Inexpensive Capital Contributes to Unemployment

In the current U.S. economic and political environment, capital is relatively free. It has almost zero cost, provided one can acquire any.  The interest rate is near zero, implying there is plenty of fungible money.  The federal government has adopted a set of policies to ensure capital has an even lower cost, through tax credits, favorable tax treatment of capital gains compared to ordinary gains, and immediate expense deductions of limited amounts of capital for tax purposes.  In fact, there is a much-used section of the tax code (1031) allowing "tax payers" to not pay taxes on the sale of capital items, provided they accepted like-kind property in exchange for their property instead of cash within 18 months.  (Example: Person X trades Person Y 100 acres of suburban sprawl for 10,000 acres of tillable land.)  Yet, people are concerned about the rate of employment growth.  Why the conundrum?

In the olden days of post-WWII economic growth, job creation was supported by lowering the cost of capital.  Capital was in short supply and therefore expensive.  The complementary inputs of capital and labor were needed to provide economic growth.  The Kennedy administration introduced the Investment Tax Credit in the early 1960s to further lower the cost of capital, to encourage investment that would employ the growing population. 

In the current economic environment, however, capital and labor are more often substitutes for each other, not complements.  So, when economic policy encourages capital instead of labor, one would naturally expect companies to invest in capital to replace labor.   Capital is cheaper than labor in the U.S. And capital is frequently more productive.  Economic theory is clear that the appropriate amounts of capital and labor to use are determined by equating the inverse price ratio of the two inputs (Pcapital and Plabor) to the ratio of the marginal productivity (MP) of each input. Thus, the amount of each input to use is where Pcapital/Plabor = MPlabor/MPcapital. When the price of capital is zero, one expects the amount of labor utilized to be minimized.

In other countries labor is cheaper than capital.  Consider the BRIC(S) countries.  I have seen small squadrons of people carrying 25kg and 50kg bags around warehouses, up stairs to blending mixers, and other places.  These people would have been replaced by conveyors, elevators, sensors and other equipment in the U.S.  But capital is too expensive in many areas to consider substituting it for labor.

I am not suggesting a U.S. policy change to support jobs for people to carry 50kg bags.  In fact, I do not know why we consider “economic impact” of events to include the bed sheet changing and dishwashing jobs that we import people to perform and subsequently complain about them “taking jobs.”  Job quality and job quantity are not synonyms.

Rather, I am suggesting that we stop emphasizing one economic input over another and let the markets equilibrate as they may.  We have encouraged capital so much that we have an oversupply and an underutilization of both capital and labor.  And we are still paying for encouraging people to have used capital unwisely.

Erecting barriers to entry, including raising the minimum efficient size or scale to compete through lack of enforcement of antitrust law, has fundamentally contributed to capital and labor being substitutes at low and moderate amounts.  It takes a large investment for capital and labor to be complements in the way envisioned by current, conflicting policy.

Mike M.