Small Matters: Without demand, no reason to hire

Posted: September 26, 2011

Every small-business owner knows that you can't survive if you pay workers more than the value they bring to the business. Owners who overpay are no longer with us or on their way out.

Labor costs typically amount to about 80 percent of a business' expenses, although this varies significantly depending on the industry in which the firm operates. Some businesses are "labor intensive," requiring a lot of employees to deliver the product or service. Others are less labor intensive.

The main reason for our current high level of unemployment is that, due to weak consumer demand, business owners have no reason to rehire the workers that lost their jobs in the recession. This is especially true in the housing sector, where new starts of single- and multifamily housing units plunged from an annual rate of 2.2 million units at the start of 2007 to less than 600,000 today - a result of building millions of housing units in the boom, but more than the population needed. There is nobody to live in them.

Job creation will require an increase in private spending. Firms will hire when they have more customers. So a business owner considering hiring, say, a $30,000 worker must peer into the future and decide whether the new employee will generate enough additional sales to at least cover the cost of hiring him. If the prospects are not good, the hire will not occur.

The government thinks it can stimulate hiring by providing tax breaks. One proposal is to provide a $4,000 hiring credit. Now, that does reduce the "hurdle" from $30,000 to $26,000, so a few more hires might be profitable - except that after one year, the tax break goes away, and the firm must cover the full $30,000.

A reduction in the employer's contribution to Social Security is also suggested, dropping it from 6 percent to 3 percent, roughly. So, with a $300,000 payroll (10 workers at $30,000 each), the owner will realize a tax benefit of 3 percent, or $9,000.

Here is the problem, though: It has nothing to do with the value an 11th $30,000 worker might bring to the firm, and thus does not change the hiring decision. The prospective worker is still a bad investment.

The owner will find some other alternative use of the funds that promises a positive return, or the owner will hold the cash as protection from an uncertain economy.

The government also proposes more "infrastructure" spending to create jobs. However, these roads-and-bridges projects require lots of heavy equipment and skilled workers and won't be available to small construction firms - like home builders whose employees are now out of work.

Government contracts are usually restricted to unionized firms (only 7 percent of the private workforce is unionized, compared with 35 percent of public-sector workers). More grants to states to keep government employees on the payroll will not create any jobs. It will prevent some job loss, since state and local governments have, on balance, been reducing employment this year.

The key to job creation is consumer spending, accounting for more than 70 percent of the gross domestic product (GDP) and most of private spending. Governments account for about 25 percent of GDP spending.

Most people are tolerating the recession and could spend more if they had confidence that the economy would improve. But if they fear the future, they will spend less and save more, slowing economic growth and job creation.

The best "stimulus" is to restore confidence and inspire consumer spending. This spending would be spread all through the economy - not just targeted here and there, like government-directed programs. Our "management team" in Washington needs to figure this out.


Bill Dunkelberg is a professor

of economics at Temple University and a nationally recognized expert on small business. Contact him

at dunk@temple.edu.

 

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