As we are all aware by now, Friedman says that incentives should be put where they will do the most good. In other words, when fiscal policy is used to stimulate employment (or anything else really) the salient concept should be value. “Where can we get the most bang for our buck?” Derek Thompson of The Atlantic Monthly argues that the $15 Billion jobs bill, which gives employers a payroll tax exemption for all employees hired during 2010, does little or nothing to change the incentives for employers. The point is made that for hiring a $60,000 per year employee, the employer can expect to save approximately $2500 in payroll tax credits. Assuming demand for the good or service produced is unchanged, the added production is meaningless to the employer (as the additional goods produced will not be bought and consumed, meaning no additional revenue for the producer), leaving him or her with a net loss of $62,500, the cost of paying the new employee minus the tax credit (oversimplified I know, but sufficient to make the point). Obviously, in this case the only employers who will hire (and thus benefit from the bill) are those who were planning to hire anyway. Incentives change for nobody. A more effective solution would be to boost aggregate demand through a more direct stimulus. Basic short-run macroeconomic theory makes clear the “multiplier effect” of government spending. Basically a dollar spent by the government goes farther than a dollar in tax cuts because the dollar is “recycled” through the economy as it passes from government to households, to firms for goods and services, then back to households for factors of production allowing for higher overall income/output in the economy. This extra money being spent increases the demand for goods and services, creating a market based incentive for employers to hire more labor in order to match the increased demand with increased supply. Newly employed workers spend more money, which creates demand for more services, which creates more demand for labor as employers need to boost supply to keep up with increasing demand, causing more workers to be hired, allowing more people to spend more money on goods and services… I think you get the point.
Mr. Thompson finishes by pointing to a blog post by Paul Krugman advocating an extension of unemployment benefits in order to increase aggregate demand. While under normal circumstances, unemployment benefits create a disincentive to find work, with a ratio of five job-seekers to every job opening, these are not normal circumstances. People want to work. The incentive structure for labor is irrelevant right now. What is far more worrisome is the lack incentive for employers to hire right now. In fact, given the interlocking relationship between supply and demand, a temporary expansion of unemployment insurance would likely increase employment in the short run. What do you think?