On the front page of yesterday's Wall Street Journal, there is an article about how a once successful black entrepreneur saw his stucco business ruined because of competition from Mexican immigrants.
It seems to me more a tale of business strategy and microeconomics than it does about immigration.
By the mid-1990s, stucco jobs increasingly took Mr. Hairston and his predominantly black crew from Atlanta to Hilton Head Island. Mr. Hairston fell in love with the moss-draped oak trees and intercoastal waterways inhabited by snowy egrets. Golf and hotels had turned the area into a resort mecca, and in the mid-1990s, a housing boom in the area allowed Beaufort County to boast the fastest growth and lowest unemployment in the state. "There was tons of work ... and only a couple stucco contractors in the whole area," recalls Mr. Hairston, a tall, strong man who sports a shaved head and a goatee.
According to the article, Mr. Hairston's most profitable year was 1997 when he had $971,000 of revenues and "roughly $500,000" of net income.
Half a million a year is a huge income even for a white Harvard educated professional living in Manhattan. What did he do to actually "earn" that income? He found a market where there was little competition, and we presume that there were barriers to entry which prevented competition. What exactly were the barriers to entry? (1) You have to be smart enough to manage a stucco business, and (2) you need to work in the industry to learn the ropes. Probably, nearly all the people with enough intelligence and ambition to run their own businesses were turned off by the idea of working for low wages as a stucco person, and they got sucked into more prestigious occupations, probably ones that require a college degree.
How much of his big income did he share with his black workers? Probably, like a good capitalist, he kept all the money for himself and paid his workers the lowest wage he could get away with. It's not just the white man keeping the black man down. As soon as a black man makes it big, he also participates in keeping the other blacks down.
But then Mr. Hairston discovered immigrant labor.
Latin American immigrants were just starting to trickle into the area, as word spread that jobs in construction and hospitality were plentiful. Immigrants were increasingly bypassing traditional gateways, like California and Texas, to seek work in the Southeast.
So Mr. Hairston, who until then had mostly relied on black labor, hired a handful of Mexicans. He says they were diligent and eager to learn. They were "prepared to acquire basic knowledge and not afraid to try" new work, says Mr. Hairston. When he needed more hands, his Mexican workers sent for their relatives back home and elsewhere in the U.S. Mr. Hairston says they presented Social Security numbers, and he in turn paid taxes and workers' compensation although he acknowledges some of them had probably entered the U.S. illegally.
It sounds pretty good for Mr. Hairston. Better quality labor for the same low price, or even lower, than before.
I have no doubt that the Mexicans were better workers. The black workers were probably from the bottom half of the black bell curve. Who else would want to do manual labor in the hot humid climate of South Carolina? The Mexicans, on the other hand, took these jobs because barriers to entry (such as being illegal and not speaking English) prevented them from working at higher level jobs. But some of Mr. Hairston's new Mexican workers were smart and ambitious enough to learn the business and then compete against him!
Mr. Serrano began to work in stucco, perfecting his skills as an employee of Mr. Hairston's Pro Plastering & Stucco. He says he earned $8 to $10 an hour during the two-and-a-half years he worked for Mr. Hairston. In the beginning, Mr. Serrano recalls, Mr. Hairston still employed several black workers. But gradually Mr. Hairston came to rely more on Mr. Serrano and other Mexican immigrants. "We showed up for work every day and we were dedicated," Mr. Serrano recalls.
On His Own
Around 2000, Mr. Serrano struck out on his own, working as a subcontractor to Mr. Hairston. He supplied Mr. Hairston with crews for several jobs. "I was able to train the workers," who were all Spanish speakers, he recalls. Mr. Hairston typically paid him about 25% of the value of the contract for the job, he says. Mr. Serrano says that he pays taxes on all his workers, as well as workman's compensation.
Mr. Hairston says that for a while it didn't bother him that some of his Latino workers, like the Serranos, struck out on their own. "I never thought I would be competing against them," he says. But he felt particularly stung when he encountered one of his workers -- who had asked for two weeks off -- working on an $80,000 job on a high-end house that Mr. Hairston's company had bid for.
Mr. Hairston's business gradually began to unravel. Mr. Hairston "would bid and another guy who used to work for him would bid on the same job," recalls Greg Goldberg, another builder, who is currently president of the local home builders' association. Mr. Goldberg himself says he hired some of Mr. Hairston's former workers.
Because of the new competition, "the Hairstons' net income plunged from roughly $500,000 in 1997 to about $70,000 in 2005."
$70,000 isn't a bad salary for a guy doing manual labor. Skilled engineers or computer programmers, jobs which require much more sophisticated knowledge, probably don't make much more than that when they are working in a low wage area of the country such as South Carolina.
Once Mr. Hairston's monopoly power was destroyed, his income sunk to the normal level of a skilled worker.
Yesterday I wrote about investment bankers. I asked, why do investment bankers make so much money? Why doesn't competition lower their income to the level of regular highly specialized workers? We might ask the same of BIGLAW, because similar principles apply. Why do BIGLAW partners make a million dollars a year?
Whenever people are making so much money, it's because there are barriers to entry and lack of real competition. Investment banking and BIGLAW both operate as cartels. A cartel is defined in Wikipedia as "a group of formally independent producers whose goal is to increase their collective profits by means of price fixing, limiting supply, or other restrictive practices.
Let's examine what investment banks and BIGLAW do differently from Mr. Hairston to maintain their market power and high incomes.
What they don't do is hire dumb employees. This is what Mr. Hairston used to do. If he had continued to hire the lousy black workers instead of the smarter and more motivated Mexican workers, he wouldn't have trained the people who ended up competing against him. Investment banks and law firms don't hire dumb people, but in corporate America, it's not uncommon for managers to purposely hire people not as capable as themselves to prevent their employees from eventually displacing them.
So how do investment banks and law firms keep their smart and ambitious employees from competing against them? One of their most important strategies is that they share the profits. This is why professional service firms are set up as partnerhips with large numbers of partners, and why so many people get large chunks of the profits. Goldman Sachs, by paying out billions of dollars in bonuses, demonstrates that it's more profitable for the employees to stay with the firm than it is for them to try to compete against it.
This is one of the things that Mr. Hairston did wrong. He paid Mr. Serrano a lousy $10/hour salary and kept all the profits for himself. If he made Mr. Serrano, and other workers who were identified as being the most likely to be able to successfully compete against him, junior partners, and upped their salary to $100,000 year, Mr. Hairston might still be making $500,000 a year. Instead of a bunch of small stucco firms competing against each other, there would be one big stucco firm with monopoly power and with several partners making big incomes.
The partnership model is used in industries where the primary barrier to entry is knowledge of the industry. In industries where there are other barriers to entry, such as high capital requirements or unique intellectual property protected by law, companies don't have to share the profits with the employees, and they don't. (Except for the CEO, but the reason for crazily high CEO salaries is beyond the scope of this essay.)
To further prevent competition within the industry, firms work towards creating group loyalty. Why do new investment bankers have to work 90 or 100 hour weeks? One reason is limit the number of people in the industry who have the knowledge of how to compete. But another very important reason is because this hazing experience actually creates group loyalty. As copied from Wikipedia:
Hazing is often used as a method to promote group loyalty and camaraderie through shared suffering, either with fellow participants, past participants, or both.
A tentative explanation from evolutionary psychology is that grave hazing can activate the capture-bonding psychological trait also known as Stockholm syndrome.
The group loyalty and camaraderie created by the grueling 100 hour work weeks and brutal treatment of investment banking associates discourages them from later competing against other investment bankers in a manner which would ruin the profits for the entire indusry.
The following description of the bidding process for stucco jobs demonstrates the lack of market power held by the stucco companies:
Mr. Hairston says that he never knew by how much he was undercut because the bidding process in construction isn't open. Builders often approach two or three subcontractors and invite them to make an estimate for a project. The builders rarely reveal the value of the winning bid to the losing parties.
What would happen if a company asked a bunch of investment banking firms, or law firms, to submit sealed bids in this manner? I'm pretty sure that the lawyers or investment bankers would say "sorry, that's not the way we do business." They know that as soon as one firm submits to this indignity, the profitability of the entire industry would unravel.
Furthermore, in investment banking, the amount paid to the bankers can't be hidden. The financial disclosure requirements, required by law, ensure that everyone knows how much the investment bankers made from the deal. How convenient that the law, which supposedly protects investors by disclosing financial details to them, has the parallel effect of making the industry less competitive and helps the investment bankers rip off the investors.
Law firms, of course, also take advantage of the law to limit their competition. All lawyers must pass the bar exam of the state in which they practice. Although passing a bar exam isn't the most difficult thing to do, the fact that each state has its own bar exam prevents lawyers from competing with lawyers from other states. So instead of one big national legal market with a large number of law firms, there are 50 legal markets each with a much smaller number of firms. The fewer the number of members, the more powerful the cartel.
Lawyers also have Model Rule 5.4 which ensures that lawyers get to keep their profits.
Mr. Hairston has learned the lessons of the lawyers and, with the help of his wife, is now trying to get the government to make his competition go away so he can once again make big profits:
In September, Mrs. Hairston presented a draft of an "illegal immigration relief ordinance" to the County Council. Under the ordinance, companies that knowingly hire undocumented laborers could have their business licenses revoked. The ordinance would require that all businesses volunteer to participate in a federal government pilot program that verifies whether a Social Security number matches an individual's name. It would bar illegal immigrants from getting a business license.