political process of corruption will find itself at a disadvantage to those companies that do.

The government has arrogated the power to regulate business. Without that power, there can be no center of corruption.

1. “When buying and selling are controlled by legislation, the first things bought and sold are legislators.”

Currency manipulation

You can thank the Chinese government for not letting the Renminbi appreciate. This is a policy pursued by many countries, and falls under the category of Mercantilism.

Mercantilism is that economically fallacious idea that a nation becomes rich by its exports.

When Spain accumulated a vast amount of gold in the 16th century. They thought gold was wealth. But gold was just a representation of wealth. The result was an enormous amount of inflation and an eventual destruction of their entire capital base.

They could buy so much foreign produce with currency they didn't produce anything to obtain (it was stolen from the New World), that their domestic industries eventually collapsed and almost disappeared. When the Gold flow ended, they lost most of their influence.

Does that remind you of someone? It should: the United States. The U.S. economic model of using printed petrodollars to buy foreign goods is exactly the same mistake. The result has been a growing trade deficit since the 1980's, a skyrocketing debt level (since every dollar created is a dollar of debt), and the outsourcing of numerous industries wholesale to foreign countries.

It's not a question of patriotism. It's a question of simple economic laws.

Now, if the Chinese government did in fact allow the Renminbi to appreciate, the wages these factory workers are getting paid would explode in real terms.

Meaning that even if the wages stayed the same in nominal terms, their value would rise due to an appreciation of the value of their currency. They could buy more with the same amount of money.

As a result, it would in short order become more profitable to use more heavily capital-intensive assembly lines, rather than getting armies of people to do menial repetitive tasks.

As always, the solution to the problem at hand is to remove government influence. Stop printing currency. Stop regulating. Stop taxing.

So why doesn't the Chinese government fix their sweatshop problem?

They don't want to.

The Chinese government is not interested in the welfare of their people. No government ever is. People in government are only interested in themselves.

Keeping the Renminbi cheap has various political benefits. It allows the Chinese to accumulate a lot of U.S. debt, which gives them the ability to quickly sell it off and crash the dollar. This has been a powerful bargaining chip for them.

Furthermore, for the Communist party of China to retain its influence, the people of China have to be mostly very poor. A well-paid and highly educated workforce would cause the Communist party to collapse quite quickly. This is why they've restricted economic growth to a few Special Economic Zones, or SEZs.

And of course, the biggest reason is that every time the government reduces its influence over the economy, they lose power. No government ever willingly gives away its power.

But to shout that the solution to sweatshops is boycotting them (which just hurts the workers even more), or new government regulations (which imposes greater costs that ultimately again hurt the employees), is counter-productive and based on silly notions about economics.