Chocolate and Gold Coins

Thursday, October 06, 2005

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.

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.


  • Excuse me? Are you serious or are you just trying to be provocative? It is not another "license". What you are proposing would give petty government officials a chokehold on every single person's life.

    90% of the employment here is in the unorganized sector. A plumber doesn't go to a school or to a firm to pick up his skills. He just learns it from some other plumber. There is no company around here which provides plumbing services. I just go ask the security guy in my building who in turn goes and taps his contacts. Your idea is going to make all day-to-day transactions in India illegal. Every one of us will be subject to constant scrutiny and harrassment by the police. What were you thinking?

    By Anonymous Anonymous, at 1:31 AM  

  • Ravikiran,

    I'd look at Michael's suggestion from a slightly different perspective. I think what he's effectively calling for is self-regulation of some kind.

    The main problem with this idea is that it cannot be implemented in isolation - the State apparatus as it exists today is sure to subvert this into another milch cow for the corrupt.

    In many ways, India's unorganised labour market is already a laizzez-faire, anything goes, really "free market". If that Ramu can fix a tap, he can start work as a plumber. He can also work as a watchman, mechanic or part-time bus driver, as long as there is someone to employ him. It is up to the customer to worry about quality of work (ie labour standards). If you have a leaky tap, a burgled house, a loose axle or a dented bus, you will not employ Ramu the next time around. This is the good part.

    But for trades which require a certain degree of skill (telephone line man, comes to mind) there is an entry barrier which Michael's farmer has to cross. Michael's solution may not perfect solve the farmers problem, but it does address the issue without getting the government involved. And that is a plus.

    By Blogger Nitin, at 5:52 AM  

  • Hi Ravikiran
    No, No I did want to drive most of the labor in India underground. I omitted the detail that there would be an exemption for currently working tradesmen. The new rules would apply only to new entrants.

    But perhaps even this is too extreme and unnecessary. I am sure that there is potentially a market for these kinds of labor corporatations that can provide certificates. It may be the case that the market, when offered the choice between a certified technician and a non-certified one, will gladly pay a premium for the certified technician that will pay for the expense necessary to get the necessary training. But the issue of fraud is there: I cannot rule out the possiblility that maybe uncertified technicians may (someday) need to be banned if they pose too great a risk to the public.

    What you are describing is a very interesting asymmetric information or "Akerloff lemons problem". If India is suffering a serious lemons problem in the skilled labor sector, that would explain the poverty there to a large extent. That deserves its own post.

    I should make clear that I do not wish the government to issue the certificates. The private labor corportation issue them just like universities would issue degrees. However, there is a role for government to prevent fraud: people cannot print up bogus certificates from reputable firms. However, I think reputation building might be sufficient to guarantee that bogus certificates from no-reputation firms would be worthless. Still, it seems like that would be fraudulent.

    I should point out that skills like plumbing, electrical wiring, auto mechanic, etc require more knowledge an training than you might first suspect. There is a lot to learn. Most of this learning is, of course, on the job. But it is important that the apprentice is carefully supervised by someone with genuine skills to make sure that the work is done properly. If it isn't done properly, the problems caused can be enormous because it is essentially impossible to reinspect the plumbing several years after a house is complete. So there really is an enormous value added to having proper training and potentially a huge increase in salary for the technician if he can prove that he has that training.

    By Blogger Michael Higgins, at 12:01 PM  

  • Hi Nitin
    Thanks for linking to my piece.

    Btw, if the pipe bursts and floods your beautiful house, it really won't do you much good to simply "not hire Ramu next time." The damage has been done.

    I'd be curious how frequent serious accidents due to faulty work are in India.

    But the issue with training is twofold: one is that trained workers need to be able to prove that they have uncommon skills to get a premium wage. The second is that unskilled people without connections will find it impossible to get any training because there won't be a way of contracting for that training.

    By Blogger Michael Higgins, at 12:41 PM  

  • Hi Michael. There exists some order in the chaos that is the labor market in India. You normally hire a carpenter, plumber etc recommended by someone else - your neighbor for instance. Also, your statement

    Most of this learning is, of course, on the job.

    is very true for the plumbers, carpenters, car mechanics. They join as "apprentices" earning nothing but tea and bun served during the day.

    I believe licensing is a great idea - but would drive costs too high.


    By Blogger Iyer the Great, at 12:54 PM  

  • See the discussion on human capital and private taxes on on my blog post.

    By Anonymous Anonymous, at 7:55 PM  

  • Mike, I think the spirit of your suggestion -- the apprenticeship, the license issued and monitored by some authority -- is what is important here. (Think this is the point Nitin is making too). Frankly, I think it is somewhat overheated to attack you on the basis of your suggestion that the government is the authority for the certificates.

    The point you are trying to address is: here is a guy who has some skills. Demands for those skills is falling. What does the man do? The easy answer to throw at him is, go learn a new skill, the world's a tough place, survival of the fittest and all that.

    To my mind, you're suggesting a mechanism to smoothen this process and make it less of a risk for both the guy learning a new skill and the people who might employ him. And I think it makes sense to find such a mechanism.

    And the larger point is that this can't be left to that catch all "free market", because what's the incentive for a free market entrepreneur to invest in training this guy?

    What I take away from this piece of yours is the spirit of it: that there are cases where interventions are necessary -- sometimes they are best done by government, sometimes by private enterprise, sometimes by risk-taking individuals, whatever. But the mistake is to presume that no intervention is necessary.

    By Blogger Dilip D'Souza, at 4:23 AM  

  • Hi Dilip
    Thanks for reading this post and I apologize that I did not notice your comment earlier.

    I think you understand the argument well enough although I would put a slightly different spin on it. It is a "missing market" Someone needs to fill the void of creating these certificates that can prove that a plumber is truly skilled and not just someone who can fix a leaky faucet.

    The problem is finding a organisation with crediblity to create this certification process. This the real problem. Would local governments do a good job? Would any private non-profit do a good job? The IIPM brouhaha shows that there are lots of people who are only too happy to print out certificates that are worthless.

    By Blogger Michael Higgins, at 6:55 PM  

  • The IIPM brouhaha shows that there are lots of people who are only too happy to print out certificates that are worthless.

    Yeah Mike, but there are also lots of people only too happy to buy those worthless certificates. Plenty of people who want shortcuts.

    I think any mechanism is going to have guys who will misuse it. That shouldn't deter us from trying to find and put in place such a mechanism.

    By Blogger Dilip D'Souza, at 11:18 PM  

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