Returns To Capital And Labour Independent?

This essay is an attempt to explore the implications of human capital a little more deeply.

In Economics we are used to thinking about how market structure (competition vs monopoly) affects (supernormal) profit levels. What is left unexplained is what determines how much of that profit goes to labour and how much goes to capital – and in fact already our economic definitions are breaking down because profit is net of costs which includes labour. A naive first cut would suggest that surely returns to labour and capital are correlated and the real determining factor is how much pie (profits) there is to share around. Certainly, the technology industry with companies like Apple seem to have high returns to capital and labour and conversely the restaurant industry suffers from both minimum wage waiters and bankrupt restaurant owners.

However, just as Peter Thiel argues that the value that an industry gives to the world and the % of that value that a company captures are independent I would argue that return to capital and return to labour are also independent. Supermarkets are a good example of industries where the return to capital (e.g. the shareholders of Walmart) is high but where the return to labour (salary of Walmart employee) is low. Conversely, the airline industry is notorious for the tiny profit margins but airline pilots actually enjoy quite high salaries. Another example is the finance industry where I saw a lecture with the economist John Kay where he argued that investment banking CEOs were getting absurdly high bonuses despite delivering very low returns to shareholders.

The obvious economic explanation is that the labour market has its own demand and supply which is largely independent of the demand and supply for the product/service. At a simple level, industries that employ low-skilled labour pay that labour less regardless of how much profits the industry is making, similarly high skilled labour tends to be highly paid.

The implication of this analysis is that maybe the best industries for us to start the human capital idea in are those industries where equity investing isn’t attractive (because the companies don’t make much money) but the labour does.