Mitt Romney’s economic plan tries to fix what isn’t broken

by pdxblake

There are many reasons to criticize Mitt Romney’s economic policies, but the simplest is that they benefit wealthy people who do not really create jobs on their own.  Henry Blodget of Business Insider has a great post explaining this seemingly simple fact:

Now, of course entrepreneurs are an important part of the company-creation process. And so are investors, who risk capital in the hope of earning returns. But, ultimately, whether a new company continues growing and creates self-sustaining jobs is a function of customers’ ability and willingness to pay for the company’s products, not the entrepreneur or the investor capital. Suggesting that “rich entrepreneurs and investors” create the jobs, therefore, Hanauer observes, is like suggesting that squirrels create evolution.

The key point is that companies that create jobs (and the entrepreneurs who build them) don’t operate in isolation.  They look at their profits and losses, a function of their revenues and expenses, and try to maximize profits, which means maximizing revenue and minimizing expenses.

The easy part is expenses.  They try to cut expenses as much as possible unless an expense can contribute to a growing profit margin.  A big part of the expenses of most businesses (particularly those of the job-creating type) is labor.  To minimize the labor costs, they try to control wages and benefits, and they are most effective on a base level when wages and benefits are low.  A big expense for small businesses are employee health insurance and pensions.  Over the past decades, health insurance has become more expensive and pension liabilities are lowered by the shift from defined benefit (here’s what you get when you retire) to defined contribution (here’s what you put in, the return is what you make of it).  The Affordable Care Act does more than anything to lower health insurance costs (although that appears to be lost by the representatives of the so-called ‘job creators’).

However, the push to lower wages (in part enabled by union busting efforts over several decades) has a perverse effect.  For many years, the cuts in wages did benefit companies by lowering their expenses and thus increasing their profits with little impact on the demand for their products (remember why Henry Ford paid high wages, it wasn’t just to be nice, it was so his employees could buy the cars he made).  That is where Blodget makes a really important point through an example of someone whose quote he uses:

Hanauer himself takes home more than $10 million a year of income. On this income, he says, he pays an 11% tax rate. (Presumably, most of Hanauer’s income is dividends and long-term capital gains, which carry a tax rate of 15%. And then he probably has some tax shelters that knock the rate down the rest of the way).

With the more than $9 million a year Hanauer keeps, he buys lots of stuff. But, importantly, he doesn’t buy as much stuff as would be bought if that $9 million were instead earned by 9,000 middle-class Americans each taking home an extra $1,000 a year.

The shift in income towards the upper income brackets at the expense of the lower-income brackets denies businesses of demand.  This hasn’t been an immediate shift because people could borrow to replace lost income and did on a massive scale.  The last source of borrowing was home equity as home prices rose during the 2000s.  When that ran out because home prices fell, demand for products tumbled and still have not recovered.  And the weak recovery is in large part due to the lack of demand growth from consumers that would normally provide a boost to companies and a signal they should start hiring again.

Without higher wages leading to higher demand, we are likely to see a continuing slow recovery in employment growth, which will make it far harder for businesses to find reason to higher and make the recovery self-sustaining.  However, higher wages are unlikely to happen when demand is slack, so something else needs to give.  Boosting exports will help but nothing will help more than increasing demand by finding someone else to start buying and that role can really only be played by the government.

The stimulus helped, but it was too small, and so as the government spending waned, the recovery faltered and had to be replaced with movement from the Fed.  This is much less effective in times like these (although it has been beneficial in keeping the economy from falling back into recession).

More stimulus is what we need, and soon, so that the economy starts growing again and private demand–from more people having jobs and money to spend–will grow.  That will give us time to address the long-term needs to make the economic growth sustainable (higher wages).  It will not help to pile on benefits to the 1%.  They have enough to pay for all their spending now, and need a vibrant economy (and more people with money to spend) in order to make themselves more money.   Tax cuts and stripping away regulation can do very little or nothing to give them the chance to make more money.  That is the single greatest reason why Mitt Romney’s economic policies are the wrong prescription for what ails us.

ADDITION: Brad DeLong delivers a takedown on Romney’s economic advisor’s case of why Obama has done poorly.