Fallow Minds

Sometimes while driving around, I might see a field of weeds. Surely this land will soon be used for something because land is too valuable to leave fallow for long. You might think, “If the owner lacks cash, he may have to put off building for a while.” But the owner’s financial situation is irrelevant. He can borrow the money and use what he is building as collateral.

In general, the amount of money that should be invested in any project is independent of how much money you have to invest in it. If you have very little money, or even a lot of debt, you should still be able to borrow as long as the marginal return on further investment is greater than the interest rate. On the other hand, if you have tons of money to invest, you wouldn’t invest more money in your firm than the amount where the marginal return on further investment equals the interest rate because otherwise you could make more money just investing in other things. The key assumption here is that you can borrow money because you have collateral that the bank can seize if you cannot make good on your loan.

Now consider a young farmer in India who is not making it. He decides to give up and move to the big city. He may have a mind that is capable of learning a good skill like plumbing. He is young and strong and healthy. He is reasonably trustworthy. He may lack any money, but he has potential. Why can’t the market help him the same way the market helps invest in firms? Why wouldn’t a free market invest in the ex-farmer’s skills as long as the return on that investment exceeds the interest rate?

In some sense, I would call this Dilip’s complaint. Dilip D’Souza understands the failings of socialism but doesn’t see why the free markets fail to help the farmer above. It is a valid question: “Why doesn’t the market help this farmer achieve his potential?”

There could be several explanations for this market failure. Amit Varma might say that there really is no free market in India. He might say that the License Raj and the myriad of regulations in India have thwarted the farmer’s potential and have stifled the markets, especially the manufacturing sector. There is truth to that, but I doubt that even in a pure free market, the farmer would find it easy to find investors for his training.

The problem the farmer faces is a problem of collateral. Banks want something they can seize if the loan goes sour. You can’t put yourself up for collateral.

This is one area where socialism might have an edge. The socialist government can and does own everyone like slaves. They would gladly invest in the people’s skills as long as the return on those skills is merited. The government knows that there is no escaping their reach (as long as you don’t leave the country) so they will get their money eventually. But do we need government that owns the farmer to get someone to invest in his potential? Can’t the market invest in the farmer without government interference?

In the early days of the colonial America, workers would become indentured servants in order to pay for passage to the New World. These indentured servants would then have to work like slaves for about seven years to pay off the debt associated with the passage over the ocean. But the people sometimes just ran off and blended with the free colonists. This was one of the reasons why the colonies went for African slaves. But any kind of contract that would virtually enslave a person would be invalid today.

In the United States, if this farmer wanted to be a plumber, he could go to the labor union. The labor union might turn him away, but if they didn’t, they would make sure he got the skills necessary to become a fully skilled plumber. The union would not fear that the farmer would run away with his skills without paying back the investment because where would he go? He has to belong to the union to be a plumber so he can never leave.

This is an important point: the union doesn’t need to own you; they just need to own your type of labor. They know that if you want to be a plumber, you cannot do it outside of their union. And they reason that you would not want to throw away such valuable skills.

However, the union is a monopoly and has a vested interest in limiting the supply of new trainees. It would be ideal to have competition between labor corporations to ensure that the market provided plenty of plumbers.

An interesting labor agreement is the contract that a baseball club signs with its minor league players. These players need years of training before they are ready to play in the big leagues. The clubs in effect own the players and can even sell them to other clubs. The players are free to quit baseball, but if they want to play baseball, they have to play for the club that owns their contract. This allows the clubs to invest heavily in the skills of the players and know that they will get that money back. After several years, the player becomes a free agent: he owns himself again and can sell his services to the highest bidder. It is an arraignment that works really well.

My idea is that the farmer could sign a contract with a firm that trains plumbers. This firm would invest in the farmer’s skills with the understanding that the farmer would belong to the labor corporation for a limited time until the debt is paid off. But what would prevent the farmer from running away and becoming a free plumber somewhere else just like the indentured servant?

In order for the labor corporation to work, they need to have some form of collateral. This collateral would be a license to practice as a plumber. The firm issues the license and can hold it as collateral during the indenture period. But in order for this to work, there need to be an enforcement mechanism. There must be a regulation that would prevent firms from hiring the farmer who ran away without his license.

There is actually a country that enforces such regulations: Switzerland. No one can do any job in Switzerland, no matter how trivial, without first doing an apprenticeship. You must be trained on the job and get your license before you can be a free agent. This has a remarkable effect: there is virtually no unemployment and virtually no poverty in Switzerland (Switzerland is doing a lot of things right, not just the labor markets). Firms gladly invest in workers because they cannot run away.

I think the same system could work in India or even in the United States. The government would have to have to enforce the rule that you cannot work in a field without first doing your apprenticeship with some labor corporation. The labor corporations would want to build their reputations since recruiting talent is how they would make their money, so they would have incentive to train these workers well and make sure that after the workers got their apprenticeships, they could command a good salary. The government would have to prevent phony labor companies that print up bogus licenses that could be used by “runaways” to skirt the apprenticeship requirement.

Getting this whole system going would take some work. The problem is that there are no companies that have good reputations and can issue reputable licenses. It would probably take some initiative to get this going and some very entrepreneurial firms that are willing to blaze a trail. Most of all, it would take a government that could understand this market well enough to pass a few reasonable regulations to protect the integrity of the licenses without gumming up the works with myriads of useless rules. I’m sure most people in India would be reluctant to give the government another excuse to require another license. But in principle, this idea could be exactly what the poor in India would need to quickly climb out of poverty.

Update
In the comments section, Ravikiran Rao (who used to blog at the Examined Life) objects vehemently with my suggestion that these certificates need to be mandated by government. "What were you thinking?" he asks. Indeed, what was I thinking?

I was thinking that this was a market of full information and the person who had received skills and not paid back the company that had given them would be able to simply run away and get the benefits of being skilled by just working somewhere else. I feared that the market for these certificates would collapse because there was no practical way to enforce the contract on the worker.

However, I think I was probably mistaken. The market for skills is definitely one of private information. Only the certification authority would have certain knowledge that a particular worker was fully trained in a particular field. The certificate (if issued by a reputable firm) would be the proof that the worker would need to show an employer that he or she is fully skilled and not just partially skilled. This proof enables the worker to get a premium wage in the job market.

So if no government agency is necessary to create these labor corporations and these certificates, why haven't they appeared spontaneously in the labor market? The answer might be that it would take many years to develop credibility in this field and it would take a bold entrepeneur to enter. But the interesting thing about this market is that the barriers to entry mean that it would be almost the perfect to be in since you wouldn't need to fear lots of competition.