Kamala and the Cost Tradeoff

If I read my notes correctly, Symone at MSNBC's The Weekend (1 Sept 2024, 9:30 AM±) said Kamala wants higher-paying jobs for more Americans.

Sounds good to me. We've been underpaid for decades. But K must consider and confront Republican criticism of her call for higher pay. The R will say INFLATION. You know they will. They will tie Harris to Biden. They will tie her to the so-called "Biden inflation". Trump is doing that already. The R will make harsh criticism. K will need a powerful rebuttal. 

The R view will be something like this: Labor cost is a big part of the cost of output. So an increase in wages can be expected to lead directly to an increase in the price of output. 

It's like a reflex. But there is more. In addition to labor costs, a business has "non-labor" costs. The non-labor costs consist largely of purchases from other businesses. Embedded in those costs is the cost of labor at those other businesses. Thus, business costs consist to a large extent of the sum of direct and indirect (embedded) labor costs. So the R have a very strong argument when they say K's focus on better wages will cause inflation. 

All else aside, wage increases that drive prices up are self-defeating.

Kamala needs an economic plan that can prevent the drubbing the R are more than willing to give. K also needs a way to raise wages without creating inflation. Here is my plan: To create higher-paying jobs, Kamala should take advantage of a cost tradeoff: The increasing cost of labor should be offset by reducing the cost of finance. 

Between 1949 and 1981, there was a cost tradeoff we have not yet recovered from. Corporate interest costs increased by about 6½ percent of corporate spending. During those same years, corporate compensation of employees decreased by almost 7 percent of corporate spending. This cost tradeoff was good for corporations, but not for their employees.

Employee Compensation and Interest Cost relative to Corporate Deductions

There was plenty of inflation in the 1948-1981 period, inflation that drove corporate spending up. So those numbers, the 6½ percent interest-cost increase and the 7 percent wage-cost decline, are much bigger (in dollars) than the numbers suggest.

To boost wages without causing inflation, K can engineer a cost tradeoff where increased labor costs are offset by slower growth of finance, slower growth of debt, and slower growth of interest cost. Kamala can offset the rising cost of wages by reducing the scope and cost of finance.  

The amount of interest paid, barring complications, depends on the interest rate and the size of the debt on which interest is paid. Interest paid rises and falls with the rate of interest and the quantity of debt.

Corporate interest cost, the red line on the graph, rises along with interest rates and the quantity of debt from 1948 to 1981. Since 1981, however, interest rates have been generally falling while the quantity of debt has been generally rising. So the red line tends to run flat, with lows only at extreme lows in the interest rate: 5 years in the early 1990s, 5 years in the early 2000s, and most of the time since 2008.

My plan is, and Kamala's plan must be, to rejigger economic policy in every nook and cranny so as to turn incentives-to-be-in-debt into incentives-to-pay-down-debt. The tax deduction for interest paid, for example, is good for those who are in debt. So, that tax deduction makes debt higher than it would otherwise be. We must change that tax deduction. We must replace it with a tax deduction (or a tax credit) for making extra payments against loan principal. This will help people and businesses pay down debt. It will make debt lower than it would otherwise be.

The objective is to bring debt down for people and for businesses.

By relying less on credit and more on income, businesses will reduce their financial costs. They will be able to use the freed-up funds to increase wages without increasing overall business costs, without squeezing profit, and without the need to raise prices. The change in policy will make the red line on the graph come down, so corporations have more money available to spend on wage increases, and more money left over to boost their profit.

Consumers will see living standards improve as businesses increase wages without increasing prices. In addition, the new policy of increasing reliance on income (and reducing reliance on credit) will lead to less borrowing, less debt, and smaller debt service payments for consumers. With finance taking a smaller bite out of our disposable income, more income will be available to spend and to save -- and this is in addition to our higher income arising from the business interest-cost savings.

As we come to rely less on credit and more on income, the quantity of money will have to rise. But as long as money grows at a replacement rate (as credit-use falls), inflation should be comparable to what it was for many years before the so-called Biden inflation: generally acceptable. And because income comes to us without the cost of interest, inflation should be lower than what we had for those many years before the Biden inflation. Or economic growth higher. Or both.

Kamala's new policy will augment labor share, increase aggregate demand, and boost economic growth. It will also help reduce private-sector debt, which is the necessary precondition for reducing the federal debt.

Go Kamala!

The employee compensation data comes from BEA Table 1.13 row 4:
    Domestic Business: Corporate Business: Compensation of employees

The data on interest paid comes from BEA Table 7.11 row 3:
    Monetary interest paid: Domestic Business: Corporate business

The data for total deductions of active corporations comes from several sources.
Recent data from three sources:

• Tax Policy Center: Corporate Tax Items, 1998 to 2020
• Tax Policy Center: Corporate Tax Returns, 1990 to 2013
• IRS: Statistics of Income, SOI Tax Stats - Table 5 - Returns of active corporations

Older data from multiple sources:

• Historical Statistics (Bicentennial Edition), Series V 132, 1948-1970 
• Statistical Abstract, various editions: SA1976-06 Table 844, SA1980-06 Table 948, SA1984-05 Table 907, SA1988-05 Table 846, SA1992-05 Table 834, SA1996-17 Table 835

The most recent data on corporate deductions at IRS (as of 5 Sept 2024) is for 2020.

My Excel Spreadsheet: Corporate Cost Components (7 Sept 2024).xls at Google Drive

Compound loss upon compound loss

You've heard of compound interest: You get interest on your money, plus you get interest on the interest. Gosh! Debtors are remarkably generous to creditors. What a lovely world this must be.

My topic here is compound loss: It works like compound interest, but in the other direction: Less instead of more, and less on top of less. It isn't about the money we get. It's about the money we don't get.

You've heard of "Potential GDP". Brookings defines it as

an estimate of the value of the output that the economy would have produced if labor and capital had been employed at their maximum sustainable rates—that is, rates that are consistent with steady growth and stable inflation.

Note, however, that "maximum sustainable" employment does not mean we all have to work 80 hours a week. I have seen people say "economic equilibrium" occurs when no one wants to change the existing conditions. No one wants more profit, for example, and no one wants to work less hours. That concept probably applies to Potential GDP.

Whatever. I just call it "best-case GDP". Here is the graph:

Graph #1: Potential GDP

It goes up. The graph shows a pretty smooth upward curve, except it goes up faster than usual in the latter 1990s.

Here's the same data, shown as "Percent Change from Year Ago" values:

Graph #2: High on the Left, Low on the Right: Potential GDP Growth is Slowing!

To my eye, two things stand out on this graph. One is that conehead-looking high spot in the latter 1990s. That's how the good years of the latter 1990s look, when you look at Potential GDP growth.

The other thing that stands out on this graph is the strong downhill trend. Except during the latter 1990s, it is all downhill from start to finish: From above 5 percent annual growth in the early 1950s, to above 4 percent in the 1960s, to 2 percent or less in recent (and future) years. Best-case GDP is not as good as it was 50, 60, 70 years ago.

You might think economists would spend their lives studying the latter 1990s to learn everything they could learn about those years, so as to duplicate that high-performance era and, well, avoid that wide gray recession bar and the lower-than-usual low that came a decade after the conehead high. That's pretty much what I do. Study the economy. Not economics, but the economy. This, my hobby. This, my life.

 

Here is a graph of Real GDP as a percent of Potential GDP:

Graph #3: It goes up and down, but the overall trend is down.
In other words, GDP is growing even more slowly than Potential GDP.

Real GDP is sometimes higher, sometimes lower than Potential. But the overall trend is down: As time goes by, Real GDP comes out to be less and less of Potential GDP. The growth of Potential, today, is half what it was in the 1960s, and Real GDP cannot even keep up with that. This is compound loss.

A linear trend line on this data in Excel shows Real GDP growth close to 1 percent faster than Potential GDP growth in the early years. In recent years, Real GDP growth is almost 2 percent slower than Potential. This relatively small loss means Real GDP growth has slowed 2.58 percent more than Potential GDP growth, which has fallen by 50 percent since the 1960s.

GDP is a measure of income. The slowing growth of Potential GDP is the slowing growth of best-case income. Best-case income growth today is half what it was in the 1960s. Real GDP growth cannot even keep up with that. And Real GDP growth is Real Income growth. 

As time goes by, we get less and less of the income we would have in a "best-case" world. The income growth in our less-than-perfect world decreases even faster than the income growth of our best-case world. This is compound loss.

And speaking of income, the next graph shows Compensation of Employees as a percent of GDP. Remember, Potential GDP growth is slowing, and GDP growth is slowing even faster. But on this graph, employee compensation has fallen rapidly as a share of GDP, for more than half a century:

Graph #4: Employee Compensation: Wages, Salaries, and Benefits as a Percent of GDP

From a high of 58 percent of GDP in 1970, it is all downhill to less than 52 percent today. Well there is the one big increase there, in the latter 1990s. But it did come back down right quick. 

We're getting paid 6 percent less of GDP now than we got in 1970. And GDP doesn't keep up with Potential GDP. And Potential GDP is growing at half the rate it was growing in the 1960s. We are dealing here with compound loss upon compound loss.