Whose is Bigger?

My conservative pal R at work came into my office the other morning to tell me there's a new website that lists New York State employees and how much they make. It was "unsettling" he said, to find out that some DPW guys he knows make $70k-plus. "No wonder the state's going broke," he said.

But R's well-paid friends are not the problem. Slow growth is the problem.

Question: What does slow growth mean? It means slow growth in the private sector. That's the problem. That's what bothers people. Nobody thinks it is "growth" when it's the public sector that's expanding. "Growth" means growth in the private sector.

The problem is slow growth in the private sector. That means guys like my buddy R and me don't get the sort of pay raises we'd get in a better economy. We fall behind.

By contrast, public-sector workers are riding a wave that has slowed less. But that isn't excessive growth. It's normal. Less than normal. It only looks excessive because the private sector is so far behind. And I think we're starting to get jealous.

Private-sector workers are starting to blame public-sector workers for the widening gap. This is dangerous. Troubling, and personal, and dangerous. My buddy R seems to think a problem can be solved by cutting the pay of public-sector workers. But that only solves the jealousy problem. It doesn't solve the growth problem.

In simplest terms, the problem is a shrinking private sector. People see that private sector growth is lousy and public sector growth is less bad. They somehow conclude from this, that the public sector is growing too fast.

Lousy growth is the problem. But making sure that everybody has lousy growth is not a good solution.

The Factor-Cost of Money

I wrote to Milton Friedman back around 1980, calling the interest rate "the price of money." He wrote back -- he must have answered every letter he ever got -- to say that the interest rate is the price of credit. And he said the price of money is whatever you give up to get it.

I was fine with those corrections for 30 years. Recently, though, I had a thought.

To Friedman's two definitions, the price of credit and the price of money, one must add a third: the cost of money.

The total accumulated cost of interest paid in our economy is the factor cost of money. I'm not saying it's good or bad. I'm simply defining terms. Because if we don't define 'em, we cannot properly analyze the economic problem.

Following up...

...on the title of a Recent Post

Pretty much everyone is aware that the Great Depression was followed by World War II. After the war we had about 30 years of Keynesian economics and then 30 years of Reaganomics.

What I didn't know is that there were different names for different stages of that 60-year postwar stretch. Here are the names I've turned up:

• The Golden Age
• The Great Inflation
• The Great Moderation
• The Great Recession

I don't have much to say about these, except that the "golden age" was a brief 15± year period that perhaps should be called The Golden Moment.

What I think, though, is that the 4-point list, above, actually misses the main thrust of the past 60 years. Those 6 decades need not be broken down into four phases, nor even two, but only one long stretch with a name that captures the essential character of the period: The Great Indebtedness.

The Indebtedness

The great burden of debt in the world today -- in the U.S. and in nations that modeled their economic policy on ours -- is the result of U.S. economic policy.

A simple change is all that is needed to correct the policy: We must encourage the accelerated repayment of debt.

Unfortunately, we waited too long. We had the financial crisis, our Paulson moment, and then the economy started to fix the problem by itself. Everybody and his brother scramble to get out of debt.

One word comes to mind: disarray.

The new policy will help: Accelerated repayment of debt will help. It will ease cost burdens a bit, and it will create confidence that government is finally doing the right thing: Helping us do what everyone is already trying to do.

So we get the debt reduced a little faster this way, because of the coordination of effort. And the Second Great Depression lasts 8 years maybe, instead of ten.

Not good enough.

Almost everybody says the economy won't recover until we get the debt paid down a lot. And everybody is doing what they can. And the new policy will help. But we need to do better, faster. The longer we wait, the harder it is to recover.

As a temporary fix for the cyclical problem, I propose direct action. Let the Federal Reserve print another trillion dollars. Only don't let them use it to buy up bad debt from the banks. Instead, let them use it to pay off debt for people. Direct action.

A trillion dollars of debt goes away, painless and quick. The money goes into the banks, not into the spending stream where it may cause inflation. And, well, borrowing creates money, and paying off debt destroys money, so the trillion dollars vanishes.

Actually, a trillion dollars of credit-in-use becomes a trillion dollars of available credit again. Our savings, in the banks, ready to lend. Ready to create growth or inflation.

But with enough debt destroyed, new spending will create growth. The reduction of private-sector debt is the key to our next golden age.

The Great Indebtedness

It is often said that our great indebtedness is the result of excessive spending, public and private. Arthurian economics denies that. The source of our great indebtedness is bad policy -- a policy that limits the growth of money, encourages the use of credit, allows and rewards the accumulation of debt.

The purpose of policy is to change economic conditions. Existing policy has changed economic conditions by creating a monetary imbalance. The solution to our economic problem is to change the bad policy. The solution is to improve policy by rewarding the accelerated repayment of debt. Little else need be done.

Tax policy to encourage the accelerated repayment of debt would induce consumers and businesses to make a few extra payments on existing debt, rather than spending those dollars at the mall, say, or on new business software. It would draw money out of circulation; it would return money to the banks; it would retire debt.

Drawing money out of circulation, it would serve as an inflation-fighting policy. It would serve the purpose that Federal Reserve policy serves at present. The Fed, of course, can remove money from circulation. But it cannot reduce your debt. The new Arthurian policy would fight inflation by reducing your debt.

Accelerated repayment of debt strikes at the source of money-creation and solves the problem simply, by encouraging the completion of credit transactions. Note that the economy is moving in this direction on its own, anyway. This is a sign of what needs to be done and what is the right thing to do.

Accelerated repayment of debt would free up the Fed to increase the growth of money. New Arthurian policy would not only permit that, but would make it a clear necessity. Repayment of debt draws down demand -- as we well know from the experience of the past two years -- and is deflationary. To counteract these downward pressures the Fed would find itself required not only to increase the quantity of money, but also to make more credit available at lower rates.

But the Fed's response would not be inflationary. It would simply counteract the deflationary pressures from the accelerated repayment of debt.

The goal of policy must be to reduce the level of existing debt while encouraging new uses of credit. That is not a zero-sum change. By discouraging the accumulation of existing debt, Arthurian policy reduces the debt burden and fights inflation. By encouraging new uses of credit, the policy encourages demand and growth.

GASP!!

As the two previous posts show:

• Over the past 6 decades, corporate interest costs increased by more than 7% of corporate costs. Corporate employee compensation fell by almost as much.
• Corporate interest costs are now 60% as much as wage and salary costs.
• If corporate interest costs could be cut in half, enough money would be freed up to increase all corporate wages and salaries, and compensation of officers, by 30%

All we'd have to do is cut corporate interest costs in half. And the easy way to do that would be to cut the use of credit by half.

GASP!!

But we need credit for growth, you say.

Well, yeah we do. I agree absolutely. We need credit for growth. But we should not be using credit to maintain the existing level of economic activity. There should be money enough in circulation to support the existing economy. Credit is for growth.

But that is not how we do things today. And that is the problem.

For years and years, the Federal Reserve restricted the growth of money to fight inflation. But to encourage growth, Congress encouraged the use of credit if money wasn't available. Congress and the Fed together created a shortage of money and an excess of credit use. They created an imbalance in our monetary system.

Today we use credit even for normal day-to-day expenses, like buying food and gasoline, because of this monetary imbalance. Because of this monetary imbalance.

As things stand now, money is in short supply and we use credit for everything. But credit is also in short supply, because the source of credit -- money -- is restricted, and because we continue to rely excessively on credit.

Congress therefore finds it necessary to coerce source-fund availability by establishing savings systems with punishment for early withdrawal: Bizarre policy, on the face of it.

And because we rely excessively on credit, our economy is vulnerable to credit crunch and financial crisis.

And because we rely excessively on credit, we have a phenomenal, inexplicable, insurmountable, unbelievable, dangerous, troublesome debt.

And because we rely excessively on credit, there are excessive interest expenses all through the economy.

The shortage of available credit, the pro-credit policies of Congress, the vulnerability to credit crises, excessive debt, and the inflation associated with rising costs all stand as evidence of our excessive reliance on credit.

Our excessive interest expenses are "extra" in the sense that there is no need for them. Excessive interest costs are the result of relying too much on credit, and too little on interest-free money. They are are the result of monetary imbalance. And monetary imbalance is the result of bad policy.

The increase in corporate interest costs and the commensurate decline in corporate employee compensation are results of a very bad policy.

Components of Corporate Cost

The previous post looked at "wages and salaries" plus "compensation of officers." But I could find those numbers for only a few years. So the previous graph gives no feel for changes that have taken place over the years.

This graph rectifies that by using "employee compensation" numbers. Now we can see 60-year trends. But these numbers are substantially higher. (I suppose they include health benefits and such.) So we're not talking 12% anymore.

Here we see "employee compensation" fall from 24.56% in 1948 to 18.34% in 2007, a decline of more than 6 percentage points. Over the same period, corporate interest costs climb from less than 1% of deductions in 1948 to 8.6% in 2007. That's an increase of more than 7.5% percentage points, 7½% of corporate costs.

The post-war trends show that corporate interest costs increased and employee compensation fell. But what happened with corporate spending is only part of the problem of rising interest cost in business, in government, and in our personal lives.

This is only a ballpark number, but if we take corporate deductions for 2007 ($26.97 trillion) and reduce interest costs enough to boost employee compensation from 18.34% to 24.56% like it was in 1948, employee compensation increases from $4.9 trillion to $6.6 trillion. That's an increase of more than one-third, in your paycheck and mine.

And it doesn't increase corporate costs a penny.

Parsing the Question (Part 2)

Let no one any longer labor under the false assumption that wages and salaries make up anything like 65% of business expenses. The number is less than 12%.

This does not mean that a substantial increase in labor cost would have a negligible effect on prices. What it does mean is that, if we want an explanation of the costs that drive prices up, there's more to look at than just the cost of labor.

In 2006 (to bring numbers forward from my previous post) deductions for corporate expenses came to $25.5 trillion. Of that, labor amounted to less than $3 trillion, about 12% of cost. ("Labor" here includes salaries, wages, and compensation of officers.)

As long as our focus is only the cost of labor, there is a very big cost number that remains unexamined: 88% of 25.5 trillion, some $22 trillion plus.

Included in that 88% is the interest expense associated with corporate business activity. Interest expense, as you may know, is the focus and concern of Arthurian economics.

The 2006 numbers show that corporate interest expenses amounted to nearly $1.8 trillion. That's more than 60% of the total of wages, salaries, and compensation of officers combined. If we cut interest costs in half, everybody could get a 30% raise and it would not increase corporate costs by even a penny.

Parsing The Inflation Question

The opening words of The Inflation Question (PDF) caught my attention:

The single most important factor determining U.S. inflation is employee compensation. Compensation accounts for about 65% of national income—a rise in compensation increases disposable income thus stoking demand in the economy. However, and more importantly from an inflation perspective, higher compensation boosts labor costs, forcing firms to raise their prices to maintain profit margins.

There are at least two reasons I like that statement:

1. I like their choice of words here: Compensation accounts for about 65% of national income. They refer to a percentage of national income, not a percentage of national economic activity. National Income is a technical term, well-defined and specific. National Economic Activity, apart from my own definition of it as "spending," is non-technical and to my knowledge undefined and uncounted.

2. I like their explanation of inflation. They consider both sides of the supply and demand equation: Rising compensation boosts demand, they say, but "more importantly from an inflation perspective, higher compensation boosts labor costs, forcing firms to raise their prices to maintain profit margins." They consider both demand-pull and cost-push inflation, and they say the cost-push forces are more significant.

I like that because, in my view also, our inflation has been cost-push for some time. Idunno, maybe J.P.Morgan and the report's author, Dr. David Kelly, are supply-siders concerned only about business conditions and not at all about customers' conditions. I see no evidence of that, but I don't care if they are. They agree with me that inflation is a cost-push problem. Good work, guys.

There are also two reasons I don't care for that opening statement:

1. It sounds like there is absolutely nothing that can be done to improve the standard of living: Any increase in payroll will cause a price increase. Of course, we know better. For if living standards can fall -- and we know that can happen -- then they can change; and if they can change, they they can rise. But you don't get that from the excerpt.

2. It is deceptive to say "Compensation accounts for about 65% of national income," and follow that with "higher compensation boosts labor costs." They make it sound like employee compensation is 65% of business cost. That's not even close.

They describe compensation as part of income. And clearly it is; but income is not the same as cost.

(After a long delay...) Here we go. The most recent corporate tax data I could find is from 2006. I found the link at Paul Caron's TaxProf Blog. (NOTE: Clicking on his "2006 Corporate Tax Returns" link starts the download of a 6½ meg PDF. Clicking on the graphic at right gives you the relevant bit of it.) On page 83 of that PDF, the two left-most columns give a nice breakdown of corporate numbers for 2006.

Halfway down that page we find total [corporate] receipts. A few lines down from that we find total deductions. Total deductions -- basically, everything bookkeepers had receipts for, and corporations paid no tax on -- added up to $25.5 trillion for 2006.

In the breakdown of costs under "total deductions" we see that compensation of officers cost more than $473 billion, or about $0.473 trillion. Salaries and wages came to $2.457 trillion. Added together, salaries, wages, and compensation of officers amounted to a bit under $3 trillion.

So, all the spending corporations did that year, or all they could legally deduct anyway, came to $25.5 trillion. All the money paid to employees came to a little under $3 trillion, or less than 12% of total costs. Not 65%. Twelve percent.

So basically, if everybody in the company got a 100% raise, that would increase costs by 12%.

But that's not a realistic raise.

Say you work for an "average" corporation where employee compensation amounts to 12% of expenses. Here: You work for SmallCorp, with total deductions of $100. Labor costs: $12. Now everybody gets a 10% raise. What happens to the numbers?

Labor costs go up $1.20, to a total of $13.20. Total costs also increase by $1.20, to $101.20. So a 10-percent pay increase translates to only a 1.2% cost increase for SmallCorp.

Of course, SmallCorp has to pass along that 1.2% increase to its customers, plus a little something for itself. So those customers see a cost increase in addition to any across-the-board pay hike of their own. And the customers' customers see somewhat greater cost increases. By the time every working stiff in the country gets that 10% raise, and those costs have worked their way through the system, we'd see a substantial jump in prices, no doubt.

My point nevertheless remains valid: Employee compensation is far less than 65% of business costs.