01 June, 2011

Government Doesn’t Create Demand

I mentioned this in a recent post, but I feel that this deserves more attention than a simple one liner.

First, a true recovery from a recession requires lower unemployment. Lower unemployment means that more people have more money to consume more goods and services which enables more producers to hire more people. Lather, rinse, repeat.

So, while all the media will constantly remind you (during a Democrat Presidency anyway) that unemployment is a lagging indicator on recovery, it’s the most important indicator. Especially for the unemployed or for those fearing unemployment.

Therefore, you’ll notice that almost all government interventions in recessions involve trying to encourage hiring. The few that don’t tend to encourage spending, which hopefully also encourages hiring.

Now, the best way to do this, and arguably the only successful way to do this is to reduce restrictions on businesses. You can do this by lowering taxes, removing burdensome regulations, or doing similar things for investors, allowing them to invest in businesses, giving them a funding shot in the arm.

If you reduce the cost of doing business, businesses can lower their prices to the appropriate demand point, and increase sales. They can also hire more people, enabling them to produce up to the demand level (assuming they are behind), and also increase sales.

So, doing this increases demand for employment, and demand for goods and services, and the economy marches forward. Success.

This only works if there’s no inventory glut, which does often happen with big ticket items in a recession. However, the first part helps even with an inventory glut. Reducing cost of doing business enables businesses to better handle the lower profit margins of an inventory glut, and stay in business. You can also make adjustments to taxation to lower the taxes on companies with high inventory.

This may or may not allow the businesses with glut to lower their price points to the appropriate demand point, and yet still make enough money to stay in business. This is not necessarily a bad thing. Often inventory gluts are caused by being unresponsive to a changing marketplace. If the business goes out of business due to their inventory glut, then the business was not needed anyway. If the good or service produced by that business is needed, someone else will produce it, or buy out the inventory and resell it. So, the end result is that in this case, demand is not increased, but that production is lowered to match demand. The remaining producers now get a bigger piece of the overall pie, and can once again grow their business. Again, success. Probably at a slower rate than the businesses that didn’t have a glut, but still success.

It’s also worthwhile pointing out that these big ticket items with an inventory glut are often dealing with the glut because people have delayed purchases due to employment concerns. If their employment situation stabilizes due to their business being able to save money, there will be increased demand for the big ticket items. No more glut. Success.

So, no matter how you slice it, getting out of the way of business succeeds when trying to get out of a recession. And it does it by increasing demand for employees and for goods and services.

And that’s what we’ve generally done in previous recessions.

Now, let’s look at the current recession.

First, we sent a lot of funding to public sector projects, rather than private sector ones. For example, in some states, school systems and first responders got a ton of money from the Federal government, but were required to use a large portion of that money to hire people. Note that the government didn’t do anything to create demand. They just gave out money to hire people. And they paid the salaries for two years. Guess what? The two years is up, and the states are discovering that they can’t afford to pay those people anymore. A lot of them are going to get the axe. Oops. Projects like these only succeed in lowering unemployment as long as the government dollars are paying for them. At taxpayers expense.

Second, the government handed out tens (hundreds?) of billions of dollars to companies suffering from inventory glut. They didn’t originally do anything to deal with the glut itself (more on that later), they just gave them money so they could keep their employees around and produce more goods in a market that was already saturated. In other words, companies were rewarded for not being able to respond to a changing marketplace. It’s not hard to see that this can’t turn out well. Also it sets a precedent that if you’re a large enough company and you’re too big to fail, then you don’t have to worry about failure. Go ahead and make whatever bad decisions you want. The government will always be there to rescue you. At taxpayers expense. No need to worry about demand. You’ve got the government. And still no demand.

Third, the government interfered in the free market, and instead of reducing expenses for business across the board, they created rules allowing greener industries to create green products and services at less costs. Or they gave one time tax breaks to consumers of these green products and services. This creates demand, but it’s artificial demand and is unsustainable. If a product or service can’t succeed in the free market without government intrusion, then it won’t continue to succeed once that intrusion is taken away. Thus, either the government has to keep on funding these green industries at taxpayer expense, or watch them die. The demand created here is temporary at best.

Fourth, the government finally realized that it needed to do something about demand for the inventory glut on these big ticket items, particularly houses and cars. So, we got some big short term tax breaks for new home buyers and the Cash for Clunkers program.

The tax breaks for home buyers was nice, but it didn’t do anything to create a bigger market of buyers, it just enabled people on the fence for buying to buy a bit sooner. And since there was already a glut, it didn’t put home builders back to work, because the tax incentives went away before the glut had been consumed. In fact, there’s still a glut. And no demand for new homes, or new home builders.

The Cash for Clunkers program was a disaster. It enabled people to get some nice incentives to trade in their old fuel inefficient car for a brand new more efficient car. Again though, this is a case of the government picking winners and losers. You couldn’t trade in your clunker on a nice new full-sized SUV. You had to get a fuel efficient vehicle. So, didn’t help that SUV glut at all. Furthermore, the clunkers were destroyed rather than join the used car market, so a big chunk of the used car market was destroyed. So here, not only did we not create demand, but we decreased supply. Low income earners could no longer afford to buy used cars. Brilliant. And not only that, just like with the home buyer tax credits, once the program was over, new car sales declined again. Because demand wasn’t created, just pushed forward. Once again, these programs create either no growth or unsustainable growth. The growth can only be maintained as long as the program is maintained. At taxpayer expense.

Fifth, and finally, not only did the government not get out of the way of business, it did just the opposite. It created a huge new healthcare program with lots of regulations and compliance expenses for every business. President Barack Obama’s (D-USA) administration wanted to increase taxes on all small business as well, but this was eventually defeated by the GOP, by forcing the President to sign the extension of the Bush tax cuts. The uncertainty over this caused many businesses to delay hiring. Also, this uncertainty caused investors to delay their investments or put their money elsewhere. They may finally start hiring and investing now, but they still have to deal with burdensome regulations and ObamaCare.

Speaking of which, we also get the EPA imposing higher CAFE standards, the FCC imposing Net Neutrality rules, the NLRB interfering with business rights to expand where they want, and literally hundreds of other agencies doing everything they can to restrict business. All of these increase the cost of doing business, and therefore make it harder for business to hire new people. In other words, the exact opposite of what is necessary to create demand for employment.

And without demand for employment there is no recovery.

The government can’t create demand. All it can do is fake it for a while, or destroy it altogether.


  1. Chris, this is a good post. I enjoy all points of view and I'm just looking for perspective and ideas on the economy.

    At one point you mentioned that deregulation of industries and lower taxes will allow for lower prices, creating increased demand allowing more jobs to accomodate the increased demand thereafter.

    I would consider this part of the "trickle down" theory.

    My thoughts are that businesses in the free market are profit driven. And unless the well being of the state and it's citizens add to their bottom line, profit still comes before God & country, and welfare of the state.

    In that kind of environment, deregulation and tax breaks amount to more profit but not necessarily jobs. What motivation do businesses have to lower prices if people are paying at the current level?

    And even if they lower prices to try to increase sales volume, if they've learned to do more with less, why will they create any significant amount of jobs?

    And a final question. Even with the creation of new jobs, how does this country deal with the undervaluation of "we the people's" labor as it is assessed by the "job creators" that create positions with nearly insane qualification requirements that barely provide for the well being of the laborer? Will there ever be motivation for businesses to raise their employee wages in an environment of deregulation and low taxes if they can still hire at low wages and pocket the profit off the laborer's surplus value?

  2. Thanks for the comments. I've already been planning another post which will address most of your issues, I think. I'm planning on writing it either tomorrow or Sunday. I'll come back here after and make sure I've addressed them or add more here if necessary.

  3. Great I'll check back soon. These questions I pose are just brain queries. No "gotcha" motives are intended.