Wednesday, September 19, 2012

PRODUCTIVITY AND PAY Increases ... Which Comes First? ... In the Private Sector, Productivity Comes First ... In the Public Sector, Productivity Doesn't Come ... The Differing Ways of Barack Obama and Henry Ford

The public sector seemingly always wants to grow in size, and it fuels its growth by first taking money and resources from the productive private sector.

The private sector, on the other hand, fuels its growth by shrinking, including its cost per unit of production. Or put another way, it improves its quality and reduces its prices relative to competition. It manages to do this by continuously improving its productivity.

Thus, when politicians say they want to create jobs, they mean it. And when the private sector leaders say they want to earn a satisfactory level of profits and thereby remain in business, they mean it, too.

In the public sector, the emphasis is on creating more public sector jobs. On the other hand, in the private sector the emphasis is on wealth creation.

PRODUCTIVITY improvements and new ways of doing things are fought tooth and nail in the public sector. These same attributes are necessarily embraced and internalized in the private sector.

What happens is that productivity improvement enables wealth creation in the private sector and therefore the nation's economy as a whole. In contrast, the public sector wants to spend money and not make money. Hence, it's pure and simple MOM versus OPM behavior, respectively.

The U.S. Needs More i-Side Economics speaks directly to the difference between an emphasis on private sector productivity and government spending. We'll begin with the words of President Obama and then move on to the broadly misunderstood example of Henry Ford. It's about paying more money to the middle class and the fallacy that that in turn will create economic growth:

"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."

Summing Up

Productivity is a proxy for improvement. Improvement lowers cost and increases quality. Lower prices follow, and the consumer benefits. As a result, more money is invested in the new way of doing things. New jobs are the result.

Schumpeter called this process creative destruction. It simply means that to create something new, we usually have to do away with or destroy something old. The old is discarded and replaced with the new.

Think of e-mail and the post office, as an example. Or Facebook and the post office. Or anything else like that, such as Henry Ford's cars versus the horse and buggy. And so on.

The public sector, using Chicago's teachers strike as an example, still clings to the status quo. This is the way they preserve and even increase public sector jobs and thereby keep costs unnecessarily high. They resist closing schools, opening charter schools, giving kids and parents vouchers to attend the schools they would freely choose to attend and so forth.

But it's worse than the high costs that ensue. The quality of the output, aka student learning, suffers and the status quo becomes the forceful enemy of educational improvement.

As a consequence, costs keep going up and quality keeps going down.

And that's why the mere act of paying more money to the middle class, or anybody else for that matter, in the end isn't giving anybody anything other than the grief associated with a sick economy.

When will our progressives learn that simple fact? Only after We the People have taught them.

And when will that happy time arrive? Who knows? I sure don't.

Thanks. Bob.

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