Robert McGarvey on how human capital is turning our economic system on its headA recent New York Times article (6 Reasons That Pay Has Lagged Behind U.S. Job Growth) highlights a great mystery: persistent wage stagnation. As the U.S. job market tightens, economic theory suggests wages should rise – it’s all about supply and demand. Problem is, wages in the U.S. have largely been flat for decades.

Many of reasons put forward to explain this – including falling union membership, globalization and automation – have been studied endlessly.

Clearly we need to look more deeply into the matter.

To explain wage stagnation, we need to revisit some basic assumptions that underpin neoclassical economics.

There’s a fundamental assumption buried at the core of neoclassical economics that sets the stage for capital concentration and wage stagnation. It all started with the 19th-century assumption that in a capitalist economy, the elements of production are capital and labour.

Value is created through the application of capital (defined as all the physical manufactured elements in the productive process) and labour (the human resources needed to mobilize the machines).

Once this fundamental idea was put in place, another wrong-headed assumption followed: that capital was more important than labour and, as such, capital should be rewarded twice, labour once.

Capital is paid for at cost and then earns equity and therefore a share of the ongoing profits of the business. Labour is less important: it’s rewarded once, at cost.

In this sense, capital is an asset and so accumulates over time, while labour is an expense. A prudent businessperson will attempt to grow the capital base while reducing costs. Hence the basic theory of economics structures downward pressure on wages.

It was this imbalance at the core of the capitalist system that led to abuses of labour historically, the need for unions, and the violent conflicts of interest between management and labour.

To get to the heart of wage stagnation, we need to reconsider the question: What is capital? And we must ask: Should all forms of capital be treated equally?

The rise of the intangible economy has upset the industrial applecart, and rendered many economic assumptions and industrial-era principles redundant. Today, value is derived not from machines but increasingly from human capital, innovation and networks of value, changing the capitalist system in fundamental ways.

Machines are no longer the productive demigods that industrialists imagined.

We need to change if we’re to reverse the rapid concentration of wealth in our society. This is not a trivial matter – growing inequality is causing untold hardship and undermining not only the economy but also the whole of western civilization.

To create a balanced system, we need to start by redefining the productive process to accommodate intangibles and start broadening the elements of production to include all the newer forms of capital, including human capital. The immediate consequence would be to redefine labour, elevating it to an equivalent form of economic capital.

This would mean that workers are an asset and not simply a cost centre. Individual employees would be paid a wage, set in the market, but also rewarded (appropriate to their contribution) with equity and an ongoing share of the profits of the business.

At least 30 per cent of the equity of every business should be allocated for the human capital value of employees, not equally or indiscriminately, but based on a realistic value-for-value proposition.

Technological advances will continue to reduce or eliminate the need for human involvement in production. This could put an end to labour and hourly wage remuneration.

Because people aren’t machines, they’ll eventually need to be rewarded with a social dividend derived from their contribution to commercial and social networks of value on a kind of equity-like basis.

The science of economics has contributed significantly to our understanding of how the economy works. But as a field of study it remains stuck in the industrial past. The underlying assumptions that drive economic thought must be altered to accommodate the massive changes taking place, particularly the rise of intangibles.

We can’t fix the problem of inequality until we admit that the iron laws of economics are part of the problem. They must be revised or our society and the very idea of a free world will fall like the ancient Roman Empire.

Robert McGarvey is an economic historian and former managing director of Merlin Consulting, a London, U.K.-based consulting firm. Robert’s most recent book is Futuromics: A Guide to Thriving in Capitalism’s Third Wave.

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human capital, economic system

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