Wednesday, February 22, 2017

Misleading Old Ideas

Let’s take a fairly simple idea. The one that follows is often heard repeated as the justification for cutting taxes. The idea: cutting taxes leads to investment; investment leads to hiring; therefore cutting taxes creates new jobs. Does this idea have actual merit? Well, it all depends on what you mean by the word “investment.”

Investment can mean buying newly issued stock, the corporation issuing them intent on raising capital for a new factory, say. If that is the “investment,” it may well eventually result in people being hired—for building the factory and then for staffing it. But most purchases of stock are not of this sort. We buy stocks already on the market. The result is that the price of the stock rises or falls.

Another kind of investment is when capital is expended on a merger or acquisition (M&A). When companies merge or acquire each other, the usual motivation is negative. The buyer’s growth or profits has been lagging. It acquires another company to get access to its market. That might restore growth—and also result in higher profits by laying off people who are no longer needed. This is often possible if services common to both organizations can be combined. In most M&A cases, job are lost, not created.

Now let us take a look at these two cases. In 2015, total US M&A activity was valued at $2.413 trillion (link), thus, to underline it, 2+ trillion dollars was spent on companies buying companies.  In the same year, total venture capital expenditures were valued at $77.3 billion (link) in the United States. If we add those two numbers, we get $2.49 trillion; of that total, venture capital expenditures were 3.1 percent.  The net result is that of 100 percent of corporate investment, nearly 97 percent was spent on activities most likely not to change employment at all or to reduce it—the reduction coming from the staff reduction as the two parties to the merger make it more efficient. Only 3 percent went toward activities highly likely to be translated to new jobs.

It’s dangerous to put one’s faith in simple ideas taught in Economics 101. In the age we live in, where M&A activity globally has averaged $3.85 trillion every years since 2007, the concept of “investment” has lost all meaning. And to that large average number must be added the totals of every year’s stock market transaction—which have virtually nothing to do with job creation.

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