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by Larry Butler

The Bureau of Labor Statistics reported Friday that nonfarm payroll employment edged up by 80,000 in June, and that the unemployment rate remained steady at 8.2%.   Observers agree that these disappointing figures reflect a weak recovery from the recession that began more than three years ago.

Conservatives cite these employment figures as evidence of the failure of the economic policies of the Obama administration.   Republicans offer several suggestions, including lower tax rates for business and investment, less and simpler regulation, subsidies for businesses and home ownership, and further reductions in government spending.   Perhaps more accurately stated, they blame the Obama administration for high taxes, over-regulation, bloated government, and -- contrary to the analysis of the Congressional Budget Office -- the Affordable Care Act.

Examine the major points of economic policy over the past four years.   Objectively, government has intervened in several major ways.   One was the direct salvation of banking and financial institutions, and even much of the US automotive industry.   Another was an unprecedented infusion of money into banks and businesses through the Federal Reserve.   Another was the extension of tax breaks on passive income and new tax credits for individuals and businesses.   Another was direct investment in roads and infrastructure as an integral part of the stimulus package.   Meantime, public sector employment was trimmed significantly.   Most of this economic policy, rather than socialistic populism, is typical of conservative Republicanism!

One assumption in particular reflects a solidly conservative interpretation of how the economy works:   business investment incentives lead to increases in employment.   I have been directly involved in decisions relating to business investment for forty years, and have learned that the relationship between investment and jobs is not causative.   Let me explain why this assumption is not valid, and explore the implications for economic policy.   I will even suggest a solution.

Let's start with the basics.   Private enterprise is generally profit driven.   As such, capital is allocated for the purpose of generating a return.   Capital investment decisions fall into three major categories:   (1) the development of new products and/or markets; (2) the development of additional capacity for existing products; and (3) the development of operating efficiencies internal to the organization.

Investments to develop new products and/or markets can indeed yield increases in employment.   New products and services can lead to profits, which is the driving motivation for this kind of investment.   Apple Inc. (AAPL) is a great example of a company that has succeeded in developing products and markets; as a consequence, they maintain a workforce of more than 60,000, most of whom are located in the US.   This is perhaps the qualitatively best kind of capital investment.   But Apple's employment pales in comparison with that of some other companies:   Wal-Mart employs over two million people, and McDonald's has nearly two million when franchise employment is included.   Other large US employers include UPS, IBM, Sears, Target, GM, GE, and Citi -- averaging over 300,000 each.   Taken in perspective, investment in new products and markets yields increases in employment that may seem modest within the context of the economy as a whole.

Investments to develop additional capacity for existing products can yield increases in employment as well.   However, in order for money to find its way into such projects, tangible unmet demand must already be reasonably certain.   If additional capacity is needed, one of two factors is at work:   (1) an absolute increase in demand has occurred in the market; and/or (2) brand identity, distribution effectiveness, or other competitive advantages have attracted demand away from competitors.   Increased utilized capacity leads to higher volume in production and sales revenue, which in turn leads to increased profits.   Capacity investment, however, does not cause additional demand -- it merely serves to meet increased demand in the marketplace.

Investments to develop internal operating efficiencies do not create jobs; they usually reduce the direct labor content of a product or service.   In mature markets, and within the companies that serve them, this is the most attractive kind of capital investment.   Such an investment avoids the risk associated with new products, new markets, and even new technologies.   Generally the decision follows the model of raising fixed costs in order to reduce variable costs for the life of the investment.   The most visible component of variable costs is usually direct labor.   By investing in more efficient processes, the labor component is reduced, profits are increased, and jobs are eliminated.

The US Internal Revenue Code has long subsidized business investment through accelerated depreciation allowances and direct investment tax credits.   This is in fact a business subsidy that has only been made palatable when accompanied by the myth that business investment inevitably yields increases in employment.   This is simply untrue.

A look at the shape of the economic recovery of the past few years helps dispel the myth.   All of the economic policies, taken together, have yielded tremendous increases in corporate profits among domestic corporations.   Before the recession, for the four quarters ended June 30, 2008, corporate profits averaged $1.247 trillion.   For the four quarters ended March 31, 2012, corporate profits averaged $1.528 trillion.   Corporate profits have increased more than 22% during a time when capital investment was subsidized in the interest of increasing employment.   During this period, total nonfarm payrolls declined from 137,640,000 to 133,088,000 -- a decline of 3.3%.   While there's a lot going on behind these numbers, one thing is clear:   neither the intuitive logic behind investment subsidies nor the results that were achieved justify the continuance of the myth.   Capital investment simply does not yield additional jobs.

So let's cut through the guano and recognize that corporate subsidies generate profits, not jobs!   Let's get rid of corporate subsidies entirely.   Let's get rid of all the subsidies that are embedded in the system of taxation we have created.   The Republican platform  explicitly accuses Democrats of using the tax code for "social engineering."   In truth, both parties have used the tax code for their own purposes -- this explains its complexity and its ineffectiveness.   The whole code needs to be thrown out entirely and replaced with a simple tax system.  

Free markets create jobs -- both the supply side and the demand side are required.   By eliminating all the incentives and subsidies in the tax code, buying and selling decisions can be returned to the marketplace.  Don't think for a minute that investment subsidies -- or any others -- actually create jobs.   Increased demand creates jobs.

 

Take action -- click here to contact your local newspaper or congress people:
Advocate tax reform that eliminates investment subsidies!

Click here to see the most recent messages sent to congressional reps and local newspapers

Years ago I made a decision to commit to a life of business management. Kids do the dumbest things! After thirty five years as a small business consultant, CFO, and university educator specializing in quantitative business and economic (more...)
 

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Just as supply and demand are both needed for heal... by Larry Butler on Tuesday, Jul 10, 2012 at 3:21:59 PM
Increasing supply without increasing demand does n... by Mari Eliza on Tuesday, Jul 10, 2012 at 3:24:42 PM
Here's an even more damaging subsidy that's relat... by Larry Butler on Wednesday, Jul 11, 2012 at 10:13:04 AM