Labour MP for Newcastle Central
Labour MP for Great Grimsby
Professor of Accounting, University of Essex
Professor of Organizational Analysis, UMIST
Unemployment and low wages are a major cause of social squalor. Without adequate and regular wage, people cannot afford decent diet and provide adequate housing, health, education and care for their families. The result is inequality and misery. Labour’s General election manifesto promised to introduce a decent minimum wage, the only substantial redistributive pledge, one that won considerable support for the Party, helping it to win the 1997 election.
However, the very concept of a decent minimum wage faces hostile propaganda and opposition from many industrialists and bosses, who themselves receive huge wages. The opponents of minimum wage claim that the payment of a decent wage will increase industry’s ‘costs’ and erode British industry’s competitiveness, resulting in lower economic activity and impoverishment of low-paid employees. These claims are based upon conventional and outdated accounting practices in which labour is treated as a ‘cost’ which detracts from profits rather than what it really is - a source of added-value essential for wealth generation. Because all too little has been done to challenge this ‘claim’, there is a danger that it will gain credibility. So in this article, we challenge the ‘claim’ by highlighting the divisive bases of the conventional accounting practices.
Conventional accounting practices are based upon the concern to maximise profits for shareholders, but completely neglect other stakeholder’s concerns. An alternative basis known as ‘Value ‘Added’ focuses upon stakeholder concerns and shows that the payment of a minimum wage is a redistributive and wealth generating effort. Under this approach, the payment of a decent wage does not increase ‘costs’, but boosts economic activity.
CONVENTIONAL ACCOUNTING PRACTICES
The conventional practices and their assumptions are best understood with the aid of a simple example. Later on, the same data will be used to illustrate the ‘value added’ approach.
Example: A company sells an item of furniture for £450. Raw materials such as wood, springs, upholstery etc. were bought for £155. Workers were paid £100 wages. Gas, electricity an other services costing £40 were used. The company was partly financed by a loan/overdraft on which an interest of £15 was paid. The company is liable to pay corporation tax at the rate of 25%. The company will pay its shareholders a dividend of £85 and the remainder of the profit will be retained in the business. From this data we can now prepare what companies call a profit and loss account and develop our arguments.
A CONVENTIONAL PROFIT AND LOSS ACCOUNT
less Materials Used
Wages Paid 100
Services Bought 40
Interest Paid 15 310
Profit Before Tax
Corporation Tax (25%) 35
Profit after Tax 105
Dividend Payable 85
Retained Profit 20
As the above example shows, in conventional accounting practices, the interests of finance capital (or shareholders) are considered to be supreme. Any increase in wages of the employees is seen to be against the interests of shareholders as it takes away from profits. For example, if the wages are increased from £100 to £110, then profit before tax will decline by £10 from £140 to £130. The above practice also shows that one of the ways of increasing profits is by lowering wages and/or health and safety expenditure etc. Thus if wages are lowered from £100 to £90, profit before tax will increase by £10. It is important to note that increase in profits is not accompanied by any increase in the production of goods, services or market share i.e. no additional wealth has been generated.
Following this logic, conventional accounting practices encourage lower wages and cuts in training, research and development expenditure. All these produce short-term increases in profits. Such accounting practices are built on the assumption that the objective of a firm is to maximise profit accruing to shareholders. It does not recognise that employees (or labour) are a major asset of any business, providing the brain and brawn to produce the goods, services and to generate wealth. In conventional accounting practices, they are considered to be subordinate to finance capital. Their positive contribution to wealth generation is neglected.
The language of accounting is also interesting. Wages are equated with ‘costs’ and so considered to be ‘burdens’. What must employers do to maximise profits and reduce burdens? The self-suggesting answer is that they must reduce ‘burdens’ and ‘costs’. In contrast, the rewards to suppliers of other essential, such as finance (e.g. from shareholders) are considered to be ‘rewards’. Thus dividend payments do not constitute ‘costs’ or ‘burdens’. What must a company do to keep shareholders happy? The self-suggesting answer is that it must increase ‘rewards’ or ‘dividends’.
Conventional accounting model pits employees against shareholders (who may frequently be the same persons). We all know that wealth generation is a co-operative effort. Neither finance capital (e.g. provided by shareholders) nor human capital (provided by employees) on its own can produce any wealth. Co-operation and negotiations between them are an essential element in producing wealth. But conventional accounting privileges shareholders and induces conflict. The emphasises on maximisation of short-term profits neglects concerns with maximising production, investment and ‘value added’.
VALUE ADDED STATEMENTS: AN ALTERNATIVE
An alternative system of accounting must focus on the maximisation of investment and wealth generation. It needs to encourage maximisation of ‘value added’ rather than short-term profits. It must privilege co-operation amongst stakeholders rather than conflict.
In a capitalist economy all wealth generation is broadly dependent upon three kinds of investments. Shareholders and creditors provide ‘finance capital’. Employees provide skills, commitment, energy and loyalty, or what may be described as a investment of ‘human capital’. The third element, ‘social capital’ is provided by society which provides the infrastructure (family, health, transport, education, care etc.). Unlike the conventional accounting model, this does not assume that ‘finance capital’ must dominate all others. Instead, all three are required to co-operate and negotiate over how demands and rewards may be shared amongst them. To maintain and increase their prosperity, all three focus on the long-term and have to ‘add value’ i.e. generate wealth.
Exhibit 2 uses the earlier data and shows that essential difference
between the conventional accounting practices and the ‘value added’ approach.
A VALUE ADDED STATEMENT
less bought-in materials and services 195
Value Added 255
Shared as Follows:
To Finance Capital
Interest 15 100
To Human Capital 100
To Social Capital
Tax etc. 35
To Maintenance and Expand Assets
Suppose, as a consequence of minimum wage legislation, stakeholders agree that the employees’ share of ‘value added’ should be £110 instead of £100. This agreement does not result in any increase in ‘costs’. Rather the decision focuses upon redistribution of wealth and a reconsideration of how the wealth generated is to be divided amongst various groups. Of course, the above illustration is highly simplified. In reality, the employees of a business are unlikely to be homogeneous. They are likely to range from machinists, cleaners, clerks, designers to executives. So the share of ‘human capital’ may need to be analysed into various categories. The allocation may be targeted to increase the reward for the lowest paid groups, such as cleaners, or salon assistants. In turn this concentrates minds on how these human assets can best be deployed - through education and training - so that their contribution to added value can be enhanced. For example, could training enable them to be more self-managing, and thereby reduce more expensive managerial overheads?
Some might object to minimum pay on the ground that it has a knock-on effect on pay scales. In the ‘value added’ approach, the logical answer to this that increases need to be supported by their contribution to added-value, and not by appealing to institutionalised differentials or induced market scarcity. A value added statement focuses upon equitable distribution and under this, it does not necessarily follow that minimum wage will increase ‘costs’ of the organisation, or that the consumers will have to pay a higher price.
In the above example, the business accounts focus on stakeholders rather than just the shareholders. The conventional profit and loss account assumes that directors are accountable to finance capital or shareholders. The Value Added Statement assumes that accountability and obligations extend to employees and society generally. Managerial decision-making becomes more inclusive, less exclusive. All three providers of capital have to negotiate to secure an equitable share of value added. The divisive language of conventional accounting which labels things as ‘costs’ and ‘burdens’ is discarded. It does not assume that employees are a ‘burden’ and that reduction in the wages paid to them will increase ‘profits’. Instead, there is an appreciation that business will only prosper through maximisation of ‘value added’. Productivity schemes which maximise ‘value added’ can be designed. As we indicated earlier, short-term profit can be increased merely by reducing wages or eliminating staff training, research, development, advertising, PR and other ‘costs’. This does not provide a good basis for business.
The claim that ‘minimum wage will increase costs’ is underpinned by conventional accounting practices. Its legitimacy rests upon the acceptance of all the biases built into conventional accounting practices. To many, such accounting practices appear to be non-political, highly technical, grey, boring and complex. The defenders of status-quo are happy to advance such an image of accounting as it disarms, critics, challengers, low-pay groups and others. It shields accounting practices from scrutiny by portraying them as neutral and unbiased. Yet accounting practices are highly political and partisan. They affect the distribution of income and wealth in a way that is disadvantageous not only for a key stakeholder group, but also for investing in people and skills.
By moving to an alternative model which emphasises stakeholder rather than just the shareholder concerns, the question of ‘increased costs’ can be challenged. In the Value Added Statement, the emphasis is on generating prosperity and sharing the outcomes. In this approach, the establishment of a minimum wage does not result in any increase in ‘costs’. It shifts the focus to negotiations and (re)distribution of the wealth generated amongst stakeholders. Isn’t it time that the government required companies to supplement their conventional published accounts with Value Added Statements.
Groups seeking an equitable distribution of income and wealth need to
question the ‘visible hand’ of accounting practices in legitimising the
present inequalities and maldistribution of wealth. Without this the opponents’
case is unlikely to be undermined. The claims advanced by them will
assume an aura of uncontestable facts unless the doubtful basis of
conventional accounting numbers is exposed.