Is it Demand or is it Uncertainty?

The first step in addressing a problem is to correctly identify what caused the problem, or what has prevented the problem from being solved.

Why aren't we creating more jobs?

Republicans argue that the problem is either that businesses have uncertainty, or that they have insufficient money to invest in jobs (or both).

The alternative position is that the problem is a lack of demand, and that businesses won't hire anyone unless their sales increase.

Obviously, which diagnosis of the problem is right has a huge impact on which solutions would actually work.  The Republican  solutions center around removing that uncertainty, or providing more money to businesses (or both).  Those concluding that lack of demand is the problem propose increasing the buying power of consumers.

Play this mind game: Imagine Company A and Company B, both in the business of making and selling widgets.  Like a great many U.S. corporations, their sales have not increased greatly, but both have cut costs in recent years and have made record profits, and furthermore are sitting on record amounts of cash.  They don't know if the regulations that affect their businesses are going to change, and they don't know if their tax rates are going to change.

Now imagine that demand for widgets increases dramatically, as more consumers begin having more money to spend on widgets.  Company A responds by hiring more workers and stepping up its production line.  Company B continues to hold back, because it still doesn't know if the regulations that affect its business are going to change, and it doesn't know if its tax rates are going to change.  Which of these two companies is more likely to prosper?

Now imagine that demand for widgets remains depressed, but regulations are removed and tax rates are lowered.  Company A sees no growth in sales, and doesn't hire additional workers (although its after-tax profits go up).  Company B says that since uncertainty has been removed, it hires more workers.  But since it can't sell any more widgets, its labor cost per widget goes up, and its profits go down.  It thereupon fires the new workers it had just hired.

OK, a little simple, I admit.  The idea beyond the uncertainty theory is that if businesses suddenly became optimistic about the future, they would take the hit of hiring people before sales actually increased, and the act of hiring and paying those people (if a whole lot of businesses do the same) increases demand in the economy, thereby increasing sales, thereby requiring more employees, etc., in a virtuous cycle.  But the problem is that right now, businesses are looking at each other, saying, "you go first."  "I'm not going first, you go first."  Somebody has to take the first step.

That somebody, unfortunately, needs to be someone whose first goal is not self-profit, but rather a concern for the overall well-being of the nation.  Which business is going to be patriotic, by hiring more people when demand does not justify it?

When actual business people, as opposed to propaganda organs such as the U.S. Chamber of Commerce, are asked what the single biggest problem is, for most common answer for the last couple of years has been "sales."  More than taxes, more than regulations.

Source: National Federation of Independent Business, "Small Business Economic Trends, August 2011."  The preparer of this report is certainly not biased towards a progressive view, since he devotes his commentary to complaining about Paul Krugman.

Small business owners, who used to complain mostly about taxes, have singled out sales since the middle of 2008.

One way to test whether the problem is lack of sales (i.e., lack of demand) on the one hand, or taxes and regulations on the other hand, is to look at job creation  in the past compared to what business said was the problem at the time.  Unfortunately, I do not have the raw data that went into the NFIB charts, so I can't make one simple chart that superimposes the data.  Instead, we need to look at several charts at once.

So first is a chart that I made that counts the number of jobs added during each presidential term, by comparing the number of jobs reported by the Bureau of Labor Statistics in the first January of a president's term to the number reported in the last December of that term.  Here is what that looks like:

We note that the lowest terms of job creation--George HW Bush's one term and George W Bush's first term, correspond to the two previous humps in the NFIB chart above when businesses identified lack of sales as a growing problem.

Now note that the line in the NFIB chart identifying taxes as the major problem tended to be the highest during Clinton's two terms, when job creation was the best it ever was, and that job creation plummeted at the same time that complaints about taxes declined, during George W. Bush's first term.

Now we'll look at one more chart from the NFIB, which shows other factors that have been identified as the single more important problem, including government regulation:

Identification of "regulation" as the most important problem was highest during Clinton's first term, which did not prevent the best job creation record ever.  Concern about regulation was considerably lower during George W. Bush's two terms, but job creation was horrible.  Today, small business owners say that regulation is not choking their business.

So whenever you hear someone claim that all we need to do to create jobs is cut taxes and cut regulations, point out that these remedies have been tried before, with very poor results.  On the other hand, when sales have increased in the past, job creation is robust.

In a subsequent post, we'll look at ways to increase demand.