The rise of contracting

Neil Erwin has a fantastic article that shines light on the labour costs minimising contract jobs creating nature of modern capitalism.

It compares the lives of a janitor in two of the leading companies of their respective times, Eastman Kodak in the early eighties and Apple today. The former started out as a full-time employee of the company, with all the attendant benefits, and rose up to become a full C-suite executive there and elsewhere. In contrast, the latter is a contractual employee of an outsourced service provider, with few benefits, and with limited prospect of moving up the labour or income ladders.

This contrast is reflected in their respective employers,

Eastman Kodak was one of the technological giants of the 20th century, a dominant seller of film, cameras and other products. It made its founders unfathomably wealthy and created thousands of high-income jobs for executives, engineers and other white-collar professionals. The same is true of Apple today. But unlike Apple, Kodak also created tens of thousands of working-class jobs, which contributed to two generations of middle-class wealth in Rochester. The Harvard economist Larry Summers has often pointed at this difference, arguing that it helps explain rising inequality and declining social mobility. “Think about the contrast between George Eastman, who pioneered fundamental innovations in photography, and Steve Jobs,” Mr. Summers wrote in 2014. “While Eastman’s innovations and their dissemination through the Eastman Kodak Co. provided a foundation for a prosperous middle class in Rochester for generations, no comparable impact has been created by Jobs’s innovations” at Apple...

But when Kodak and similar companies were in their prime, tens of thousands of machine operators, warehouse workers, clerical assistants and the like could count on steady work and good benefits that are much rarer today. When Apple was seeking permission to build its new headquarters, its consultants projected the company would have 23,400 employees, with an average salary comfortably in the six figures. Thirty years ago, Kodak employed about 60,000 people in Rochester, with average pay and benefits companywide worth $79,000 in today’s dollars. 

Job creation is increasingly detached as a priority for successful business enterprises of our times,

Part of the wild success of the Silicon Valley giants of today — and what makes their stocks so appealing to investors — has come from their ability to attain huge revenue and profits with relatively few workers. Apple, Alphabet (parent of Google) and Facebook generated $333 billion of revenue combined last year with 205,000 employees worldwide. In 1993, three of the most successful, technologically oriented companies based in the Northeast — Kodak, IBM and AT&T — needed more than three times as many employees, 675,000, to generate 27 percent less in inflation-adjusted revenue. The 10 most valuable tech companies have 1.5 million employees, according to calculations by Michael Mandel of the Progressive Policy Institute, compared with 2.2 million employed by the 10 biggest industrial companies in 1979. Mr. Mandel, however, notes that today’s tech industry is adding jobs much faster than the industrial companies, which took many decades to reach that scale.

Many of the professional jobs from those companies in the 1980s and ’90s have close parallels today. The high-paying positions setting corporate strategy, developing experimental technologies and shaping marketing campaigns would look similar in either era. But a generation ago, big companies also more often directly employed people who installed products, moved goods around warehouses, worked as security guards and performed many of the other jobs needed to get products into the hands of consumers. In part, fewer of these kinds of workers are needed in an era when software plays such a big role. The lines of code that make an iPhone’s camera work can be created once, then instantly transmitted across the globe, whereas each roll of film had to be manufactured and physically shipped.

Apart from not creating jobs, these enterprises also pride on enhancing business efficiency and value for money by contracting out every possible service, without any concern for the social negative externalities that follow.

But major companies have also chosen to bifurcate their work force, contracting out much of the labor that goes into their products to other companies, which compete by lowering costs. It’s not just janitors and security guards. In Silicon Valley, the people who test operating systems for bugs, review social media posts that may violate guidelines, and screen thousands of job applications are unlikely to receive a paycheck directly from the company they are ultimately working for. And the phenomenon stretches far beyond Silicon Valley, where companies like Apple are just a particularly extreme example of achieving huge business success with a relatively small employee count. The Federal Express delivery person who brings you a package may well be an independent contractor; many of the people who help banks like Citigroup and JPMorgan service mortgage loans and collect delinquent payments work for contractors; and if you call your employer’s computer help desk, there’s a good chance it will be picked up by someone in another state, or country.

Apple claims that it creates far more jobs, more than 2 million jobs in the US itself, through all the economic activities associated with the Apple products eco-system. However this line of reasoning overlooks not only the similar eco-system effects associated with all products and with Apple's own competitors in the modern economy. And mind you, it still does not address the fact that the overwhelming majority of these jobs are exactly the minimal protection, temporary contract jobs that impose massive social costs. 

Its social effects are corrosive,

But it is also clear that, across a range of job functions, industries and countries, the shift to a contracting economy has put downward pressure on compensation. Pay for janitors fell by 4 to 7 percent, and for security guards by 8 to 24 percent, in American companies that outsourced, Arindrajit Dube of the University of Massachusetts-Amherst and Ethan Kaplan of Stockholm University found in a 2010 paper. These pay cuts appear to be fueling overall inequality. J. Adam Cobb of the Wharton School at the University of Pennsylvania and Ken-Hou Lin at the University of Texas found that the drop in big companies’ practice of paying relatively high wages to their low- and mid-level workers could have accounted for 20 percent of the wage inequality increase from 1989 to 2014... In interviews, tech industry contractors in Silicon Valley describe a culture of transience. They can end up commuting to a different office park that houses a new company every few months; in many cases 18 months is the maximum a contractor is allowed to spend at one company. “I would rather have stability,” said Christopher Kohl, 29, who has worked as a contractor at several Silicon Valley companies, including a stint doing quality assurance on Apple Maps. “It’s stressful to find a new job every 12 to 18 months.”

For Silicon Valley’s contracting class, there are reminders large and small of their second-class status. Contractors generally do not receive the stock options that have made some midlevel Silicon Valley workers wealthy over the years, nor the generous paid time off for vacation, illness or the birth of a child. The health insurance plans tend to be stingier than those that the tech giants they serve provide for their direct employees... The problem with contracting is, you could walk in one day and they could say, ‘You don’t need to come in tomorrow.’ There is no obligation from the companies.

This is a very nice analogy that captures the way employers view labour,

When an automaker needs a supplier of transmissions for its cars, it doesn’t just hold an auction and buy from the lowest bidder. It enters a long-term relationship with the supplier it believes will provide the best quality and price over time. The company’s very future is at stake — nobody wants to buy a car that can’t reliably shift into first gear. But when that same automaker needs some staplers for the office supply cabinet, it is more likely to seek out the lowest price it can get, pretty much indifferent to the identity of the seller.

Labor exists on a similar continuum. The right product engineer or marketing executive can mean the difference between success or failure, and companies tend to hire such people as full-time employees and as part of a long-term relationship — something like the transmission supplier. What has changed in the last generation is that companies today view more and more of the labor it takes to produce their goods and services as akin to staplers: something to be procured at the time and place needed for the lowest price possible.

And this lies at the heart of the matter and is telling,

There’s no inherent reason that work done through a contractor should involve lower compensation than the same work done under direct employment. Sometimes it goes in the other direction; when a company hires a law firm, it is basically contracting out legal work, yet lawyers at a firm tend to be paid better than in-house counsel. But as more companies have outsourced more functions over more time, a strong body of evidence is emerging that it’s not just about efficiency. It seems to be a way for big companies to reduce compensation costs. Firms in the United States are legally required to offer the same health insurance options and 401(k) match to all employees — meaning if those programs are made extra generous to attract top engineers, a company that doesn’t outsource will have to pay them for everyone. More broadly, there are a whole set of social pressures and worries about morale that encourage companies to be more generous with pay and benefits for employees who are on the same payroll. 

Nice article. Wish there were similar articles on the effects of the use of robots in Maruti or Volkswagen's Pune car factory or the widespread use of contract labour by our manufacturing firms.

This highlights the difficult choice for governments in countries like India in the area of labour market reforms. Whether we like it or not, flexibility in labour markets is an important contributor to business competitiveness in a globalised market. Outsourcing services to specialised labour contractors is central to this flexibility. The natural policy response should have been to mandate that contract labour too enjoy all the same benefits and social protections. But, as we read above, if the primary objective of contracting is to reduce compensation costs, then such policies run counter to them. But perpetuating this arrangement, apart from its political risks, also creates an unsustainable economic system.

A strong social safety net that goes beyond just the poorest and covers a majority of citizens is a possible solution. But this, in turn, raises the troubling question of fiscal sustainability.

These are really difficult challenges and representative of many social or economic issues, with no satisfactory answers. Governments often make judgement calls, which are always likely to be perceived as sub-optimal, in directions based on the political imperatives that motivate the decision. It is very easy to miss the big picture and criticise governments when passing judgement on policies.