In one of the most thought-provoking economics books of our times, A Farewell to Alms , Gregory Clark, discusses the concern that improved machines would reduce demand for labor. The answer during the Industrial Revolution was remarkably “no”. Most unskilled workers in fact benefited hugely from the Industrial Revolution, but not all:

“there was a type of employee at the beginning of the Industrial Revolution whose job and livelihood largely vanished in the early twentieth century. This was the horse. The population of working horses actually peaked in England long after the Industrial Revolution, in 1901, when 3.25 million were at work. Though they had been replaced by rail for long-distance haulage and by steam engines for driving machinery, they still plowed fields, hauled wagons and carriages short distances, pulled boats on the canals, toiled in the pits, and carried armies into battle. But the arrival of the internal combustion engine in the late nineteenth century rapidly displaced these workers, so that by 1924 there were fewer than two million. There was always a wage at which all these horses could have remained employed. But that wage was so low that it did not pay for their feed.” (page 286)

The U.S. has 15 million officially unemployed workers and additional tens of millions who aren’t working and aren’t looking for a job. Could these folks be the draft horses of the 21st century?

The cost of a low-skill worker has increased tremendously in the U.S. Let’s look at four kinds of costs:

direct payments for wages and payroll taxes

health insurance

mistakes

employment lawsuits

The minimum wage has increased steadily in the U.S. even as the average skill of a high school graduate has fallen. The federal minimum wage was increased in July 24, 2009, 1.5 years into our current economic depression. More important, perhaps, are the heavy increases in payroll taxes over the years, notably for Medicare and Social Security.

Most companies cannot culturally stomach denying health insurance to certain classes of worker. Apparently it is okay to pay the CEO 319X what the average worker gets, but it is not okay to tell low-skill workers “You aren’t important enough for us to buy you health care in the world’s most expensive and least efficient system.”

Most subtly, and perhaps most significantly, the potential cost of a mistake by an individual worker has skyrocketed. In industrial plants, the link between individual employee action and billions in losses is fairly obvious, e.g., with the Bhopal explosion. A tiny misstep in a chip factory and a wafer containing hundreds of valuable integrated circuits becomes worthless scrap. Computer networks, however, have made the potential costs of a clueless or careless office worker dramatically higher. Suppose that a company hires a low-skill not-very-alert office worker for $10/hour. This person accepts an email invitation to follow a hyperlink. One click later and the company’s network is infected with a virus. Best case: IT department spends $50,000 cleaning up; worst case: customer lists, customer credit cards, and other private data are compromised, costing millions of dollars.

As the government has increased the number of ways in which an employee can sue an employer, the expected cost of litigation from each additional employee has gone up. The cost of trying out a worker who might not work out is much higher than formerly, especially if that worker is older, female, or belongs to a government-recognized minority group. It might be smarter to employ fewer higher skill workers because the chance of litigation is lower with 100 workers than with 200 workers.

What’s the practical implication of all this? Policies that encouraged companies to hire the unemployed after the Jimmy Carter “malaise” years may no longer be effective. Health care spending as a percentage of GDP in 1980 was 8.8 percent (source) compared to nearly 20 percent today. Only a handful of companies had Internet access and there were as yet no viruses.

Or we can rephrase the entire posting as “How comfortable would you feel working at your present job alongside someone whom you would rate as among the least competent 25 percent from your high school?”

[Update: An economist sent me this article on how U.S. firms have job openings, but can’t find skilled workers to fill them.]