The supply side argument goes that if companies (and the rich) have more money (through incentives, lower tax rates, etc.), they will use that extra money to invest and create jobs.

This argument is silly.  Republicans have been making this argument since Reagan, and perhaps they really believe it…but it just doesn’t make sense. (And to boot, the empirical evidence says it is wrong as well.  In an environment of overcapacity, supply side policies just make the rich richer.)

Why?

Imagine a gold rush.  People come and dig up gold.  Merchants spring up around the mines and rivers to sell to the people.  The merchants get rich.  Then the gold starts to dry up.  The local government gives tax breaks to the merchants to stay in the town and continue to sell, to employ some of the people that were previously miners.

Do the merchants take the extra money and invest in the town, employ some extra people…or do they take the money from the tax breaks (and all the rest of the money they’ve saved over the previous boom) and move to another boom town?

Easy:  They take their money and leave.

Why?

No one in the city has any money to buy their products.

How does this apply to us?

1) Tax breaks for companies and the rich do not create jobs if there is no one to sell to.

If the companies and the rich take an ever larger share of GDP growth (which they are), people will not have any money to buy their goods…and that will eventually be bad for all parties.

It may make sense for any one company, or any one rich person to try to amass as much as possible; however, the model falls apart if it happens in aggregate.  History is pretty clear on what happens when the rich get too much and the rest have too little.

Henry Ford famously paid people twice the going wage so that people could afford to buy his cars.  Conversely, if we all work at McDonalds (or are unemployed), have houses with negative equity (and mountains of student debt), and are one health issue away from bankruptcy….no amount of tax breaks in the world will incent companies to try to sell to us.  We won’t be able to buy anything.

The rich do not create a lot of demand for real goods; if you give them more money they simply have more money.  A tax/incentive structure that favors wealth distribution to the middle and lower classes creates demand.

To illustrate, if a rich man has enough money to buy 4 houses, he will not buy 4 houses.  He might buy 2.  If you divide the money among 4 middle class people, they will buy 4 houses.

2) Companies are not in business to hire people.  It isn’t their purpose.  They are in business to make money.  They would hire ZERO people if they could get away with it.

If, before the recession, emerging markets were the best place for companies to invest, then after the recession if you give them more money, they will invest even faster in emerging markets.  It does not make them want to hire more people in the US, especially when those people don’t have any money.

Let me repeat it again more plainly: If a business’s purpose is to make money, and you give them money (through tax breaks), then why hire people?  They’ve already achieved their purpose.  Businesses hire based on demand, not profit.

Also, all this mess about companies are not hiring “because they can’t get credit” or “because they are ‘uncertain’ about future regulations” is complete crap.

Let’s take these one at a time:

1) Companies are not hiring because they can’t get credit.

Credit is the easiest thing in the world to get; it is created out of thin air.  If there is no credit available, the most likely reason is that the people (or businesses) asking for credit are not credit-worthy.  Banks are  not lending as much as before the crisis; there is a ton of bad debt out there and no one knows what is going to happen with it.  That creates uncertainty…no doubt; however, please be reminded that the Banks themselves created the uncertainty that is now causing them to be uncertain about lending.

2) Companies are “uncertain” about future regulations.

This is complete crap.  I don’t doubt that there is some uncertainty about future regulations that might affect business.  No argument.  However, I know for a fact that companies do not sit around wondering about regulations that might have some affect on them in some number of years.  Companies are not nearly so forward-looking.  I work in HR consulting and we haven’t had not one company come to us asking what to do about the new healthcare regulation.  And I work in HR!!  If HR isn’t asking, the business itself is certainly not asking.

Business decisions to hire or not are much more immediate; they are not forward looking.  Companies do not hire until the very last second when the demand needed to keep that person busy has already existed for months and current employees are starting to complain or leave because of the workload.  If they cannot leave (and with high unemployment they often can’t), they don’t need to hire anyone else at all.

Again, it is about demand for the business’s goods/services, only then might a company hire.  They might also just buy additional equipment to automate, or hire someone in another country.  To repeat:  Giving a company more money does not incent them to hire people.

So do I have a policy recommendation?

Sure, when there is overcapacity (excess labor, or plant capacity) it is DEMAND that matters.  More supply won’t make a lick of difference as there is already over-supply (we have excess plant capacity and plenty of labor on the sidelines already).

So we must create demand. How do we do that?

1) The government can temporarily produce demand by deficit spending. However, it must be deficit spending.  It cannot be funded stimulus.  If it were funded then the government is taxing money away from us to re-spend the money on us.  The net result is zero.  If they hadn’t taxed the money in the first place, we would’ve spent it anyway.  That isn’t stimulus (unless we think the government can spend it better than us, which might be the case if all the money is going to the rich).

Unfunded (deficit) spending is new demand that would not have existed otherwise.  The jobs program is a fine idea for a policy recommendation.

I’ll tell you what isn’t a good idea:  Austerity.  The balanced budget camp needs a wake up call.  You can make all the arguments you want about the long term needs for a small government with continually balanced budgets; that is a big and worthy question….however, the short term effect of less spending is less demand….which is bad.  Let me repeat:  Austerity is bad for us in the short term.

2) Hmm…..the longer term issue of how to create demand is more complicated.

How do you level out income inequality so that people actually have money to spend?

How do you compete with economies like India and China that have absolute, not comparative, advantage?

How do you keep the financial sector from ruining the economy again?

How do we keep down run-away healthcare costs?

How do we improve education while keeping its costs (which are rising faster than healthcare’s) down?

Is the day finally arriving where technology is eliminating jobs faster than we are creating them?

Can we maintain our standard of living in a service-based economy?

Can we sustain our out-sized military spending?

What level of societal welfare benefits do we consider appropriate?

When does it become a supply and not a demand issue? Stated another way:  How much GDP growth (demand) would eventually wreck the environment (supply)?

So, that’s it.  Simple.  In the short term, with excess capacity, we must create demand.

One Response to “Capitalism, Jobs, and Supply Side Economics: Companies are not in business to hire people. They are in business to make money.”
  1. Dad says:

    Very interesting. I will study. It has been a while since you have added to your blog. I miss the stimulating articles.

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