Does cheaper labor translate to a better startup ecosystem?

May 20, 2014
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The bulk of President Hollande’s economic policy, which was named the “responsibility pact”, consists in helping to lower French labor costs by cutting employers’ contributions to the French Social Security scheme. Lower labor costs are supposed to make the French manufacturing industry (and thus the French economy!) more competitive, and therefore help to curb unemployment and make everything better. But will the policy change anything for entrepreneurs? Can it encourage entrepreneurship and innovation?

Probably not…

It creates an environment that will ultimately discourage entrepreneurship (or make it a lot more difficult for some):

What the French call “Social Security” is a system that provides universal social insurance against ill health, unemployment and old age. Everyone in regular residence in the territory has a right to health care coverage, including the most disadvantaged (submitted to resources). The system is relatively cheap and the health care is (still) one of the best on the planet. It is funded through employees’ and employers’ contributions.

Cutting employers’ contributions could have two effects: that of lowering the quality of care and the “refunds” the insurants get, and that of spurring them to subscribe to an additional private insurance, which by the way could ultimately make labor costs more expensive since it will become a necessity for employers to offer the best private coverage packages to lure in the talents they need! Ultimately this starve-the-beast policy aims at replacing the public system with a private one, likely to be significantly more expensive.

The French Social Security is an amazing cushion against risk. You can risk your job and create a business without losing your coverage or you can do it while unemployed because you receive unemployment benefits. No accident or disease can make you bankrupt if you’re on your own. Obama’s Affordable Care and Patient Protection Act (dubbed “Obamacare”) aims precisely at creating such an environment and spurring the economy by removing one of the obstacles to business creation and self-employment. In people’s minds there’s nothing more American than creating a business and yet, before Obamacare, health care was a gigantic obstacle to business creation, especially for the middle-aged or those unlucky to have a “pre-existing condition” like diabetes—and they are numerous: one in three Americans will have diabetes by 2050 if the current trend continues.

What if Facebook hadn’t been started for want of health insurance? No one but President Obama said it better: “The commitments we make to each other through Medicare and Medicaid and Social Security, these things do not sap our initiative, they strengthen us. They do not make us a nation of takers ; they free us to take the risks that make this country great”.

It sounds a hell of a lot more inspiring than “let’s lower labor costs to become more competitive”, doesn’t it?

Furthermore, lower labor costs just feed the rent-seekers and impede innovation

The very idea that lower labor costs can make an economy more competitive is a moot point. Price competitiveness depends as much on productivity (which is high in France), real estate prices and the cost of capital. But mostly competitiveness should be more about product quality, sales force, the lure of our brands and especially our ability to implement what Clayton Christensen calls empowering innovations, the only ones which create jobs.

Lower labor costs may be perceived as a short-term relief by French companies but they could impede innovation. They increase a company’s efficiency, but as economist and venture capitalist William Janeway put it: “efficiency is a dangerously overrated concept” and “the enemy of innovation at the systemic level”. It also “cripples a government’s effort to offset contraction in private sector”.

High labor costs encourage innovation. For long Germany was extremely competitive in spite of (because of?) its high labor costs. Low labor costs will obviously discourage investment. What’s the point in acquiring sophisticated expensive labor-saving equipment if labor is cheap? What’s the point in acquiring expensive 3D printers (they are getting cheaper, I’ll grant you that)?

Janeway believes both “Schumpeterian waste” (at the entrepreneur’s level) and “Keynesian waste” (at the government’s level) should be bolstered by the state. In addition to funding research, the state should serve as an early customer of innovative products not yet ready for commercial competition (much as the US Defense Department did in the early years of the digital revolution) or deploy open platforms on which entrepreneurs and investors can “dance”.

Once again, the government’s short-sighted approach to helping the economy relies on an outdated vision of the economy where the “economy” equates with the “manufacturing industry” and business with the rent-seeking corporations whose sole purpose is to squeeze their costs to be more efficient. Entrepreneurship and empowering innovation aren’t part of that picture…

photo via flickr