On Friday, Aug 5, The Wall Street Journal had an interesting piece entitled, Small Firms Hunger for Sales, Not Credit. (Click on link at end of this post.) The collapse of credit at the very beginning of the recession was, no doubt, a major factor in the downsizing or bankruptcy of many small businesses. Today, lending to small firms still has still not returned to pre-recession levels, but perhaps not because credit-worthy firms are being denied loans. In fact, they simply are not applying for loans. According to the article, “In many cases, small businesses don’t want loans. Their sales are so weak they just can’t justify taking on debt to expand operations.”
This should not surprise us. John Kenneth Galbraith said in one of his books (I can’t recall which one) that though credit collapsed at the beginning of the Great Depression, credit to credit worthy business customers was restored as soon as Roosevelt took over, and remained available throughout the 30s. Yet there was very little business borrowing or spending. Why? If a manufacturer had half of his factories shut down and his warehouse was stacked to the ceiling with unsold goods, what sense would it make take on more debt to build another factory? And why would a dept store chain build more stores if they have insufficient customers for the stores the already have.
Severely tightening credit will stop the economy, but loosening credit won’t necessarily re-start it. That is the great limitation of monetary policy. You can’t push a string. And if you are trying to control an aggressive Great Dane by using a choke leash, if you jerk the leash so hard that it chokes him into unconsciousness and he dies, just loosening the leash is not likely to make him magically spring back to life.
And this is why “supply side” economics doesn’t work. The whole rationale of supply side is that giving money to corporations and very wealthy individuals grows the economy by growing private capital, which then becomes available for loans to business. And when business borrows and invests this money, this investment will create jobs. There’s just one problem. At any time when the economy is so sluggish that we really need jobs, no businessman in his right mind will take on more debt to make additional investments. So supply side only works when you don’t need it. It’s like a life boat that works except when you put it in the water.
So, would supply side policies work when the economy is in the opposite state--when we have full employment, high inflation, and a shortage of all manufactured goods? We were in this situation for part of the 1970s, and that is when supply side ideas first became respectable. But if you actually employ this tactic at such a time, and manufacturers actually do borrow money and invest it, the immediate effect is to fan the flames of inflation even more by creating more demand for steel, copper, Portland cement, plywood, and skilled construction labor—the very things already in short supply.
If monetary policy doesn’t really work, then what does? What works is fiscal policy. Spend more and tax less to expand the economy; tax more and spend less to shrink it. Since our main problem, at least in the short run, is unemployment, (which is probably over 17% if all those out of work are counted) then the last thing we should be trying to do is balance the budget. It should not be a question of whether we balance the budget by raising taxes or by cutting gov’t payrolls. We shouldn’t be doing it at all. Ironically, if most of the unemployed were back to work, the increased taxes collected from them, along with the reduced layout for unemployment benefits, Medicaid, and other welfare expenses would, in itself, balance the budget. As I have mentioned in an earlier blog post, when Roosevelt took over in 1933, he inherited a 25% unemployment rate. By using deficit spending to expand the economy, by late 1936 the rate had been reduced to 10%. Then conservatives in Congress convinced him to quit worrying about unemployment and balance the budget. It was a disastrous decision. By late 1937, the rate was back up to 25%, and were it not for WWII, the depression might never have ended. We are now making precisely the same mistake.
If we are to create jobs by taxing less, then what kind of tax relief works? What we are now doing, just giving more tax breaks to billionaires, is supply side economics, and as we have seen, this doesn’t work. If you really prefer to use tax relief to create jobs—fine--but don’t just hand sacks of money to billionaires. Use “demand side” economics, like employment tax credits. Just extend tax credits to all employers who agree to a net increase in the number of permanent employees. If any of the new jobs turn out not to be permanent, that is, not last a certain specified number of months, the money is clawed back.
If you want to use increased public spending create jobs, fine! Hire someone! That creates a job. Or you can spend public funds to purchase goods and services that will cause people to be hired. There is no shortage of things needing to be done. The infra-structure effort to convert our country to a post-petroleum economy alone would keep us all working for half a century.
The general approach I have described is called Keynesianism, and we did it for over half a century, and it worked. I believe that, if properly done, it could still work. For an analysis of the limits of this policy, see: Does Keynesian Policy Still Work? in the archives of this blog. http://online.wsj.com/article/SB10001424053111903885604576488054002109720.html
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