The Progressive Path to Jobs

Steve Roth at Angry Bear yesterday covered similar ground to one of mine from February, "Debunking the Notion that Inequality Wouldn't Impact the Economy". Roth's "GDP, Prosperity, The Wealth Effect, and Marginal Propensity to Consume", took a slightly different track. Whereas I discussed the impact on GDP from inequality of income, Roth looks at inequality of wealth. As of yet, it's hard to say which is the better angle, although as Roth notes, the distinction starts to blur with age, since "people nearing or in retirement start paying a lot more attention to wealth than income." That is, unless you're dealing with folks who have nothing but social security because -- among other possible reasons -- they never had high enough disposable income to put anything aside.

Either way, whether income or wealth is the more important factor, clearly inequality matters. It impacts our commerce, our GDP. At least so long as the people at the middle (let alone the bottom) have wants and needs they can't fulfill for lack of means, a reduction in inequality achieved with the effect of getting more means to those who will use it will increase GDP and general prosperity. Ironically, spreading the wealth around a bit should lead to more potential for our economy to support more wealth. [Caveat: of course, we shouldn't go overboard. Just more equitable ... not perfectly even.]

And by progressive policies leading to more equitable distribution, that would constitute a way that -- contrary to what both candidates said or implied in tonight's debate -- government most certainly can create jobs. What leads to more commerce generally leads to more jobs, and a more equitable distribution would mean more commerce.

Clinton's Convention Speech in Images

On the argument for President Obama's reelection:

Are we doing better than that today?

Job scoring:

Republican economic policies:

Trickle-down:

Debunking the Notion that Inequality Wouldn't Impact the Economy

It's been claimed -- incorrectly -- that overall activity would neither be increased nor diminished by how evenly or unevenly money is distributed within our national economy. According to that line, we'd get the same amount of commerce regardless of whether we have a larger share of the pie held by the wealthy or by the lower and middle classes. "Money is money," or so they say.

Except that in reality, lower average propensity to consume (APC) results from significantly increased real income.¹ Who has how much matters because people tend to spend different portions of their income at different levels of wealth. Wealth and income distributions make a significant difference to effective demand. We're not concerned with what people would like to have if they had enough money; we're concerned with what people will spend with the money they're getting. If Warren is a wealthy person and John is a poor person and over time Warren attains a higher share of the available money, total spending -- effective demand -- generated by those two consumers will drop.

If there's $1,000,000 of total income between the two at time T1 and Warren gets $950,000 while John gets $50,000 and Warren spends 33.33%² of income to John's 100% of income, then total spending by these two individuals at time T1 will be:

T1: $316,635 + $50,000 = $366,635.00

When income ratios shift and there's an inflation-adjusted $1,000,000 of total income at time T2 and Warren gets $975,000 while John gets $25,000, Warren's spending ratio (APC) will likely have fallen slightly from the previous propensity, but we'll stick with 33.33% for simplicity and understatement. Meanwhile, John can't spend as much as before because John's available funds have dropped. Even if Warren still spends at the same rate -- which is unlikely -- then total spending would be:

T2: $325,967.50 + $25,000 = $349,967.50

That would be a drop from time T1 to time T2 of $16,667.50 in inflation-adjusted spending. I've picked an arbitrary APC for Warren, but herein we're just showing the rough effect. The dollar values are merely for illustration of the concept. Even if the exact average amount might vary slightly from the $16,667.50 of our illustration, the point remains that there would be a shortfall. With more of the money shifted to those with a lower APC, you get lower consumption which is to say lower effective demand.

Even if total income increases, with enough shift from those who will spend higher percentages of their income to those who will spend lower percentages of their income, total spending can fall. More total wealth does not necessarily translate to more total spending. More total wealth will only increase total spending when distribution among varying APCs (and thus the overall APC) remains sufficiently stable. Having wealthy people is useful; but we need enough money in the hands of average consumers to support that wealth. Concentrate too much of the available wealth into too few hands and you get less ability to consume which means less effective demand.

Confronted with that reality, the "money is money" crowd rely on APC's flip-side, average propensity to save (APS). They're two sides of the same coin. As APC drops, APS rises. Our hypothetical Warren has a lower propensity to consume but a higher propensity to save. Some try to claim that the reduction in APC would be balanced out in terms of economic activity by the corresponding increase in APS. Unfortunately, that would only hold true in a closed economy with no outlets for investment other than productive investments (such as business start-ups and expansions). We're not a closed economy, so even when increasing APS does translate the savings into productive investment, those investments need not necessarily be domestic. For the United States, given that foreign returns are out-pacing domestic returns from such investments, much of the savings naturally translates into foreign investment which does absolutely nothing to balance out the reduction of consumption in our domestic economy.

Even if we were a closed economy, we have a variety of investment options beyond just productive business investments alone. For instance, Warren might buy gold ETF shares from Glenn who might then use the proceeds to speculate on the British Pound or perhaps to buy Treasuries.³ A dollar of savings lacks any certainty whatsoever that it would spur even a penny of business investment. Particularly when many businesses are avoiding expansion because they already have more than enough capacity to meet projected demand for their goods and services for the next several years, we find ourselves in a situation where there is both a shortage of effective demand from consumption and a shortage of available productive investment options due to insufficient need to expand caused by that same shortage of effective demand.

This all matters because we need a certain level of effective demand in order to sustain full employment. Without sufficient consumption, businesses need fewer workers. With less demand for labor, wages fall. Dropping wages and employment both further depress the nation's ability to consume, leading to yet more unemployment and dropping wages. With too much of our wealth concentrated at the top, we can't support as much wealth. That's bad for rich and poor alike. As Franklin D. Roosevelt said, "we all go up, or else we all go down, as one people." We as Americans believe in promoting wealth and affluence. But to do so effectively, we must have enough of a strong base underneath the top to support a growing top. To have steadily growing affluence, we must mitigate the divergence of our most wealthy from our lower and middle classes.

 Notes:

1. When the shift is initially happening, we refer to the marginal propensity to consume (MPC), essentially the rate of change in APC. Herein, we're not concerned with the rate of change but rather just the implications of such a change from one state of APC at one point in time to another state of APC at a second point in time.

2. The 33.33% and 100% value are arbitrary representations of the fact that higher income consumers spend less of their total income than lower income consumers. The actual observed multiplier for various income levels may vary. What's important here is not the specific percentages but rather the impact of the difference in percentages.

3. Treasuries arguably could indirectly contribute to productive domestic investment when the government spends within the economy. Likewise, the gold seller could use the proceeds to invest domestically. However, neither of these have the direct impact on domestic economic activity seen from domestic consumption or direct domestic business investment. They're not a clear proxy for domestic activity. They're a case where savings may or may not translate to investment.

Debunking the Notion that Inequality Wouldn't Impact the Economy

Update: A newer revision of this piece is available than the one below. While this version is still OK, the newer version is recommended as both more complete and I think a better read. The newer version is available at  http://thoughtstate.blogspot.com/2012/02/debunking-inequality-economy.html and http://www.addictinginfo.org/2012/02/10/debunking-the-notion-that-inequality-wouldnt-impact-the-economy/.

It's been claimed that, "Money is money: demand is made by those who have it to spend. If it is unequally spread, the amount of consumption remains the same if saving remains the same."

Except that in reality, lower average propensity to consume (APC) results from significantly increased real income. Who has how much matters because people spend different portions of their income at different levels of wealth. Wealth and income distributions make a significant difference to effective demand. We're not concerned with what people would like to have if they had enough money; we're concerned with what people will spend with the money they're getting. If X is a wealthy person and Y is a poor person and over time X attains a higher share of the available money, total spending -- effective demand -- will drop.

If there's $1,000,000 of total income at time T1 and X gets $950,000 while Y gets $50,000 and X spends 33.33% of income to Y's 100% of income, then total spending at time T1 will be $316,635 + $50,000 = $366,635.00.

If there's an inflation-adjusted $1,000,000 of total income at time T2 and X gets $975,000 while Y gets $25,000, X's spending will likely have fallen from the previous propensity but we'll go with 33.33% for understatement. Meanwhile, Y can't spend as much as before because Y's available funds have dropped. Even if X still spends at the same rate -- which is unlikely -- then total spending would be $325,967.50 + $25,000 = $349,967.50. Admittedly, I've picked an arbitrary APC for X, but the point is to show the effect. Even if the exact average amount might vary slightly from a drop of $16,667.50 in spending between T1 and T2, the point remains that there would be a shortfall. With more of the money shifted to those with a lower APC, you get lower consumption which is to say lower effective demand.

Even if total income increases, with enough shift from those who will spend higher percentages of their income to those who will spend lower percentages of their income, total spending can fall. More total wealth does not necessarily translate to more total spending. More total wealth will only increase total spending when distribution among varying APCs remains sufficiently stable. Having wealthy people is useful; but we need enough money in the hands of average consumers to support that wealth. Concentrate too much of the available wealth into too few hands and you get less ability to consume which means less effective demand.


Note on totals versus individuals: the figures above are not intended as a complete representation of our entire economy. They're just looking at two selected hypothetical consumers within that economy and the total between those two. In order to represent the total economy, we'd need to involve such factors as the ratio of upper incomes to lower incomes with many Y-type consumers existing for each X-type consumer. However, representing the entire economy is thoroughly unnecessary for illustrating the main point. We're not looking to calculate out the exact total dollar amount shifted out of the domestic economy by shifting income shares from lower-income individuals to higher-income individuals. The point is simply to explain the fact that there is some amount being shifted out of the domestic economy.


Note on the impact of increasing APS: It's been argued that this reduction in APC would be balanced out in terms of economic activity by the corresponding increase in APS. Unfortunately, that would only hold true in a closed economy with no outlets for investment other than productive investments (such as business start-ups and expansions). We are not a closed economy, so even when increasing APS does translate the savings into productive investment, those investments need not necessarily be domestic. For the United States, given that foreign returns are out-pacing domestic returns from such investments, much of the savings naturally translates into foreign investment which does absolutely nothing to balance out the reduction of consumption in our domestic economy. Further, even if we were a closed economy, we have a variety of investment options beyond just productive investments alone. There is absolutely no certainty whatsoever that a dollar of savings will necessarily even spur a penny of business expansion. Particularly when many businesses are avoiding expansion because they already have more than enough capacity to meet projected demand for their goods and services for  the next several years, we find ourselves in a situation where there is both a shortage of effective demand from consumption and a shortage of available productive investment options due to insufficient need to expand caused by that same shortage of effective demand.

The Wealthy Don't Create Jobs; Good Jobs Create The Wealthy

What came first, the wealthy or the building blocks of wealth? This is no idle "chicken or the egg" question. Major political players base real policies with serious impact on their own answer to the question. What if most of them are getting it wrong? What if getting it wrong could wreck the system and ransack wealth?

To get the answer, the GOP base are obviously looking at wealthy investors. Our tax-cutting crowd clearly thinks they're the starting point. They say that getting more money to them will mean more jobs. The idea runs that investors bet their capital on starting or expanding a company that can then hire folks, thus jobs. This seems to pass for unquestionable truth among the "starve the beast" set. They figure that the more money the wealthy have the more they'll put into creating jobs. Even leaving aside the question of whether they'd likely choose to invest their money elsewhere, the anti-tax set need to reconsider two questions: 1) Is that usually how jobs are made? and 2) Where'd the capital come from in the first place? These two questions are necessarily linked. You can't explain where the capital came from without considering ways to make jobs without capital.

So where'd the first capital come from? Unless you think it was somehow handed over to man by divine intervention -- capital raining down from heaven or appearing from nothing -- it had to come from work. We can set aside the factor of inherited wealth, since somebody had to collect it in order to pass it down to lucky heirs. That first capital accumulating work -- whatever it was -- was collecting and/or making something that could be sold or traded. In short, it was a job. It may not have been a modern job, but close enough for our question. Somebody did some work. It may have been all on his own. Or the work may have been getting others to do things for him. But whatever it was, somebody did some work that produced a surplus. Perhaps that surplus was then -- directly or through heirs -- reinvested by getting other folks to do more work to produce more surplus. At root, the workers involved still created the surplus. The worker-created surplus was then used to spur more work to create more surplus. The job came first. The assets produced were just a product of the job that lets that job contribute to even more jobs. Get together a lot of surplus produced from a lot of jobs, and you've got wealth. Even if you then use that wealth to spur more work that creates more wealth, the wealth still didn't create itself but rather came as the sum effect of the work ... the jobs.

"Labour was the first price, the original purchase - money that was paid for all things. It was not by gold or by silver, but by labour, that all wealth of the world was originally purchased." -- Adam Smith 

Ultimately, the idea that wealth comes from somebody investing in business is a myth. If I build a factory and hire 50 people to make widgets, I'm not going to get any return on my investment unless there are people who can be interested in widgets and have enough money to spend on my widgets. If my widgets aren't essentials, those people will only have enough money to spend if they're making a surplus beyond the cost of living. Even if the widgets are essential, folks who don't have an income aren't going to be buying many widgets. If I don't have enough potential customers to break even, I'm not going to be employing those 50 widget makers for long. But if I have enough customers to make a profit, I'll keep employing them. And if I have too many customers for them to keep up, I'll hire more. Then who really created the wealth I reap from my factory? Sure, I made the factory investment that allowed me to sell widgets. But without the customers, that investment would have just been a foolish building that couldn't support long term jobs. It's the customers who really make the difference.

Jobs further wealth in two ways. Obviously there's the surplus collected by the initial business owner. But there's also the circulation of resources wherein the worker's share of surplus is spent at other businesses. The worker's paycheck allows him to be a customer contributing to other jobs that yield other surpluses for other business owners. The paychecks from those other jobs may in turn be spent at yet further businesses or even end up winding back to the initial business. Jobs have no choice but to create wealth, even when they fail to do so directly for a specific employer. Unless they're inefficient jobs, they'll create a surplus. And even if they're inefficient jobs they'll mean money for workers to spend at efficient businesses yielding surplus. The job just can't hold itself back from contributing to the creation of wealth. Wealth, on the other hand, can sit idle. It can be stored in some valuable thing that'll sit collecting dust. Sure, wealth may be further invested in jobs and help yield more wealth. But it can also hang on the sidelines for years or even centuries and do nothing productive.

Clearly it's the job that creates the wealth. We can use that answer to figure out what to do to get our economy rolling again. We want wealth and jobs. We need to push the one that creates the other. If we change our tax structure to get more money to the wealthy, we're just tinkering with accelerating redistribution of income to the rich who may just sit on it. That risks having it grind to a halt if too much money is removed from the system to just sit idly in the stockpiles of the wealthy. I'm all for building wealth, but not at the cost of having all the money locked down to the point where it no longer flows from business to business through employees and customers. Since wealth ultimately comes from jobs, those of us who want both more jobs and more wealth need to focus on jobs in order to get both. With more wealth, there doesn't necessarily have to be more jobs. With more jobs, there will be more wealth.

Now we've got a situation where there isn't enough demand for products and services to spur widespread hiring. Too many people don't have enough money to spend. And unemployment causes much of that current lack. Private industry can't fix the situation because it won't make any sense for them to hire until there's demand for products and services. There's only one credible way out: govt must step in to fill the void. Govt must stop hiding their heads in the sand and pretending that we can count on the wealthy to hire out of the goodness of their hearts -- without enough demand causing it to make sense as an investment -- if we just help a bit more money stick in their accounts. Govt must stop laying off workers and start hiring so there will be more paychecks to spend on goods and services. And to do that, govt is going to have to start leveling with us and facing that we'll have to rack up a future bill in order to make things work here and now ... and for the future.

The Golden Fleece

The drums sound. The town crier roars, "Fleecing the rich! Fleecing the rich!"

But who is fleecing whom? And is the only fleece here just wool for pulling over eyes?

Fleecing the rich is a red herring. We have a demand-driven economy. There aren't enough folks in the very top to take care of all the demand. If the middle and lower classes combined don't have enough money, they can't keep commerce flowing fast enough. That matters, because jobs come from spending. Sure, they come directly from business, but business gets its money from spending at that business. Without enough spending, we can't support as many jobs. There's a minimum level of spending the economy needs for businesses to bring in enough money to need the current workforce to meet the demand. More commerce than that level means more jobs are needed. Less commerce than that level means fewer jobs are needed.

"But wait", the supply-siders say, "the wealthy will buy more Bentleys with their tax cuts or vacation more or something and cover that commerce."

Will they? Let's leave aside the fact that Bentley Motors Limited, like Rolls-Royce, is a British manufacturer and a Bentley purchase may not be as likely to create American jobs as a Fiesta or a Cruze purchase. Even more importantly, each wealthy person only needs so many cars, even if they were purchasing American made cars. The 400ish billionaires in the US can only wear so many clothes, eat so much food, or use so much of anything themselves. Yes, there are more millionaires -- several million of them -- but still, they only need so much each. It's the hundreds of millions of people who are less affluent who will always make up the bulk of need for goods and services. It's not strictly for any lack of patriotism among millionaires; it's just that there aren't enough people at the top to need enough goods and services themselves to keep everyone employed.

With the amount of wealth held by the middle and lower classes declining, we have a serious problem. That's all of us ... not just the middle and lower classes, but the wealthy too. The rich may be more insulated from unemployment and stagnant wages than the rest of us, but if the level of commerce falls too low it can fail to sustain their investments. And the bigger argument for those of us who would like to join the ranks of the wealthy: if commerce is shrinking rather than growing, there's not much chance for new members of the upper class. In order to have rising affluence, you have to have a healthy economy. In order to have a healthy economy, the middle class can't be declining ... because the middle class is the core of spending and the heart of the economy.

"But wait," they defenders of trickle-down say, "if we cut they're taxes, they'll have more money to invest. You're saying that if people have more money to invest then the natural inclination is to NOT invest that money? You're saying that if there's an opportunity for a greater return on that investment, people are less likely to invest that money?"

Sure, they'll invest. Many of them will sink the cash in things that don't create jobs (or at least not in significant numbers) such as buying stocks, foreign bonds, money markets, and commodities like gold. If one billionaire buys a zillion shares of Corporation X from another billionaire, that's generally 0 jobs created ... although it may help maintain a job at a brokerage and then the broker's income may help create or sustain a few other jobs (but still, effectively close enough to no jobs versus what certain other uses for that money could do).

Some few of them might invest in venture capital funds that specialize in US startups or expansions. Some few of them might directly invest in US entrepreneurship. But with raw no-strings-attached tax cuts there's no guarantee that any of them will. If other investments look more profitable, most of them won't invest in such American job-creating investments.

Some might also invest in venture capital or direct entrepreneurship in other countries that compete with our own ... thus destroying American jobs. It is entirely possible that some large amount -- potentially even 100% -- of the tax cuts for the top 1% could end up being invested in foreign companies that will end up killing jobs here. It's not likely that every penny will go abroad, but there's no guarantee that any of it will stay. And it is very likely that at least some of it will go to foreign investments that compete with us. Growth in China is currently high, so odds are good that quite a few of them will risk the possible Chinese housing bubble and such in order to capitalize on their high growth rate. Chinese entrepreneurs are probably thrilled that we're considering borrowing money from China to free up no-strings-attached cash from our wealthy such that some of our wealthy will have more money to invest in China.

Of course, it's probably just a coincidence that this is coming right after Republican wins that saw large chunks of their add money coming from the US Chamber of Commerce that gets large chunks of their money from foreign members such as state-owned Chinese companies. Surely it's entirely unrelated that some of the most lucrative investments around are Chinese companies that compete with American companies. I'm not saying there's any cause and effect there. Probably a coincidence, but a very unpleasant one for our prospects of this tax cut for the wealthy being a good thing for the nation.

Perhaps the most interesting potential: The top bracket could all invest the cuts into Treasuries, so we'd be freeing up money for them to lend back to us at interest to cover the money we gave 'em interest free. Merry Christmas to them, eh?

But the long and short of all this is that while tax cuts for the wealthy will mean more investment, that investment won't necessarily help the American economy and may in fact hurt ... because the bulk of it could be investment in our competitors.