The misallocation of capital is one reason the recovery is stuck between lack and luster.
By ANDY
KESSLER, WSJ Opinion, September 19, 2012
The misallocation of capital is one reason the recovery is stuck between lack and luster.
By ANDY KESSLER, WSJ Opinion, September 19, 2012
No jobs? No wonder, given what passes for economic thought these days.
In his acceptance speech at the Democratic convention in Charlotte, N.C.,
this month, President Obama said, "We believe that when a CEO pays his auto
workers enough to buy the cars that they build, the whole company does better."
And last month in Leesburg, Va., the president said, "When we've got new
teachers doing great work with our kids, then you know what, they go to a
restaurant and spend that money. And so suddenly businesses are doing well, the
economy is doing well, and we get into a virtuous cycle. And we go up."
This myth—that you can just give money to the middle class and good things
happen—is widely shared and is at the basis of a lot of government policy. And
it is why the recovery is stuck between lack and luster.
Let's go back. Henry Ford is popularly credited with inventing the middle
class by doubling his workers' salaries to $5 per day in 1914. A multiplier for
the economy, right? Wrong.
The year before, Ford revolutionized manufacturing with the moving assembly
line, slashing automobile build times to just 90 minutes from 14 hours. That's
productivity. It allowed Ford to reduce the price over time of his Model T to
$290 from $950. Demand took off because it was far cheaper than the cars made by
his 88 competitors.
By 1927, 15 million Model Ts were sold to people (most of whom did not work
for Ford) and businesses that retired their horses and used these new
automobiles productively to lower their own costs, fueling a boom. Raising wages
was a byproduct, not a cause. From Ford Motor's corporate website about the wage
increase: "While Henry's primary objective was to reduce worker attrition—labor
turnover from monotonous assembly line work was high—newspapers from all over
the world reported the story as an extraordinary gesture of goodwill."
But 98 years later, the Obama administration still doesn't get it. According
to an Aug. 15 article by Paul Tough in the New York Times Magazine, the
administration's economic team during the financial crisis—Lawrence Summers, Tim
Geithner, Jason Furman—"was carrying around this list of multipliers" from Mark
Zandi of Moody's Analytics. A dollar spent to cut corporate taxes would grow the
economy 30 cents; make the Bush tax cuts permanent, 29 cents; extend
unemployment benefits, $1.64; food stamps, $1.73. "And food stamps was always at
the top. That had the largest multiplier." This is economic malpractice.
Food-stamps recipients are up 70% in four years, to 46.7 million. But,
surprise, we haven't seen that "virtuous cycle." Jobs build the middle class,
not handouts or pay diktats.
There is a huge misunderstanding between spending and investment. Sure, it
makes sense that the less well-off will spend whatever they are given, but
unfortunately, not on the things to spur a hiring binge.
In a famous exchange, Austrian economist Friedrich Hayek was asked, "Is it
your view that if I went out tomorrow [with a government subsidy] and bought a
new overcoat, that would increase unemployment?" "Yes," answered Hayek, "but it
would take a very long mathematical argument to explain why."
Minus the math, Hayek's argument was that money would be removed from the
productive economy, and capital would be wrongly allocated to overcoats based on
this false demand. Substitute Chevy Volts and you get the picture.
Yes, the wealthy, most of whom got rich by risking capital and delivering
something productive to the economy, tend to save more. But they don't shove it
under the mattress, they invest it in the productive fabric of the economy. The
president's rhetoric harps on the notion that millionaires and billionaires
don't "need" the money from a tax cut. But think of it this way: They, like
Henry Ford, have proven that they can invest the money productively—better than
any government program—whether directly into companies or into stocks, private
equity or venture capital that create long lasting jobs and expand the middle
class.
Some would call this supply-side economics. President Obama on the campaign
trail calls it "trickle-down snake oil," even "fairy dust." I like the term
i-side economics—for investment and innovation and individual incentive—rather
than g-side economics, as in "what has the government given me lately?"
Perversely, class warfare hurts the group it is alleged to help. For every
dollar of stimulus or government spending paid for by the half of the population
that pays taxes, you take away a dollar that might have been invested in
creating higher-paying jobs. That's just dumb. Misallocating capital is a
formula—a negative multiplier—for stagnation, not growth.
Investor Peter Thiel put $500,000 into Facebook in August 2004, a company now
worth $50 billion based on its prospects for transforming the media industry.
What multiplier would you put on his investment? This month, after investing
billions over the years on R&D, Apple released the iPhone 5. The company is
worth $666 billion based on prospects that hundreds of millions of users will
lower their cost of doing business with the latest iPhone and iPad mini and
whatever else is coming. What is that multiplier?
President Obama says that "rebuilding a strong economy begins with rebuilding
our middle class." He's got it backward. You can't grow an economy by paying
teachers to eat at Denny's or overpaying workers on federal projects via the
Davis-Bacon Act.
As in Henry Ford's day, it is workers' productivity that drives long-term
wage gains, not workers' wages that drive growth. And almost always by selling
something—a Model T or a Samsung Galaxy—cheaper than the current way of doing
things.
With the right investment-side rather than handout policy, the economy will
act like a coiled spring or a super ball—the rebound will be a huge bounce.
Meanwhile, we wait.
Mr. Kessler, a former hedge-fund manager, is the author most recently of
"Eat People" (Portfolio, 2011).
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