Last week the Commerce Department reported corporate profits of $1.659 trillion in the third quarter of 2010. However, unemployment continues to hover around 9.5%. So, where are the jobs?
A quick look at the business cycle from an Austrian Economics perspective might be illustrative. Generally, the banking community increases interest rates in order to attract savings. Conversely, as savings increase, banks tend to lower interest rates.
These adjustments in interest rates act as signals to the business community. Low interest rates tell the business community that society is delaying current consumption in favor of future consumption. The business community responds by investing in business expansion aimed at that future consumption. The expansion results in increased employment.
However, when those aforementioned interest rates are the result of central bank intervention, the signals to the business community become distorted. The savings that would have led to future consumption doesn’t actually exist. As the business community discovers that savings-fueled demand is lower than expected, many of the projects in which they invested go bust. Consequently, investments in those projects, including employment, are liquidated. The output that was geared toward future consumption no longer exists.
This is an abbreviated description of the Austrian Business Cycle, but it does provide an illustration of just why unemployment reached such high levels.
So now, we return to the question of why increased profitability didn’t result in decreased unemployment, as it usually does. One answer may be that the business community is beginning to understand that those low interest rates which, in the past, signaled increased wealth for future consumption no longer provide that same signal. They are beginning to understand the distortion from central bank intervention.
On top of the central bank distortion we have the uncertainty caused by rules that are unintelligible and unpredictable. When new workers are potential threats because of Labor Department regulations, businesses have little confidence to hire. Recent legislative initiatives such as the health care bill and the Dodd-Frank Regulatory Act have created just such a regulatory paradigm. The Wall Street Journal reports, there will be “no fewer than 243 new formal rule-makings by 11 different federal agencies.”
The foregoing may explain why unemployment remains so inflexible, but it doesn’t explain the increase in profitability. There are reports that indicate that those large profits stem from companies cutting payrolls to the bone and freezing or slashing spending (e.g., R&D) that is essential for creating sustainable growth (and a demand for permanent full-time workers).
American businesses are able to increase profits by rising productivity, increasing exports, cutting costs, and in some cases raising prices. Productivity simply means extracting more or the same amount of work using fewer workers. Globally, U.S. companies are leaders in productivity due to the corporate culture prevalent in the U.S. and the fierce competition in many industries.
Efficiency gains reduce the chances recession-casualty jobs will come back.
“When the productivity growth comes, then watch out because that is when companies start not needing so much labor,” Edmund Phelps, a Columbia University economist and Nobel laureate, said in an interview.
In other words, corporate profits were not the result of increased demand for goods and services, which would have been the impetus for job creation.
This begs the question, why would not the business community use those profits for business expansion despite the distorted low interest rate signals. After all, wouldn’t they be beneficiaries of the increased demand resulting from the increased employment? The recession made the business community realize that they needed to build up reserves of cash fast. They could no longer rely on the markets to provide even basic financing when they needed it. So they cut costs, especially capital investment and labor, through a mix of redundancies, reduced hours and lower pay. Investors worry about what will happen in an economy that even Alan Greenspan, former chairman of the Federal Reserve, fears may be heading for a double dip. They now view the higher profits as an entirely cyclical phenomenon. In fact, the share of GDP accounted for by profits seems to be rising over time, so even a sub-par cyclical recovery may deliver outsized profits.
According to the Economist magazine, “This focus on improved efficiency without investing in growth will last a while. Compared with previous waves of restructuring, this one was more about generating operating efficiencies by cutting jobs and capacity than about restructuring balance-sheets.” There’s still a lot more juice to be squeezed from the lemon, says Hal Sirkin of Boston Consulting Group. One obvious area is procurement, where a growing number of firms are starting to “squeeze their suppliers a second time”, after realizing that the first round of renegotiations following the financial crisis did not go far enough. Many of these suppliers have themselves reduced their costs in the past 18 months and have yet to pass those savings on. Mr Sirkin also expects merger activity to accelerate, which should release “another significant amount of juice.”
The bottom line is that as long as the Fed continues to distort the interest rate signals and fears of a double dip recession persist, the unemployment rate will remain high.
ABOUT THE AUTHOR: Carl L. Reed received his BA in Economics from the University of California at Los Angeles (UCLA) in 1987. Currently he is self employed as a real estate agent in Lacey, Washington.
A quick look at the business cycle from an Austrian Economics perspective might be illustrative. Generally, the banking community increases interest rates in order to attract savings. Conversely, as savings increase, banks tend to lower interest rates.
These adjustments in interest rates act as signals to the business community. Low interest rates tell the business community that society is delaying current consumption in favor of future consumption. The business community responds by investing in business expansion aimed at that future consumption. The expansion results in increased employment.
However, when those aforementioned interest rates are the result of central bank intervention, the signals to the business community become distorted. The savings that would have led to future consumption doesn’t actually exist. As the business community discovers that savings-fueled demand is lower than expected, many of the projects in which they invested go bust. Consequently, investments in those projects, including employment, are liquidated. The output that was geared toward future consumption no longer exists.
This is an abbreviated description of the Austrian Business Cycle, but it does provide an illustration of just why unemployment reached such high levels.
So now, we return to the question of why increased profitability didn’t result in decreased unemployment, as it usually does. One answer may be that the business community is beginning to understand that those low interest rates which, in the past, signaled increased wealth for future consumption no longer provide that same signal. They are beginning to understand the distortion from central bank intervention.
On top of the central bank distortion we have the uncertainty caused by rules that are unintelligible and unpredictable. When new workers are potential threats because of Labor Department regulations, businesses have little confidence to hire. Recent legislative initiatives such as the health care bill and the Dodd-Frank Regulatory Act have created just such a regulatory paradigm. The Wall Street Journal reports, there will be “no fewer than 243 new formal rule-makings by 11 different federal agencies.”
The foregoing may explain why unemployment remains so inflexible, but it doesn’t explain the increase in profitability. There are reports that indicate that those large profits stem from companies cutting payrolls to the bone and freezing or slashing spending (e.g., R&D) that is essential for creating sustainable growth (and a demand for permanent full-time workers).
American businesses are able to increase profits by rising productivity, increasing exports, cutting costs, and in some cases raising prices. Productivity simply means extracting more or the same amount of work using fewer workers. Globally, U.S. companies are leaders in productivity due to the corporate culture prevalent in the U.S. and the fierce competition in many industries.
Efficiency gains reduce the chances recession-casualty jobs will come back.
“When the productivity growth comes, then watch out because that is when companies start not needing so much labor,” Edmund Phelps, a Columbia University economist and Nobel laureate, said in an interview.
In other words, corporate profits were not the result of increased demand for goods and services, which would have been the impetus for job creation.
This begs the question, why would not the business community use those profits for business expansion despite the distorted low interest rate signals. After all, wouldn’t they be beneficiaries of the increased demand resulting from the increased employment? The recession made the business community realize that they needed to build up reserves of cash fast. They could no longer rely on the markets to provide even basic financing when they needed it. So they cut costs, especially capital investment and labor, through a mix of redundancies, reduced hours and lower pay. Investors worry about what will happen in an economy that even Alan Greenspan, former chairman of the Federal Reserve, fears may be heading for a double dip. They now view the higher profits as an entirely cyclical phenomenon. In fact, the share of GDP accounted for by profits seems to be rising over time, so even a sub-par cyclical recovery may deliver outsized profits.
According to the Economist magazine, “This focus on improved efficiency without investing in growth will last a while. Compared with previous waves of restructuring, this one was more about generating operating efficiencies by cutting jobs and capacity than about restructuring balance-sheets.” There’s still a lot more juice to be squeezed from the lemon, says Hal Sirkin of Boston Consulting Group. One obvious area is procurement, where a growing number of firms are starting to “squeeze their suppliers a second time”, after realizing that the first round of renegotiations following the financial crisis did not go far enough. Many of these suppliers have themselves reduced their costs in the past 18 months and have yet to pass those savings on. Mr Sirkin also expects merger activity to accelerate, which should release “another significant amount of juice.”
The bottom line is that as long as the Fed continues to distort the interest rate signals and fears of a double dip recession persist, the unemployment rate will remain high.
ABOUT THE AUTHOR: Carl L. Reed received his BA in Economics from the University of California at Los Angeles (UCLA) in 1987. Currently he is self employed as a real estate agent in Lacey, Washington.
1 comment:
Fantastic!
Robert Higgs has written about the longevity of the Great Depression as partly caused by business traumatized by "regime uncertainty". We have seen Bush and O both enter the business world to provide favors (bail-outs and stimulus) to certain favorites and threaten (Obamacare skeptics)others.
It is better to stay on the sidelines, amass and protect your capital that hazard its loss by DC intrusions. The essay's explanation of free market signals gone awry due to the meddling of Greenspan (Bernanke, Bush, Pelosi, Reid and O) have created this economic climate.
The Tea Parties began the dismantling of the mistakes. Further work must be done to fully correct the mistakes. Oh, that work means getting the hell out of the way.
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