The latest attempt by Congress to wrestle the high unemployment rate is the HIRE Act, which is little more than a tax holiday for companies who hire additional workers. Even if this Act works as intended and encourages businesses to hire more workers, which in and of itself is not a guarantee, then other measures undertaken by the Obama Administration have the opposite effect, by actually stifling hiring by business. Some of the measures that counteract intentions of the HIRE Act are the minimum wage increases of the last few years, uncertainty of pending legislation on healthcare and cap-and-trade, and the Davis-Bacon Act that requires government contractors to pay wages that are above the market rates.
The idea behind the HIRE Act is that the payroll tax holiday would reduce the cost of labor for participating companies by temporarily suspending the employer’s share of the Social Security payroll tax, thus coercing companies to hire new workers. However, the impact of such a measure is unclear, since the tax holiday will only be temporary and will have little impact – a qualified employer who hires a worker earning $51,000 annually will receive a subsidy equaling roughly $264 per month. However, these subsidies amount to lost revenue in the Federal Social Security Trust Fund – an institution that even without this additional burden is running a significant deficit.
The minimum wage increases in the last couple of years have contributed to a rise in the unemployment rate. The minimum wage was increased from $5.15 to $7.25 between 2007 and 2009. It is a fact that unemployment goes up as the minimum wage increases because businesses have to pay workers more to keep them employed, and inadvertently not all workers are kept after the minimum wage increases. Congress made their task of decreasing the unemployment rate that is currently hovering around 10 percent more difficult by their actions from several years back.
Another reason why businesses are reluctant to hire more workers is because they feel a sense of uncertainty for what bills may be enacted by Congress. Critical bills such as healthcare reform and cap and trade legislation are currently being contemplated, which could significantly increase the price of labor for businesses. Until they are certain about whether or not they must pay for healthcare of ever worker on payroll, or whether the cost of energy could potentially rise due to cap-and-trade legislation, businesses are not going to be enticed by a temporary payroll tax hike to hire workers whose wages will need to paid indefinitely into the future.
The Davis-Bacon Act is yet another measure currently on the books that hinders rather than encourages more hiring. Government construction spending has to cost more than the market rates, and to pay for this extra cost, the government takes money through taxes from elsewhere in the economy. But Congress cannot reduce unemployment through public works projects, because for every job that it creates in the public sector, at least one job is not being created in the private sector and in the best-case scenario the net job creation is zero, but 160,000 jobs are actually lost because of this legislation.
Although the HIRE Act is intended to reduce unemployment, there are many other bills and laws currently on the books that directly counteract the goals of this bill. Congress should consider how to assuage negative effects of these other laws before looking for new ways to decrease unemployment. The fact that Congress is looking at ways to decrease the unemployment rate is a good sign, but attempts by Congress to decrease the unemployment rate will never succeed if other laws are passed that actually lead to higher rates of unemployment.
My Corner post from last Wednesday — pointing out that government “stimulus” spending does not add new purchasing power to the economy because the government must first borrow that purchasing power out of the economy — caused a stir among liberal bloggers Brad DeLong, Matt Yglesias and Stan Collender. Their posts suggest they likely didn’t actually read the report I linked to — which anticipated and answered their counterarguments.
Brad DeLong predictably relied more on insults than analysis. Eventually, he asserted that my point that government “stimulus” cannot alter short-term demand must be false, since it would also mean that demand (and therefore income and spending) must always be fixed, making economic growth impossible. But this ignores that demand growth can come from sources other than fiscal policy.
Recovering from a recession requires first correcting the imbalances that caused the recession. Thereafter, economic growth is a function of productivity and labor supply. Rather than raising immediate productivity or labor supply, government spending (and tax rebates) typically redistributes existing demand from one group of people to another. This is zero-sum.
Yet demand can still grow other ways. Demand is nothing more than purchasing power, which is a function of goods and services provided and sold. Income, by definition, results from productive activity. When productivity increases (thus increasing employment and eventually wages), income increases and demand increases, all in tandem. So the key to increasing demand is to allow the economy to correct its imbalances and then to encourage productivity and labor supply.
Matt Yglesias argued that, during a recession, government spending can put unused resources to work. The problem is that, even in a recession, the spending must be financed by borrowed dollars that would have otherwise been employed elsewhere in the economy. Congress can borrow $10 million from the residents of Anytown to re-open an idle factory in Flint, Michigan. But this leaves Anytown’s residents with $10 million less to spend, which (by the same logic) will cause the idling of resources there. So rather than create new economic activity and multiplier effects, the stimulus has merely transferred them to a new town (my report covers the case of foreign borrowing as well).
Stan Collender asserted that people and businesses aren’t spending their money, so Congress can increase demand by transferring it from “savers” to “spenders.” This argument — which I dealt with at length in my report — ignores the existence of the financial system. Savings do not drop out of the economy. Nearly all people invest their savings, or put it in banks, which lend it out to others to spend. Thus, the financial system transfers one person’s savings to someone else who can spend it. The only savings that drop out of the economy are those hoarded in mattresses and safes.
Collender may contend that recession-weary banks are hoarding savings well beyond the legal minimum reserves. Yet even when banks hesitate to lend their deposits, they invest them in Treasury bills to keep them circulating through the economy and earning interest. In fact, the federal funds market — where banks lend each other any excess cash at the end of the day — exists because banks refuse to sit on unused cash even overnight. Thus, even in recessions, one person’s savings quickly finance another person’s spending.
Yes, we hear about “excess reserves” in the banking system. But those aren’t customer deposits being hoarded in massive bank vaults. Rather, they represent a glut of new dollars held at that Federal Reserve that have not yet been injected into the economy. Held at the Fed, those reserves are not financing the stimulus (more here and here).
Stimulus spending advocates like Collender must be able to show that nearly all the money lent to Washington would have otherwise sat idle in mattresses and bank safes (where it could not be consumed, invested, or deposited in banks for investment spending). Otherwise, Washington is merely a middleman transferring purchasing power from one part of the economy to another — and the justification for government spending as stimulus collapses.