How are jobs created?

In the wake of the financial crisis in 2008, there’s been a lot of bad economics floating around. Perhaps none is more prevalent in certain circles than the idea that rich people are job-creators; after all, when was the last time a poor person offered you a job? This entirely misunderstands our modern economic system. To see why, I’ll start with a simple example of a job I used to have at Target.

When I stocked shelves at Target one could say that I was employed by the wealthy shareholders of Target (acting through a human resources department). But, of course, the shareholders didn’t do this as an act of philanthropy, they did this because they needed another employee to maximize profits. In a very immediate and tangible sense, my job was created by the fact that there were empty shelves to fill. Those empty shelves, in turn, were created by lots of individual people taking things off the shelf and buying them. In economic terms, we call the purchases of all of those individuals aggregate demand.

Now, it turns out, that aggregate demand does a lot more than just employ retail workers. There’s also the people who made and transported the goods on the shelf. And the service industry also relies on people buying services from them. In every single economic transaction it’s important that there’s someone demanding the good or service offered.

Now, it’s very important that I’m also clear on this point. Supply also matters. It is possible for an economy to suffer from slow growth because high tax rates or regulation or natural disasters or whatever else prevents individuals from bringing goods to market. But that’s not what is happening now. Even if you think Reagan and Volckler did everything right in fighting the stagflation of the late 70s, that fact remains that those are not our current economic ailments.

In 2008, the housing bubble burst, and created a giant hole in aggregate demand. In the run-up to the crisis, people had already failed to save enough, and so there was no way to maintain current spending levels with plummeting housing values. One of the more obvious signs that this demand shortfall continues is that corporations have lots and lots of extra cash. Now, it makes sense for corporations to hold more cash as precaution against instability. However, the reason corporations usually stop holding cash is because they want to invest it into growing their business (i.e. making more goods or services). They know that if they don’t do this, one of their competitors will. If Target fails to spend money to keep its shelves stocked then people will shop elsewhere and Target will lose market share. But there’s no reason to invest if there’s no demand for the good or services. Firms have the ability to produce more goods and services (aggregate supply) than they are doing currently. The reason they don’t is because there is no one to buy those goods and services.

This leads to a few interesting conclusions. First, because rich people and poor people have different rates of marginal consumption (i.e. a poor person is more likely to spend all of each extra dollar they earn than a rich person), redistribution can boost demand. This means cutting the payroll tax can have a bigger impact on the economy than cutting the income tax. It also means that increasing the minimum wage could be at least slightly stimulative. Again, this is because those minimum wage workers making extra money are likely to immediately spend it on goods and services. This is one of many possible reasons why empirical studies find no evidence that raising minimum wage leads to increased unemployment.  Perhaps this growing evidence is why no less an establishment than the International Monetary Fund has suggested that inequality may take a toll on stable growth. It turns out that not only is reducing inequality morally necessary, it’s also economically prudent. 

Update: This morning’s weak report from the BLS on job growth (88,000) with a particular weakness in retail (-24,000), fits perfectly into the aggregate demand theory of job creation. The payroll tax cut ended in January, and now we’re seeing the results of low wage workers having less money to spend at retail outlets. There is a little bit of good news in the report though, “The number of persons employed part time for economic reasons (sometimes referred to as involuntary part-time workers) fell by 350,000 over the month to 7.6 million.” I’m not really sure why that happened, but if part-time workers became full-time it would also partially explain the weak growth in overall job creation.

Update 2: Testimony from Nick Hanauer, an entrepreneur and venture capitalist (and fellow philosophy major) to the Senate banking committee:

That’s why I am so sure that rich business people don’t create jobs, nor do businesses, large or small. What does lead to more employment is a “circle of life” like feedback loop between customers and businesses. And only consumers can set in motion this virtuous cycle of increasing demand and hiring. That’s why the real job creators in America are middle-class consumers. The more money they have, and the more they can buy, the more people like me have to hire to meet demand…

Anyone who’s ever run a business knows that hiring more people is a capitalists course of last resort, something we do if and only if increasing customer demand requires it. Further, that the goal of every business- profit-, is largely a measure of our relative ability to not create jobs compared to our competitors. In this sense, calling ourselves job creators isn’t just inaccurate, it’s disingenuous.


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