Return on Labor Employed

Benjamin M. Lavine, CFA, CAIA

Co-CIO, 3D/L Capital Management


Illustration from 19th century

Source: (“Peasant Uprising in Germany, Easter 1525)

“The true price of anything you do is the amount of time you exchange for it.” – Henry David Thoreau

The Wall Street Journal ran an interesting piece on what shape the labor market is taking as we emerge from the pandemic lockdowns and social distancing restrictions.  Titled, “Forget Going Back to the Office—People Are Just Quitting Instead,” the article highlights the stronger bargaining position of the broad U.S. labor force (not just white collar high-skilled but across the skills spectrum) – a structural shift that has implications for company management behavior as to how they view the capital/labor mix going back to the 1980s, a period which saw the initial decline of labor’s bargaining power from the post-war period.

This follows on another interest piece penned by Martin Hutchinson, blog writer for True Blue Will Never Stain wherein Hutchinson draws a crude parallel between today’s renewed bargaining position of the labor force vis-à-vis executive management and the improvement in rights and living standards of European medieval serfs vis-à-vis their feudal lords following the Black Plague of 1348.  As the plague had wiped out a third of England’s population, a severe labor shortage emerged that was initially met by upper class oppression (Statute of Labourers Act of 1351 that prohibited demands for higher wages).

However, subsequent generations of serfs did enjoy higher wages during a period retrospectively known as “Merrie England” (at least for serfs not drafted into the War of the Roses).  Eventually the upper-class landed gentry had to acknowledge the reality of a labor shortage, resulting in a permanent shift between lord and land worker that would eventually see the end of the feudal system and the emergence of a merchant middle class.

What these two articles hold in common is the newfound strength of laborers in the face of economic labor shortages, even when potentially facing longer-term threats of capital displacement from technical advancements.  As Hutchinson writes,

“During the pandemic, the corporate serfs have tasted freedom. Freed to work from home, they have discovered that a modest house in the unfashionable outer suburbs, well within their purchasing capacity, is now affordable. Suddenly, a family and a decent lifestyle no longer seems impossible, provided only that they are not forced to go into the big-city office too often. Naturally, preserving this new-found freedom is a top objective for the serfs’ post-pandemic living, just as preserving the freedom of working for a decent wage was vital for the serf of say 1370.”

Hutchinson believes an initial crackdown by company management will be attempted to return to the pre-pandemic office work environment, but the ‘stay-at-home’ genie has already been let out of the bottle, forever changing the working landscape.  Hutchinson concludes,

“Eventually, the 14th Century serfs got their freedom. This is likely to be true also for the great majority of the corporate serfs who have tasted freedom during Covid-19. The CEOs will find themselves with two choices: either they can sit in solitary splendor in their big-city offices, with staff visiting them occasionally and otherwise communicating via Zoom, or they can sit in solitary splendor in their big-city offices, with no staff at all and their corporate empires collapsing around them.”

One can be forgiven if one believes Hutchinson gives in to hyperbole, but consider this anecdote from the WSJ article,

“In March 2020, Edward Moses was hired as an information-technology specialist at a software company, believing he would be part of a team supporting colleagues in four U.S. offices. Instead, after a round of layoffs, he found the team had one member, and he was it… The days were stressful, he said, with few opportunities for promotion. A 5% raise after a strong performance evaluation didn’t quell his frustration. This spring, Mr. Moses gave notice and started a new job—and career path…” 

Labor’s renewed muscle flexing isn’t just to be found in higher wages but around better living standards such as workplace flexibility, not being overly burdened with the work of multiple colleagues, or a realignment of one’s career with one’s skillsets, rather than just making do.

Now, one can debate whether the Biden Administration’s renewal of jobless benefits have contributed to the labor shortage or whether businesses could not recover the operational capacity that would keep pace with the pandemic recovery.  However, a labor shortage in the U.S. economy currently exists as evidenced by the following charts.  First and foremost is that the U.S. Labor Force Participation Rate has yet to recover to pre-pandemic levels (admittedly on a downward decline since the Clinton Administration); this is one of the primary indicators that has kept the Federal Reserve from ‘normalizing’ monetary policy.

Figure 1 – Will the Labor Force Participation Rate Climb Back to Pre-Pandemic Levels (or Even Back to the Peak Reached During the 1990s)?

Source: Bloomberg

Even more telling is the Job Hirings–to–Opening ratio which is at a multi-decade low, encapsulating the worker shortage employers currently face.

Figure 2 – Hiring-to-Openings Ratio Encapsulates Today’s Labor Shortage

And it’s not just worker anecdotes that speak to the increased bargaining power that labor is flexing.  The Voluntary Quit Rate has also reached multi-decade highs suggesting that workers are not putting up with either compensation levels or workplace conditions in this new post-pandemic reality.

Figure 3 – ‘Take This Job and Shove It’ as Voluntary Quit Rates Reach Multi-Decade Highs

Assuming a rational response from employers that relies more on ‘carrot’ rather than ‘stick’ (see Hutchinson’s comments earlier), the labor shortage should eventually ease as the cost of labor meets the ‘normalized’ demand from employers.  Whether this will translate in more permanent (not transitory) higher wage pressures (Figure 4) depends on future productivity (Figure 5), which has recovered quite nicely although this could be a result of short-term base effects rather than a sustained rise.

Figure 4 – Will Higher Quits Translate Into Higher Wage Pressures?

Figure 5 – Higher Wage Pressures Can Be Non-Inflationary If Offset by Higher Productivity

Source: Bloomberg

Classic business management theory covers the capital/labor mix and ways to optimize the use of both as well as trade-offs between one versus the other.  In the post-COVID business environment, faced with a labor shortage, company management may be tempted to further increase capital usage relative to labor, but we may have already reached that limit as indicated by the hires-to-openings ratio.

Since the 1970s, as capital’s share has grown in relation to labor, equity shareholders have tended to care more about return-on-invested capital as a key indicator of company management’s effectiveness.  The 1980s Corporate Raider (think Gordon Gecko from Oliver Stone’s Wall Street) would target ‘bloated’ inefficiently run companies through leveraged buyouts with promises to shareholders that the ‘bloat’ would be removed.  Putting aside the leveraged buyout, companies would be rewarded over time with higher equity valuations if they generated higher returns-on-invested capital and vice versa to the point that industries unable to generate returns higher than their cost of capital would experience investor outflows (think capital intensive industries such as energy exploration and mining, whose recent newfound capital discipline has resulted in our current commodities supply deficit).

However, the COVID-19 pandemic and the technological capabilities that have enabled widespread adoption of ‘work-from-home’ for many industries across multiple labor categories will force company executives to compete not only on investment capital deployed but on labor employed.  Human resources may well represent the new hot growth area in business management.  Return on labor may become just as important as return on capital with respect to company valuations as long as productivity maintains its upward trend.  


The above is the opinion of the author and should not be relied upon as investment advice or a forecast of the future. It is not a recommendation, offer or solicitation to buy or sell any securities or implement any investment strategy. It is for informational purposes only. The above statistics, data, anecdotes, and opinions of others are assumed to be true and accurate however 3D/L Capital Management does not warrant the accuracy of any of these. There is also no assurance that any of the above are all inclusive or complete.  This article does not constitute an offer to sell or a solicitation of an offer to purchase interests in any investment vehicles or securities.  This article is not a prospectus, an advertisement, or an offering of any interests in either the Strategy or other portfolios.  This article and the information contained herein is intended for informational purposes only. It does not constitute investment advice or a recommendation with respect to investment. Investing in any strategy should only occur after consulting with a financial advisor.

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By: Benjamin Lavine