Ex Shell boss tackles capital vs labour debate

Nick Pattison is a former chairman and managing director of Shell Oman

Former chairman and managing director of Shell Oman, Nick Pattison, is perfectly positioned to comment on the Omanisation debate.

Here, in the second of a series of articles for OmanGBnews.com, Briton Nick discusses the pros and cons of substituting capital for labour.

In my previous article I mentioned that more businesses will need to be able to compete with international companies since there will be more 100% foreign-owned businesses in Oman in the future.

This fact sits uneasily with the announcement by the World Economic Forum that Oman dropped 13 places to become the 46th most competitive country in the world.

While the absolute level is based on a series of inputs, some of which are subjective and therefore open to debate, the fact that it has fallen does have some significance.

I shall be talking later about Omanisation and how we might stimulate it, but for the moment I want to address a far more urgent, but connected, issue: that of the highly inelastic labour market.

In a competitive economy/industry the labour market is defined as elastic. So when wages go up, companies look for ways of reducing labour costs by even more than the wage increases.

Usually the way to do that is to substitute machines for people, or capital for labour. In Oman, however, when wages go up the supplier usually continues to employ the same amount of labour and either tries to renegotiate his contract, accept reduced margins or simply put prices up.

When operating in high added value areas that may be acceptable, but this inelasticity of labour demand was indirectly the major reason (even if perhaps not apparent at the time) for the creation of the Public Authority for Consumer protection (PACP).

The wage increases were turning up immediately in price increases and the Government was concerned about the impact of those price increases and sought to control them.

It does seem strange at first glance that companies when faced with these increases do not attempt to change their business models. I feel that this is largely due to a lack of experience and knowledge of international practices at management level.

It takes time of course, but I see no signs, for example, of companies investing in hydraulic platforms to enable just one person to deliver a domestic refrigerator, rather than the three or four. In countries with high labour costs they are forced to substitute capital for labour because labour costs are so much higher.

To turn it around another way, if companies invested in machinery they could afford to pay their reduced labour force greater salaries since labour costs become a smaller part of the cost build up. That, incidentally, is one important pre-requisite for Omanisation: higher wage opportunities for Omanis.

Let’s look at an example. Take a company that spends capital to keep labour to a minimum. Let’s say it has a bottling line. Instead of having 30 people produce, for example, 30,000 filled and capped bottles a day, the company buys a machine that is capable of handling 50,000 bottles a day and gets rid of its labour force.

As production increases from 30,000 to 50,000, the incremental cost of production goes down. With the labour heavy approach, it will probably go up. Unfortunately there is an almost pathological aversion to substituting capital for labour in Oman.

This argument does not just apply to production: it applies equally to, for example, finance departments, construction companies and car service centres.

The recent Chatham House report contains this statement about Oman: “It is evident that successful labour force indigenization (.ie.Omanisation) is associated with sectors with high capital investment and low labour intensity, where investing in expensive programmes and confining jobs to nationals is affordable. Given the obvious costs, there is little incentive to do the same elsewhere.”

Let’s turn this statement around. If a company substitutes capital for labour it will be inclined to employ relatively more Omanis and fewer expats since their increased costs of employment play a smaller role in the sectors costs. Obviously they need to be trained though, and I shall address that next time.

NB – A version of this article also appeared in Muscat Daily.