Unemployment Today: The Marginal Efficiency of Capital

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December 21, 2009

Tonight I was reading and started thinking about the marginal efficiency of capital.John Meynard Keynes

It’s probably obvious that I was not reading the latest copy of Vogue or one of the tabloids.  I actually came across the 1936 book ‘The General Theory of Employment, Interest, and Money‘ by John Meynard Keynes.  In his time, his economic theories were quite controversial.  But, after the Great Depression, Keynesian economics began to gain favor and had prominence up into the 1970’s.  The book itself it quite fascinating to read if you’d like a look at marco-economics.  It puts forth the idea that unemployment rates can be lessened if you stimulate the economy with increased government spending.  With the Obama administration in place, it is again a source of guidance for digging out of our current economic situation.

As I was reading, I focused on one particular chapter regarding the marginal efficiency of capital.  To oversimplify this aspect of this particular theory, the marginal efficiency of capital is the relationship between the prospective yield of  a capital asset and the replacement cost.  So in terms of applying this to human resources, it is the relationship between the work you personally can perform and the benefit you provide compared to the cost of the employer to replace you.

I’m wondering how the current economy is affecting this relationship.  It could go a couple different ways:

  • The cost to replace you could be less because with unemployment so high, there are more available candidates to fill your role.
  • The cost to replace you could be more because even though there are an overabundance of candidates, employers are finding they are not candidates with the right skills.

So, what do you think?  Are you seeing that replacement cost for workers who leave has increased because there are few candidates with the right skills?  Or are you finding the opposite, that there are plenty of candidates who can fill the openings, so the replacement cost is relatively low because people are willing to work for less?  Let me know in the comments.

8 Comments

  • Wow… too early on Monday to be looking at Keynesian economics!

    But it did get me thinking. Ouch – another coffee please!

    Here’s something to consider. The marginal efficiency of capital discussion is about decisions to ADD additional capital in an area based on expected returns – not necessarily a way to to calculate whether to actual swap out a person (or in the old days – a machine) ie: replace existing capital.

    The “replacement” cost in the equation is only the explanation on the way to value the new asset. In other words, the replacement cost in the MEC equation is the costs associated with hiring a new employee (hiring/on-boarding/training/etc.) That then is bounced against the future return of that investment and as long as that return exceeds the rate of return I could get in another asset class it is a good deal for me to add that person.

    But the question you pose is a great one…

    When does it make sense to replace employees and are we in a economic situation where it makes sense to swap out old, expensive capital with new, cheaper capital (apologies for using financial terms for people – I’m not really that cold-hearted)?

    My personal belief is that the employees companies have now fall into either one of two camps – top performers who made the cuts and are working hard to maintain that level of performance so they don’t get cut in the future – or – employees that were cheap to keep (ie: newbies, lower level performers) and therefore are probably not paying for themselves or are paying a much lower rate of return on their salaries.

    If you have the first category of employee the chances that you will replace them with “better” employees is either low or a push – so the expense of replacing them would outweigh any return.

    If you fall into the other category – lower performers left – then you have to decide if the current market is filled with low performers or high performers. If everyone followed your lead and kept the cheaper labor then you would believe you could trade up and get top performers and it would make sense.

    However, if everyone else kept high-performers then the market is filled with low performers and long term this will be a bad strategy.

    So the net is that if you believe the market is filled with top performers and you kept the dregs of your employees to reduce costs – time for an upgrade. Otherwise, the risk of actually getting less production in the future would be too high to consider replacing your current folks.

  • Trish – Paul is right – you are really challenging us on a cold December Monday morning – I had to reach for that third cup of coffee. I suspect that some of the analysts on our team will have some wildly divergent views on your excellent questions (although it is hard to find a Keynesian to admit it publicly).

    I’ll leave the debate to them – but will share that we have been tracking a very specific trend over the past two years of companies terminating a higher percentage of management employees for reasons of performance, currently rolling at over 1/3 of all involuntary terminations – up from just about 10% at the beginning of the recession. As voluntary terminations have dropped, for obvious reasons, it appears that the large companies that we track in People Report are taking the opportunity to deepen their bench and add some talent. Average years of experience and years of education have also increased.

    While we track the foodservice industry specifically, my best guess is that you would see the same pattern in large big box or specialty retailers, banks and grocery.

    Joni

  • I really dig Keynesian economics, but in addressing human capital, and I know many folks hate that term, it’s more messy and contextual. And although booms and busts come and go and the level or knowledge needed for any given position varies from industry to industry, I believe the constant in the equation is the average replacement cost with the long-term variable being performance.

    Consider:

    – Knowledge capital lost (whether from keeping a poor performer too long or losing a top performer)
    – Sourcing costs (still have to the right candidate with the right skills)
    – Recruiting costs (narrowing the field and making offers)
    – On-boarding and ramp training costs
    – Employee development and long-term training and retention costs

    More isn’t better. The key here is identifying, hiring and retaining the top performers, but then again, that’s why I’m in marketing and have only played an economist on an old episode Family Ties. 😉

  • I can’t even begin to comment on this. I am writing a Work/Life post for you. I am too busy trying to go on vacation to consider the cost/benefit analysis of human capital in Kynesian terms!

    Therefore, I choose not to. 😉

  • I concur with my colleagues who commented. Trish, this post is an interesting intellectual think piece. It is well researched, and extremely well written. Your post made me feel sad. Having taken the unemployment hit, I know how painful it is to recover from the blow. The two bullet points you cited above really say it all. The cost to replace an unemployed person is either high or low depending on your rank and value to the organization. I think what Americans need is hope for a better future.

  • @Paul- You didn’t do too bad for a Monday morning. I realize that applying the theory in the fashion I did is not exactly what Keynes had in mind, however, it was an interesting question. I enjoyed your comparison of both sides; keeping the high performers vs. the low performers. Always love your contribution to the discussion here..

    @Margo- Thank you and I am sorry it made you sad. It is reality thought that certain companies value employees more than others. The challenge is to find on that values the skills you bring. I know you’ll find that in 2010 my friend.

    @Joni- I love throwing ideas out that can spark a debate in opinion. I want to thank you for adding some meaningful stats to the discussion. Very interesting to hear that the large companies you track are tending to continue to hire more experienced pros instead of opting for more junior, less expensive candidates. Thanks for joining the discussion.

    @Kevin- You’re right- performance is the variable that is important here that economics cannot account for. That’s why there are marketing and HR gurus. 🙂 Thanks for commenting. And, what’s this about Family Ties?!?!

    @Mike- Aren’t you glad I asked you to post about flexibility and not economics??

Comments are closed.

John Meynard Keynes
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About Trish

A former HR executive and HCM product leader with over 20 years of experience.

HR HAPPY HOUR LIVE! TALENT ACQUISITION & ONBOARDING

THE FUTURE OF WORK

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