Thursday, 23 June 2011

Cut Rents not Wages to Save Jobs in Retail

Nat O'Connor: Retail Excellence Ireland (REI) has released a survey of their members, which they contend shows that abolition of the JLC system would lead to thousands of jobs being created in retail (Press Release, 15 June 2011). There are good reasons to believe that this is a mistaken point of view.

REI got responses from nearly half their members, 342 companies which operate 4,445 stores, who said that if the JLC system was abolished that they would save 2,896 vulnerable jobs and create another 2,888. Treating this as a representative sample, REI estimate the total number of jobs created would be four times this, as there are c. 25,000 stores in Ireland.

There are three problems.

Firstly, good business sense does not add up to good economics. Say one business cuts the wages of its staff - that business has saved money and, all things being equal, should become more profitable (although staff performance might also fall). However, one stores's employee is another store's customer. If the 200,000+ generally lower paid workers protected by the JLC system all suffer pay cuts, that is going to lower demand in the economy; i.e. they are all going to have less money to spend in the local economy. And people on low wages spend most or all of their money. (All of this is basic economics). Hence, the companies consulted by REI might believe today that they could save and create jobs - but if demand falls, as it surely must from cutting the JLC system, than the same stores will find that they cannot expand employment after all.

Secondly, we cannot be sure if the 342 companies that responded to REI are in fact a representative sample. These companies have an average of 13 stores each, but there are many one-off stores among Ireland's 25,000. We do not know if these stores would be in the same position to save or create jobs. So, REI's multiplication by four might be over-stating the probability of job retention/creation.

Thirdly, the international evidence is broadly against any strong relationship between cutting wage levels and job creation. The strongest studies are of US States, and even counties within those states. These studies compare two areas side-by-side (with similar workforces, similar industries, etc) where one of them cuts wage protection and the other does not. Over time, no great difference in job creation is shown. This evidence strengthens TASC's confidence in the theory that while individual businesses may benefit from lower wage costs, they equally suffer from the economic effects of reduced demand. (See references below)

Therefore, it is fairly safe to assume that cutting the JLCs will neither save nor create jobs in retail.

There is hope however.

REI also found that the companies surveryed would save 7,791 vulnerable jobs and create 5,072 new jobs if the Upward Only Rent Review (UORR) was abolished. Unlike the JLC system, which affects demand that retail so badly needs, there is no such effect with rents. Most commercial landlords are higher income individuals or companies that save rather than spend most of their incomes. Therefore, cutting those incomes will not greatly affect retail demand as they are likely to cut their saving rate before they will drop their lifestyles (spending habits).

However, we still don't know if the multiplier of four would apply or to what extent these 4,445 stores experience of UORR is representative of others. In fact, city centres (where rents are highest) tend to be dominated by chain stores. So, it is possible that many one-off local stores are less affected by UORRs; although excessively high rents can be a problem for any business.

We could be more conservative than the REI and suggest merely doubling the survey findings to estimate the likely employment effects. That would mean abolition of UORRs could lead to c. 15,000 vulnerable jobs being saved and c. 10,000 new jobs being created.

On REI's website, there is a banner headline stating: "High Rents Are Killing Retail Jobs". In a similar vein, Declan Ronayne, MD of DSG Ireland (Currys, PC World, etc) spoke on RTÉ's Morning Ireland programme (23 June 2011, c. 8am) that the focus on JLCs was a mistake, and that rent levels was a much more pressing issue.

Economic theory and evidence concurs with this perspective. Cutting rents, not wages, is indeed likely to save and create jobs in retail.

Thanks to Tom McDonnell for these.

Card D. and A. Krueger (1994). Minimum Wages and Employment: A Case Study of the New Jersey and Pennsylvania Fast Food Industries. American Economic Review. 84(4), 772-793. Available here.

Dube, A, L, T. William, & Reich, M. (2010). Minimum Wage Effects Across State Borders: Estimates Using Contiguous Counties. UC Berkeley: Institute for Research on Labor and Employment. Available here.

The preface to this book puts the results into plainer English.

Note: the economy is a dynamic, complex system. Establishing causality is notoriously difficult in the social sciences. Just because a study argues there are ‘no employment effects’ or ‘substantial employment effects’ should never be grasped as proof about an underlying economic relationship. All we can ever have is estimated probabilities.

The Duffy/Walsh report made the point that there was evidence of publication bias in wage-floor research. Evidently ‘employment effect’ results were more likely to get published than ‘no employment effect’ results. They referenced this: Doucouliagos, H. and T. D. Stanley (2008). Publication Bias in Minimum-Wage Research? A Meta-Regression Analysis, British Journal of Industrial Relations.


Robert Sweeney said...

Regarding the abolition of the JLCs, is there not the additional sample bias that those being surveyed have a stake in the outcome? Given recent media attention surrounding the JLCs, it seems reasonable to assume that at least some employers will claim a positive employment affect regardless of whether or not they really believe it to be true. I think it is obvious that the crisis is being used, both in Ireland and elsewhere, as an opportunity to dismantle welfare provisions despite the negative impact such policies are having on economies.

Nat O`Connor said...

That kind of sample bias is possible, and a lot would depend on how questions were phrased. The REI have only published a press release, not a full research report.

There are no doubt those using the crisis to dismantle worker protections and welfare. But it seems that there is also a great deal of misunderstanding or ignorance about how economies work in reality.

Neil Callanan said...

This column is utter nonsense as it completely fails to take account of the economic impact of abolishing UORRs respectively. Nama alone have estimated losses of up to e2.25bn on its portfolio, that's excluding the sub-E20m loans remaining on Irish banks balance sheets. Based on Nama writedown alone, the cost per job saved is E90,000, true cost per job probably close to E160,000. The money could be better spent on job creation efforts rather than inflating the profits of many retailers and office tenants. Also note the non-use of the word full-time jobs by REI, most retail staff part-time and don't pay tax. We wouldn't get any of the money back.
Upward only rent reviews weren't the problem, retailers ripped Irish consumers off and then bid aggressively against one another for shops. So on Grafton Street the highest rents are paid by River Island and Tommy Hilfiger, both of which bid up the rents on a NEW lease. That drove other retailers rents up when rent review came around. The retailers created the problem and now are looking for us to preserve their profits.
Messing with property market can have serious consquences, look at what Govt actions here did while rent freeze in the 70s in Britain led to a secondary banking crisis.
Do some research please before posting something like this.

Tom Dunne said...

you kindly provided references for your views about the effect of wage cuts. Might the same be provided for the studies that pointed you to your judgement about extending the ban on UORRs to legacy leases?
Tom Dunne

Rory O'Farrell said...

@Neil Callanan

Are you seriously suggesting that high rents are good for the economy?

If NAMA uses its monopoly power to keep rents high it might be good for the NAMA balance sheet, but not for the rest of the economy.

Must we resort to shops going into receivership before rents reach a more realistic level? That doesn't seem very efficient to me.

Neil Callanan said...

Why should the retailers survive after they ripped us off for years. REI have never said how many jobs were created after shops close. In many cases, other businesses will set up, take over the shops at market rent. Think of who the biggest tenants in the country are: Tesco, Dunnes, Microsoft, H&M, Zara, TK Maxx, Arcadia group. All are massively profitable. Why should we as taxpayers give them any money. The solution is to introduce new zonings, limiting the type of retail units that can open on certain streets, thereby placing a natural rental cap on many streets. At the moment the proposal benefits the most profitable, not those who are actually struggling.

Rory O'Farrell said...

Sure some shops tried rip people off. Others didn't. We can't base policy on who was nice. Equally, many shops charged high prices because they were/are being ripped off by landlords.

I don't see how the most profitable would benefit the most. Its not just the high street that is affected. Also, ability to pay would affect (downward)rent reviews. The big retailers can use their market muscle, the smaller ones can't.

Allowing adjustment through bankruptcy is hugely costly. Not only are there the human costs, but expertise in the running of a business is lost, units are left vacant, staff are unemployed and units have to be refitted.

We aren't going to get out of this mess by continuing to prop up the property market. If NAMA makes a loss so be it. We would benefit more due to lower prices and more employment.

Neil Callanan said...

You don't have to use bankruptcy. This is the misnomer. The courts allow retailers to exit onerous leases using examinership. Look at Bestsellers - massively profitable international retailer - exited leases here, then announced it was opening more stores than it had had beforehand and employing more people. Those who need an out already have it. You say that only some retailers ripped us off but you're advocating a position where all tenants regardless of sector or financial situation will qualify for rent reductions.

Rory O'Farrell said...

High rents, no more than high electricity prices, are good for the economy.

If a firm is very profitable I'm not too concerned if they get a rent reduction. The fact they are highly profitable shows they already have room to cut prices, so would probably just put the rent reduction in their back pocket. Its just a matter of who gets the money, the landlord or tenant.

However, those in difficulty are more likely to be in a competitive market. I accept your point about bankruptcy, but examinership itself is very expensive, and a streamlined system would be beneficial.

Bleeding tenants white to feed NAMA isn't sound economic policy, and there is no point in seeking vengeance against any shops you perceive to have ripped you off in the past.

Landlords simply have to realise that Ireland is a peripheral country, a suburb to the European core. Land prices here should be considerably below that of the core. Its a comparative advantage (squandered during the boom) of a peripheral location. Obviously property prices are adjusting, but why hinder this? NAMA won't loose money due to the abolition of UORR, they lose because they overpaid for some of the assets.

Its inevitable that property prices will adjust. UORR hinders this adjustment, keeping us mired in recession.