Businesses Hire When They are Swamped with Demand, Part XXV

Our friend John Harvey wrote a great new piece on why businesses hire. Really, he didn’t write it, it’s a letter from a businessman friend of his, who wrote a letter to his congressperson, and John reprinted the letter in his column over at Forbes.

Check out these key lines:

“As an owner of two small businesses, I can tell you that no amount of tax decreases or deregulation is going to convince me to hire more people. Businesses only hire when they have to. That is, when demand for a product is greater than what we can produce at current staffing level”

Hey! This seems like common sense, but some people do not understand it. For example, here is someone who does not understand businesses hire when they are swamped with demand. Meet Tyler Cowen:

“The simple Keynesian explanation for the initial unemployment is that aggregate demand — the country’s combined spending and investment — has been too low. But it’s unlikely that spending is the only problem, as unemployment is too high and too persistent relative to similar episodes of disinflation in recent history. If weak demand was the main problem, profits should be collapsing too, but they are not. Investment and corporate profits have been fine for some time now, and they are broadly within the range of pre-recession estimates.” [Bold Mine]

There are so many errors in this paragraph. Tyler does not understand there is little or no relationship between overall demand and corporate profits. Rather, corporate profits not closely related to employment levels or hiring rates. (Update: the relationship between corporate profits and government spending is part of another post.are highly dependent upon the level of government deficit spending.)

I demonstrate this here:

It’s a bit hard to believe someone like Tyler Cowen could be completely ignorant of a such a strong non-relationship between two things he is talking about in this article in Foreign Policy magazine!  It’s as though he never even bothered to look at the historical record

Wow.

There are easy ways to explain it to people, in ways that match the historical record. Here is Paul Davidson talking about a restaurant he visited:

“Recently I went to a well-known restaurant in Evanston, Illinois. This restaurant has a reputation for providing excellent food and service. But the night I was there, it was less than half full. I asked the manager if he would he hire more waiters and chefs if his taxes were reduced and/or government removed the existing regulations controlling the way his restaurant could operate. His answer was that even if his taxes were reduced and regulations eliminated, he would only hire more staff if more customers came in for dinner. On the other hand, if there were twice as many customers for dinners than there were on this night (and there were many more customers before the recession began in 2007) he would gladly double the number of workers he employed even if his taxes were not reduced or regulations changed.”

 

 

Comments

  1. Detroit Dan says:

    Excellent stuff. Thanks for providing the graph…

    • Thanks Dan. It’s remarkable what people can get away with just because they don’t bother learning much. You’d think plotting inflation adjusted corporate profits against unemployment rates would be an important first step before you base an entire article around the claim “high corporate profits cause lots of hiring”

      It’s good to see that business people actually understand this .

  2. common sense has never stood up to “free market” supply side ideology. you simply can not win this argument when the other person has a vested interest in their position.

    • It will be a long slow battle. But so few of us use persuasive language, or even try.

      To be memorable, you must tell a story.

      http://www.bakadesuyo.com/2012/11/secret-communicating-memorably/?utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+bakadesuyo+%28Barking+up+the+wrong+tree%29

      Preparation doesn’t even matter. It just needs to be a memorable story. So pull out the story about a restaurant being 1/2 full vs. a line out the door, and let people figure it out themselves.

      The phrase “Businesses hire when they are swamped with demand. ” is a mini-story, which makes intuitive sense to people after one listen. You don’t need to explain the story, and it works even better on businessmen. Every business person knows they would hire if they had too much business to handle with existing staff and they expected this to continue into the future – that’s the “swamped with demand” part.

      If someone – anyone – pulls out any other argument about business hiring that uses second and third order derivatives on why businesses hire, just respond with this phrase.

      The chart is so when someone like Tyler Cowen puts an article based on the claim hiring is related to corporate profits into Foreign Policy magazine, he looks like a clown who didn’t bother to do his homework. I say, “Businesses hire when they are swamped with demand”, and then pull out the chart which empirically destroys his argument .

  3. Good post Mike. Great Paul Davidson quote because you can see it with your own eyes. Last weekend, I was at a restaurant in my old Atlanta neighborhood I hadn’t been to in a few years. When I was a regular there, it was packed every weekend, but last Friday it was less than half-full.

    On the one hand, it was nice not having to wait in line for a table but on the other, unless the business model includes a box for “laundering drug money”, I doubt it can stay open if they’re not filling tables on what should be a busy night.

  4. Clonal Antibody says:

    Mike, 0.

    I downloaded, the data in the graph, and calculated the correlation. There is a weak positive correlation between corporate profits and employment. An R Squared of about 0.07 Which would make sense, as periods of high employment would lead to more demand, leading to somewhat higher profits. However, as a behavior pattern, corporations preserve profitability by mass layoffs in recessions being the reason for the correlation being weak

  5. “The study of business cycles is the study of what happens to employment when nothing is done to keep demand where it should be…
    The confidence of businessmen is important because so much of the enterprise and the investment of society is in their hands. This confidence is upset as much by a large unbalancing of the budget as it is by a much larger one that may be necessary to achieve sufficient total demand to provide full employment… It is therefore the very worst possible policy to unbalance the budget sufficiently to upset the businessmen without going all the way to bring about full employment …”
    Abba Lerner, The Economics of Control (pg 299, 320)
    http://203.200.22.249:8080/jspui/bitstream/123456789/1052/1/The_Economics_of_control.pdf

  6. Jeremy Mills says:

    Nice articles/quotes.

    “hangemhiNovember 17, 2012 at 4:19 pm
    common sense has never stood up to “free market” supply side ideology. you simply can not win this argument when the other person has a vested interest in their position.”

    I agree to both points. I experienced the latter point most recently in a debate with Warren Mosler about “imports are a benefit”.

    “Michael SankowskiNovember 18, 2012 at 10:19 am
    Clonal – excellent! That’s a good point. I have data which shows the correaltion between government deficit levels and inflation adjusted corporate profits 2 quarters has an r2 of above 50%.”

    As you know correlation does not mean causation. This is especially true in macroeconomics with all of the variables involved (i.e. there is a high chance of omitted variable biases, etc.)

    One could argue that high unemployment increases profits since it increases the bargaining power of business owners vs their employees.

  7. Couldn’t lower taxes and less regulation lead to lower prices, higher demand, and more hiring?