Public Enemy Number One
If you are confused, bored, or frustrated by the debate over the President's economic proposals, join the club. It's a big one already, and growing fast. Taxes, expenditures, deficits, interest rates, inflation, recession -- all the remedies offered so far to get the economy moving again -- seem to involve too many painful trade-offs.
The basic thrust of the Reagan program makes sense to most businesspeople.Keep the tightest lid possible on government expenditures.Concentrate on building up the private sector. Make control of inflation a major policy objective. We argue with none of these worthwhile goals. The President may even luck out before his term is up and look better than he does now. But the odds have turned against him.
A recession came sooner and hit harder than he and his advisers expected. What appeared to be moderate goals -- beefing up the nation's defense while moving toward a balanced budget -- have proved ever more elusive, as the size of the growing deficit shows. Today, with short-term recession and unresolved inflation, solutions to our economic woes are harder to find than they were when the President took office.
Maybe we're looking for those solutions in the wrong places. I maintain that most of our economic problems would take care of themselves, if we only took care of unemployment. It's as simple as that.To get the economy moving, we need to get people working. And in order to get people working, we have to help smaller businesses -- the nation's most effective job makers.
Involuntary unemployment is not only demeaning and demoralizing, it's the straw that can break the back of a weak economy, turning a recession into a depression. Every percentage point jump in unemployment adds $25 billion to the federal deficit, as the government pays out additional benefits. And unemployed workers don't pay taxes. The resulting increase in federal expenses and decrease in revenues means more government borrowing. Interest rates go up. And so it goes in a vicious cycle.
In the 1980s, we need to add 15 million jobs, in addition to the ones we've lost in the present recession, in order to reach full employment. Since we added 19 million jobs in the 1970s, this is not an impossible task.
But creating jobs in the '80s will be mere complex than it was in the last decade. We need to do it without further inflation and without making government bigger. We must do it in the face of growing competition from abroad in our home markets. We must do it while retraining workers in new high-technology skills.
We cannot rely on the big firms to create jobs the way we used to. The capital-intensive industries are now laying people off. We hope they're preparing to rebuild and retool in order to become more competitive. But even if the Reagan policies help them, their recovery will take more time than we can afford. The smaller, labor-intensive firms can hire more rapidly, even during recession.
David Birch, a researcher at MIT, has shown that between 1969 and 1976 alone, two-thirds of our new jobs were created by firms with 20 or fewer employees; about 80% were created by firms with 100 or fewer employees. "Smaller businesses more than offset their higher failure rates with their capacity to start up and expand dramatically," he says in the Fall, 1981, issue of The Public Interest.
"Larger businesses, in contrast, appear rather stagnant," Birch adds. "They may be expanding output with more capital equipment (although those who study productivity suggest that this has not been the case recently) or they may expand by opening operations abroad. Whatever they are doing, however, large firms are no longer the major providers of new jobs for Americans."
Unemployment is the rogue elephant in both the fiscal and monetary gardens. Secretary Regan and chairman Volcker ought to concentrate on it, rather than on one another's shortcomings. If unemployment is the problem, new small business formation and existing small business growth are the solutions. But the government is failing to help small businesses become stronger so they can create more jobs.
Almost a year ago, we urged the Administration and Congress to include in the 1981 Economic Recovery Tax Act provisions to stimulate small business start-up and growth. Half the tax-cut benefits, we argued, should go to business; half of those should be directed toward small companies.
We still do not know how much of the estimated $750 billion in tax-cut benefits will go to large companies and how much to smaller ones. If anyone in the federal government actually knows the figures, it's time to make them public. We suspect the tilt toward the larger companies is so great that the government is afraid to disclose it.
The Los Angeles confirmed this view in a December 27, 1981, article entitled "Reagan's First Yer: Winners and Losers." Some 80% of the benefits from the new capital cost recovery provision of the act, it estimated, will go to just 2,000 companies over the next five years. Those are the same companies that now receive at least that big a share of the investment tax credit. Those are also the companies that will get $30 billion in benefits by 1986 from the sale and leaseback provision of the act.
Certainly the 1981 act included a number of useful provisions that should be left alone. What it did not do was encourage enough small-scale risk taking and, therefore, job making. And this neglect is precisely what will hurt us in the year or two ahead.
We can surely cut back on the benefits flowing to the larger firms by 10% or 20% -- or whatever amount is necessary -- in order to direct half the tax benefits to smaller firms. In past issues, we've discussed in detail the kinds of incentives that could prove useful in stimulating small business growth. There's no reason, for example, why the present administration can't cut the benefits to larger firms in order to finance a job tax credit for labor-intensive firms.
The federal government should also follow California's lead in further lowering the capital gains rates on payoffs from long-term investment in new and smaller companies. (See INC., November 1981, page 14.) We can pay for the resultant tiny revenue loss by taxing megamergers and by denying deductibility for interest and expenses on these giant deals.
We can give new, independent firms three to five years' tax exemption to encourage their growth. It would be simple to provide safeguards against abuse. Any small revenue loss could be made up easily by dropping or modifying the sale and leaseback provision of the 1981 act.
If small business is to lead us to recovery, we need to get -- and keep -- interest rates down. That means slashing the deficit. To do so, we must hang tough on budget cuts and postpone the bulk of any defense buildup for at least one, and probably two, years.
As far as monetary policy goes, the Federal Reserve Board simply has to learn to do a better job of managing the money supply. Its efforts to control inflation by manipulating supply are not effective in limiting access to credit by larger companies and by the government. But they work only too well in shutting down the flow of credit and raising rates unconscionably high for smaller firms. It is time for the Fed to recognize that we now have a de facto allocation of credit. A tight money supply means only that marginal creditors or one unsupported by institutional bargaining power are shut out. If the Fed can't find a fairer way to manage supply, it will have to institute a more general easing of credit.
At bottom we need a change in attitude and perspective by economists and politicians. "Economics as if People Mattered," was the subtitle of E. F. Schumacher's book, Small Is Beautiful. What we lack in our national outlook is a balance between so-called "asset management" and "economics as if people mattered."
We can't rest content, as the Administration seems to be doing, with trying to shrink the government while favoring larger firms. We need to help that part of the private sector -- the small business part -- that's best able to take up the employment slack.
We will come out of this economic morass sooner or later, no doubt. But the test of good leadership will lie in how we come out of it. We need to create policies that will bring us to economic health in the fastest way possible, with the least damage to the people.
It won't take all that much to get those elements most essential to new and small company growth moving again. Risk-taking investors, entrepreneurs, owners, and managers -- they'll go into action as soon as they see daylight.
Targeting some tax cuts better, limiting or withdrawing others, and getting the deficit down should do it.