11/14/2011 09:08 am ET | Updated Jan 14, 2012

American Corporations Owe Nothing to American Workers, and That's a Big Part of the Problem.

In last Wednesday's CNBC-sponsored "Your Money, Your Vote" Republican Presidential Debate, an intriguing question was posed that goes to the heart of the issue "to what extent should America be willing to rely on the private sector for our economic recovery?" That question came fairly early in the evening, when CNBC's "Mad Money" host Jim Cramer asked:

Governor Romney, do you believe public companies have any social responsibility to create jobs, or do you believe, as Nobel Laureate Milton Friedman, the most important, most influential conservative economist of the 20th century held, that corporations should exist solely to create maximum profit for their shareholders?

Cramer's question is, of course, much more interesting than the response it elicited. However, Gov. Romney's answer is illustrative of the prevailing Republican view in Congress about how to fix the ailing economy: Leave it to the private sector. This view, in turn, is diametrically opposed to the Democratic solution of targeted stimulus spending to create jobs and increase demand for products and services. This intractable opposition, of course, is why absolutely nothing is getting done on Capitol Hill in the name of economic recovery.

In response to Cramer's question, Romney responded:

This is a wonderful philosophical debate. But you know what? We don't have to decide between the two, because they go together. [Emphasis added.]

Our Democratic friends think when a corporation is profitable, that's a bad thing. I remember asking someone, "Where do you think profits go? When you hear that a company is profitable, where do you think it goes?" And they said, "Well, to pay the executives their big bonuses."

I said, "No, actually, none of it goes to pay the executives. Profit is what is left over after they have all been paid."

What happens with profit is that you can grow the business. You can expand it. You have working capital and you hire people. [Emphasis added.]

The right thing for America is to have profitable enterprises that can hire people. [Emphasis added.] I want to make American businesses successful and thrive.

What we have in Washington today is a president and an administration that doesn't like business, that somehow thinks they want jobs, but they don't like businesses. Look, I want to see our businesses thrive and grow and expand and be profitable. I want to see more --

Captain of industry that he is, Romney's explanation is partially right. However, considering the unwavering politician that he also is--one of his primary opponents, John Hunstman, has described Romney as a "well-lubricated weather vane"--Romney's answer, in context, is misleading. Cramer's question goes to the heart of whether voters in the 2012 election would be wise to rely exclusively on American corporations for the country's economic recovery. Consequently, clarification and analysis of Romney's answer are in order.

A domestically based corporation, particularly one that is publicly traded and, consequently, subject to the financial reporting requirements of the Securities and Exchange Act of 1934, can do one of two things with its after-tax "profits." It can choose to reinvest all or some portion of those after-tax profits into the business, placing them in the line-item "Retained Earnings" on the Income Statement, or it can distribute all or some portion of those after-tax profits to its shareholders, placing them in the "Dividends" line-item on the Income Statement, so long as the sum of these two line-items adds up to 100% of after-tax profits. So, as to this part of Romney's answer to Cramer's question, Romney is correct.

Romney's false logic is revealed, however, when you extend the correct part of his answer to comprehensively answer Cramer's question, as there are a number of assumptions Romney's answer requires to make it truly responsive. As a prefatory matter, there is no evidence to show that shareholders receiving corporate dividends are "job creators" per se. In fact, considering the proportion of equities held in retirement and other types of investment accounts that automatically re-invest those dividends (into other equities, other asset classes, and/or debt instruments), it requires a leap of faith to get from dividend payments to job creation. This, of course, is a fundamental flaw in arguments posited for lowering federal income tax rates on higher-income taxpayers, who tend to draw a much higher proportion of their taxable income from dividends and investment interest.

Given the increasing number of domestically based corporations that are, indeed, truly multinational (i.e. have both manufacturing and sales abroad), or at least have manufacturing or customer service operations outside the United States, one cannot assume that Retained Earnings will, in fact, be invested in capital assets within the United States and, therefore, potentially lead to the creation of new jobs in America. Put more simply, there is no automatic link between Retained Earnings and domestic job creation in an increasingly global economy.

So, the first part of Romney's answer to Cramer--"We don't have to decide between the two, because they go together" [Emphasis added]--is not correct. Under Friedman's statement, the intellectual basis for Cramer's question, it is only when the creation of one additional job can be shown to increase, incrementally, the profitability of the corporation (i.e. it maximizes profits) that the corporation will add that new job. If a new job in Bangalore or Taipei meets this metric but the same new job in Anderson, IN, or Montgomery, AL, does not, that new job will not be created in the U.S. So, the bottom line is that Romney's answer probably should have just been "yes," but that wouldn't have allowed Romney the cover, through obfuscation, his actual answer affords him and his policy approach to economic recovery.

Similarly illustrative of the false impression created by Romney's response, in answer to Cramer's question he also said "What happens with profit is that you can grow the business. You can expand it. You have working capital and you hire people." [Emphasis added.] Unless, in Romney's world, a corporation is "investing in people" by actually purchasing them with Retained Earnings, salaries and benefits--unlike capital assets--are a component of the Cost of Goods Sold line item. Accordingly, hiring new employees must be justified by projected increases in Gross Revenues for the years in which new hires are expected to be completed and, presumably, continued into future years. Put more simply, these new hires can only be justified by projected increases in demand, which has nothing to do with a corporation's profitability. In fact, if demand increases as sales prices decrease, one could argue the opposite to be the case because lower prices result in lower gross profits per unit.

Ironically, then, only an increase in demand for a corporation's product or service will justify hiring one additional person under Friedman's profit maximization theory of why corporations exist. Giving corporations greater freedom to deploy their capital will neither assure that capital will be invested in the United States nor that the economic conditions will later exist to warrant increasing employment costs, by adding new employees (i.e. creating jobs). Furthermore, inasmuch as fully loaded employment costs (salaries, wages, benefits and allocable share of administrative costs) is oftentimes the largest component of Cost of Goods Sold, adding employees by definition directly reduces profitability.

So, perhaps the only two things we really learned from Cramer's excellent question Wednesday night is that Romney is an unabashed Free Marketeer in the Milton Freidman mold, and that perhaps his "corporations are people, too" mantra may be supplemented by adding "and they use Retained Earnings to buy other people when they're ready to expand." That sounds about right.