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 --
(APPLAUSE)]
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.
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Cramer's question presented a false choice -- companies don't NEED to choose between social responsibility and shareholder value - it's designed to make social responsibility look like a good thing and shareholder value a bad thing. When in fact both are good things, both can be achieved -- which is a different matter entirely than what is being done in practice.
I think a better question would have been: "Do you believe public US companies have a social responsibility to create jobs in the USA, and if so how are they going to do this in today's economic climate". Because that's really the heart of the matter.
It was offshored to low cost labor pools by corporations who could import back in duty free, or it was automated with machines paid for with investment tax credits, or it was taken by an illegal alien who works for half the pay with no benefits and no worker protections.
Globalization is just union busting in a new dress.
Profits including big profits......and creating jobs (hiring Americans).......are SEPARATE issues for any company.......and it is a BIG LIE of the Repugs to say they will go together if you just lower taxes on corporations.
Does not legitimize itself.
If a company has more profits (including lower tax rates) that does NOT mean they will hire more people.
Only demand for their products and the need to make or provide more of them (needing manpower) will get them to hire people.....and those people may NOT be Americans.
Yet too many Americans actually believe the "free market" Repug BS.
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Put another way, a highly profitable company with low tax rates may not hire or may even fire workers.....while a less profitable company which may have higher tax rates will probably hire if they need the manpower.
Profits and creating jobs (hiring) are SEPARATE issues for any company.
IT'S THE BIG LIE!
Labor is not the only cost in the equation revenue - costs = gross profit. Labor levels could remain the same while other costs are decreasing such as raw materials, marketing, distribution and logistics, and development being recouped. Additionally, new products with new features and options can be developed to command the greater revenue in the future as the exisitng product is phased out.
Does the author buy electronics? This is the exact model in that industry. Prices initially high and then drop dramatically over time while a new product is developed commanding greater margins and the cycle continues.
Also, in your comment you selectively quoted from my blog, leaving out another statement I made about the fully loaded cost of labor often being one of the biggest components of Cost of Goods Sold. Clearly, for those operations where that's not the case, there is less pressure on the U.S. manufacturer to off-shore production to take advantage of dramatically lower wage rates.
So, what was your point again?
In highly competitive markets, like electronics, small changes in price can cause customers to switch (ie elastic demand), therefore manufacturers try to minimize costs. Even though labor is a small part of overall COGS, it can drive changes in price and thus competitiveness driving manufacturers to make product in low labor cost countries. Another way to say it, consumers do not place a value on electronics made in the US versus those made in low labor cost countries and are unwilling to pay a premium. The manufacturing expertise in China may not be as good as here, but it is good enough to meet the quality standards of consumers.
Clearly there is a positive correlation between profit growth and job growth but not causation in all cases. The more profits a company has the more likely it is to invest in new products and thus potentially more jobs. If a company has not profits (ie losing money) job growth is not likely to happen.
Labor is not the biggest component of COGS for most consumer products companies. Raw materials (or ingredients) and capital used in conversion are typically larger. As I stated in the first part of this response, even though labor may be a small part of the cost, in a competitive environment small changes in price can have a big effect on competitiveness.
This is driven by consumers. If a consumer goes to the store and sees a $15 t-shirt made in the US along side a $13 t-shirt made in Indonesia, they will invariably buy the $13 one. Its all those people decrying "evil" corporations exporting jobs overseas that pick the t-shirt made in Indonesia driving jobs overseas.
So what that means is that we need to do what we can to make the business environment here more profitable than "there" wherever there is. Right now, with the highest corporate tax rates in the world, increasing regulation, uncertainty and negative economic speech from the White House, it is decidedly not "here."
In the second paragarph, the commenter (that's you....Duh) wrote "Right now, with the highest corporate tax rates in the world, increasing regulation, uncertainty and negative economic speech from the White house is decidedly not 'here.'" First, the U.S. does is not even close to having "the highest corporate tax rates in the world." If you look at effective corporate tax rates (that's what the corporations really pay in taxes, after all deductions and credits...Duh), the U.S. has one of the lowest corporate tax rates among developed countries. BTW, on this point, look at the difference between Italy's and Poland's respective corporate tax rates, and their relative industrial productivity, and you'll see there's absolutely inverse correlation between the two.
Finally, there was more regulation under Bush than Obama, and more uncertainty under the Tea Party dominated Congress than there's been on Capitol Hill for at least half a century. Get you facts straight.
Unfortunately the stated US corporate tax rate is the highest in the world and having worked for global multinationals for the last 20+ years, the stated tax rate is what is used to build the business case for new projects. The only way a company can get a lower rate is to get tax breaks which require the company to do something that is likely not relate to the project and therefore is not known to those building the business case. Also, the duration of the tax break is unsure so often times they will only take into account the first year or two. The bottom line is that multinationals looking to invest don't say what tax rate might we get if we invested in the US vs another country, they look at the rate and make the decision accordingly.
You appear to not have much actual Fortune 500 experience with your statements about costs and how companies make decisions. Also, your comment about the "Tea Party" congress exhibits your lack of intellecutal honesty and objecitivity -- Republicans have been in control of only ONE house of congress for about 8 months. Dems have been in control of both houses of congress for almost 5 years and the presidency for nearly 3 years.
Briefly, (200 words) the world has excess production capacity because we have been tremendously successful at mechanizing labor. Our situation right now is that we do not know how to deal with our success at eliminating the need for vast amounts of human labor. Keynes said we shorten the work week to fifteen or twenty hours and expand the idea of human potential. I like that idea, but I recognize the immensity of the social transition that requires. Like everything else that society must evolve, but it would be nice to know we can at least envision it. Ironically, such a society would be a realization of the ideal Greek democracy.
I'm much more interested, of course, in your suggestion that we actually have excess production capacity (with which I agree intuitively, although I've not seen any specific data to that effect), which presents two separate yet related problems: First, the wastefulness of allowing such excess capacity to sit idle without endeavoring to re-purpose it; and second that with far more workers in the global economy being less productive (ranging, presumably, between unemployed, unemployable, and underemployed), we're likely in an unsustainable downward spiral where less productivity on a per capita basis means less consumption, thereby creating even more excess capacity because demand is not meeting production.
The notion that we would take all this excess capacity and translate it into a more engaged, thoughtful, and participatory world culture is evolutionary, and likely far too radical for the average fan of Survivor and American Idol to comprehend it (to Colette Rice's point). This is certainly worthy of its own blog post and discussion.
Where and when did our ancestors get together and decide, or the gods agreed, that the primary purpose of the human life would be to grind away the years in mostly unnecessary labor in order to secure life sustaining access to goods that exist in abundance? Could anything be more insane? Unlike the people formulating our foreign policy, I know that cultures cannot be reoriented or perceptibly changed in a short time, but the change that does evolve is due to reactions to the inadequacies of the present.
This horrible oversimplification of a problem, and taking it in a direction that will (by self-definition) not help America, may not be scary or dramatic enough to get the attention of the voting public, but it's good to know he understands that he's not a patriot, he doesn't understand the role of government, and he does not have the best interests of all Americans at heart. "The law allows what honor forbids."
What time period/s are you exactly referring to?
Peter, thanks for the thought provoking article!
quote quote.
Sad to say,, that is close to the truth. My only modification of your statement is that there are no absolutes in the real world. If only it were as easy as "unfettererd discretion" there is no such thing as pure "unfettered" discretion by anyone or any entity; and a most of the time it is the U.S. jobs that get the ax.
For sure, you put your finger on the pulse--small businesses in the U.S are the engine of growth in this country. As I mentioned I owned a successful landscaping company for 8 years in the early 90s, looking back in time--had I actually known about all the obstacles that I would have to deal with I am not sure I would have done it! So ignorance was bliss! The more money we made, the more high profile we were and guess what? The local taxation, BPOL, the state of VA, and the Feds all lined up for their cut; and I had to pay--sort like Uncle Vido disguised as Uncle Sam.
Keep up the good work Peter--someone's got to do it because I am totally jaded :)
but I respect him totally, I have read his books and he has more street credit and more bona fide's than I can count. When I really started paying attentin was during that interview with Erin Burnett when he blew his cork about the FEDS.. if you have a chance check out that scream fest on U Tube in 2007 before the big melt down.
I don't have to defend James Cramer.. he can speak for himself and does loudly.
I don't recall any democrat/progressive ever saying the being profitable is bad. I want my company to be profitable. What I have heard, and believe, is the problem occurs when the company is profitable at the expense of the workers, when maximizing profit becomes the end-all and that any and all steps to maximize profit are justified by that end. Eliminating or reducing salaries/benefits to maximize profit, shipping jobs overseas to maximize profit, or fighting against safety regulations to maximize profit are a bad thing. A local chain was bought out and promptly closed down, not because it was not making a profit, because it was, but because it wasn't making enough profit for the new owners. Result - hundreds of employees now without jobs. Its when greed takes over as the driving force of a company, that it becomes 'bad'.
Also, in case you missed it, I posted several weeks ago a blog entry in which I talked briefly about the potential for socially responsible U.S. companies to take the lead in our economic recovery. In case you're interested, that blog entry can be found at http://www.huffingtonpost.com/peter-smirniotopoulos/three-innovative-ideas-th_b_999955.html
I plan to make this subject of socially responsible corporations and their potential to help us out of our economic woes the subject of my next blog entry. Stay tuned.
Second, a company cannot set the wages of people, the market does. A person will be compensated for the scarcity of his/her skills. Let's take two extremes. A NFL player makes $$ millions because there are very few people who can do the job and there are a large number of people willing to watch it on TV, buy tickets to the games, etc.
On the other end of the spectrum you have the fast food worker. Nearly everyone can do that job and people are not willing to pay a huge amount of money for fast food, subsequently, they make little in wages.
I'm all for a company doing well and optimizing income and profits. The problem occurs when only a few benefit from the work of the whole. I recognize that if some CEO has the business sense to do well and should be compensated appropriately, but that has gotten out of hand. Going from 40x the average worker salary to over 200x (rough numbers), CEO compensation has exploded while middle class incomes have stagnated. Blaming 'the market' is just an easy excuse to keep doing what they are doing.
The local chain situation does raise an issue. Some corporation buys a chain of stores to make a profit, it doesn't pan out as hoped, they close the chain. That corporation has the perogative to do so, they bought the chain. But that demonstrates the problem of the greed and selfishness that predominates business today. Because the 'investors' didn't make as much as they wanted (note, this wasn't a loss, it just wasn't 'enough'), others suffered. Not only were those employees affected individually, this put 300 more on unemployment, reduced the buying power of those families which then affects the stores that they used to buy at and on and on. There is a domino effect.
I'm an employer, during this recession, it would've been easier to let go a couple employees to optimize overhead and profits, but that would've added to the bigger problem, even though only a bit, not to a solution.