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?
March 8th, 2010 at 5:22 pm
I work at a hardware store. I supply a service. I am only able to supply my service when there are enough customers in the store, or, in other words, when there is enough demand. Because my boss does not want to pay me $8.00 an hour when customers are low, he sends me home. If there is not enough demand (customers) and too much supply (me, providing my service), my boss cuts the supply to create equilibrium between supply and demand. He does this because he is rational. He does not want to pay me $8.00 an hour when there isn’t enough work for me to do. Suppose a third party came into the hardware store and said, “I’ll pay you $1 dollar an hour to keep him working at $8.00.” What do you think my boss would do? He would with a look of disgust tell them to leave. And if there were only a few customers, he would tell me to leave also. Why would he do this? Because he thinks that there are not enough customers for me to help even at the $7.00 an hour that comes out of his pocket. But, if that third party came into the store and said, “I’ve given 1000 people each $10 to come shop at your store.” my boss would make sure his supply of workers met the demand of customers. This situation would be much more efficient and beneficial. My boss is better off because a lot of customers are shopping at his store. I am better off because I have more hours to work, and the 1000 people who were each given $10 are better off because they are satisfying their hardware needs.
If government (the third party in the model) really wants to stimulate the supply of jobs, they first need to create demand that allows those who supply goods and services to meet the demand on their own. The suppliers of goods and services know a lot better than government does concerning how many resources they need and how to allocate them in order to meet demand. Government is putting incentives in the wrong place. It makes no sense to stimulate supply when there is not enough demand to meet it. That is like my boss hiring two extra people even though there aren’t enough customers to keep his workers already at the store busy. Kinda crazy.
On a last note, I was looking at the two graphs in the article showing tax breaks and real income less transfer payments. Given this data I am curious as to whether giving tax breaks, or actually handing out cash would have any difference on the effectiveness of stimulating demand. Does anybody know?
March 8th, 2010 at 10:27 pm
Tyson, that was a perfect real world example of my point. If demand is not increased, supply-side incentives are somewhat useless.
As far as the question as to whether or not simply handing out money actually stimulates the economy, real world data tend to support the conclusion that government spending on real goods and services tends to produce a more favorable multiplier than simply handing out money or cutting taxes, the reason being, a recessed economy tends to distort consumer confidence, making people less likely to spend. Keynes would refer to this phenomenon as the “Animal Spirit”. While it is empirically true that a multiplying coefficient for government spending exists, the actual size of the multiplier is still the subject of much dispute among economists. Furthermore, the value of the intertemporal tradeoff is the subject of intense debate. In a nutshell, what is spent now has to be paid back later. The short-run boost to GDP may not be worth the possible drag to long-run.
March 8th, 2010 at 10:34 pm
Sorry, this is what I get for posting from my iPhone…
I was saying, the short-run GDP bump may not be worth the possible negative effects on long-run growth (current savings equates to future capital which spurs economic growth.)
March 8th, 2010 at 10:35 pm
So I guess the quick and dirty answer is that it depends on who you ask.
March 9th, 2010 at 1:45 pm
I think this post and article is a great example of why Bastiat argued that legislatures need to consider the “unseen” aspects of legislation. Yes, on the outside (”seen”) it looks like a great idea; “let’s give “tax breaks” to businesses who hire people in 2010 so that they’ll have an incentive to hire.” Yet, as Fan?? illustrates the policy doesn’t actually remedy the true issue at its’ source, which is decreased demand in goods/services. I mean even law firms are getting more and more picky about who they hire and even the days of wooing new associates by taking them to broadway shows or ridiculously expensive dinners are virtually gone. I mean things must be pretty bad when companies and people are deciding to hold off on suing because it’s too costly for them at the moment. I guess just making your would be ex-husband move to the basement is a good alternative for now… Government can definitely do better in implementing pro-hiring incentives to businesses than this. The only question is whether or not they’ll ever figure out how.
March 12th, 2010 at 1:06 pm
I think the argument that is made for unemployment benefits being extended is exactly right. It is not a disincentive to extend these benefits to people because people want to work, they simply do not have the opportunity. The only thing that I worry about is a president that could be set because of this. As we recently discussed about eminent domain, once the government has set something it is hard for them to change it. Unless the bill is given a sunset clause which would end it at a certain time, not leaving it open to be renewed unless changed, I fear that it would create a disincentive for people to find work. Unemployment is already abused in this country. When I worked at a credit union in my home town, there were constantly people coming in to see if we were hiring. The strange part was that if we said yes, often times these people would leave. When we said no, they would ask for an application. All they were trying to do was fill their quota for how many jobs they had to apply for in order to continually qualify for unemployment. If these are extended and not repealed, the incentive will be to not work. But, for a temporary measure, to insure that the economy is being stimulated, I believe that it would be a grand idea to extend the benefits.
March 12th, 2010 at 1:37 pm
You bring up a good point Ben. As Krugman contests, because of the current low demand for labor, the incentives created by unemployment insurance are probably the least of our worries; however, when the economy recovers (and it certainly will eventually) the disincentive to find work will again become a serious issue. For this reason I agree that a sunset clause is necessary to ensure a temporary extension of UI and not a permanent one.