Penny Wise and Pound Foolish Economics

In this op-ed piece in The New York Times, today, Pankaj Ghemaway, a Harvard professor of business administration, and Ken A. Mark, a Toronto-based business consultant, offer a novel defense of Wal-Mart's avaricious tactics. According to them, Wal-Mart has contributed to the overall productivity of the nation and provided a real value to consumers because of its low prices, regardless of the fact that the only way it can continue to offer such deep discounts is by paying its employees the miniumum wage and denying them adequate health and pension benefits.

But these two business apologists make a flawed argument.

Since most of Wal-Mart's customers are poor - especially the rural poor - their benefit from sharply discounted prices comes at a huge expense to themselves and their families because in order to keep prices so low while also maintaining profitability, Wal-Mart drives out competition, which includes other stores that actually pay higher wages. Wal-Mart also guts communities, leaving formerly thriving downtowns bereft of their retail centers. In the place of once prosperous stores are loan shark operations and bail bondsmen. Thus, the towns where the rural poor used to seek economic opportunity have become destabilized high crime centers.

Here's the money quote:

"These kinds of savings to customers far exceed the costs that Wal-Mart supposedly imposes on society by securing subsidies, destroying jobs in competing stores, driving employees toward public welfare systems and creating surban sprawl. Even if these offenses could all be ascribed to Wal-Mart their costs wouldn't add up to anything like $16 billion." Note: $16 billion is the amount these authors claim Wal-Mart saves consumers every year.

Similarly, the savings to customers also exceed the total surplus the company generates for its shareholders - a surplus that would be wiped out if Wal-Mart's million-plus employees were to receive a $2 per hour pay increase, modest though that sounds. Such a possibility would unacceptable to Wal-Mart's shareholders, who include not only Sam Walton's heirs but also the millions of Americans who invest in mutal funds and pension plans. Instead, the more than 100 million Americans who shop at Wal-Mart would most likely just end up paying higher prices."

Mr. Ghemawat and Mr. Mark are two business people who know the price of everything and the value of nothing.

Wal-Mart can only offer poor people its low prices because it pays its employees, who are often the very same people who are its customers, such low wages. And because it stints on health benefits and pension plans, many of Wal-Mart employees are also on Medicaid and they put a huge strain on other taxpayers in their communities.

There's also domino effect at play here.

In order for Wal-Mart to sell cheap and also make a profit it buys deeply discounted products from suppliers. Most suppliers, in fact, hate to do business with Wal-Mart because the company plays such hard ball on prices. But because Wal-Mart is the 500 pound gorilla in the retail sector, the suppliers have no choice but to sell to Wal-Mart.

And in order for those suppliers to keep their own prices so low and still maintain their profitability - you guessed it - they too have to pay cutthroat low wages to their workers. In fact, most of the products that Wal-Mart stocks comes from overseas, usually from low wage countries like China.

So while in the short run Wal-Mart's cheap prices are good for the rural poor, in the long run those cheap prices are exactly what keeps them poor. It's a vicious circle. And, yes it's also a race to the bottom of the barrel.

Frankly, I couldn't care less about Wal-Mart and what its greedy investors would stand for in the way of profit if the workers got a two dollar raise at the expense of their mutual funds and pension plans.

Although the authors are implying that those mutual funds and pension plans also benefit ordinary middle class workers, the truth is most middle class workers would improve their own lives with better job security and higher wages. They're losing good pension plans and with low wages they will be able to afford neither mutual funds nor savings accounts, anyway.

The middle-class is desparately losing ground as good jobs disappear. And the poor have less of a chance to reach middle-class status precisely because of Wal-Mart and its tactics.

In the past, the only thing that turned factory workers from being impoverished, living in steaming tenements and toiling in sweatshops into middle class suburbanites was a strong union movement that fought against robber barons and greedy factory owners and forced them to share the wealth that they and their investors were making off the sweat equity of workers in the first place.

And that's what it will take to expand the middle class again. Poor people don't need dirt cheap, shoddy products produced by those who are even worse off than they are. They need decent jobs, a living wage, and health and pension benefits. I'm sure that given a chance, most of Wal-Marts' employees would be delighted to be able to afford to pay a higher price for a better quality good. No worker needs a vicious cycle where they can only buy cheap goods because their own wages keep going down.

To suggest otherwise is indeed to be penny wise and pound foolish.