Depending on how you handle it, the multiplier effect may be an optical illusion or it may be turned into something that will do wonderful things for your business and for the entire economy. In fact, what you have in the science they call economics is the undeniable fact that the economy of a nation is made of all the transactions that take place within its jurisdiction. Consequently, every transaction you conduct will stimulate the economy to a degree that is proportional to its weight. This means the larger the transaction, the larger the stimulation.
Now, given that injecting money into the economy by the government is a transaction that is as big as the stimulus package, such injection is supposed to stimulate the economy to a degree commensurate with the size of the package. But the question remains: By exactly how much will a known amount of money stimulate the economy?
People have studied various attempts to stimulate the economy in history and have come up with basically two different conclusions. But when you look closely at the studies, you find that even though they seem to differ on the surface, the two conclusions say almost the same thing except that because they take different approaches, one conclusion speaks the language of job creation while the other speaks the language of growth in the GDP.
Let us take the argument of the two approaches and apply them to the current debate regarding the package to stimulate the US economy passed by Congress not long ago. The American economy now produces about 14 trillion dollars worth of goods and services made by a work force that numbers 140 million people. Divide one by the other and you come up with the figure of 100,000 dollars as the average contribution to the GDP made by every working person in America.
One group of economists says that you can reverse the process and create one job with every 100,000 dollars you inject into the economy. But the other group says that you will need 300,000 dollars to create one job because the rule of thumb is that it takes on average a capital outlay equal to 3 times the annual salary of a worker to create a job for him or her.
Thus, according to one version, the 787 billion dollars of the stimulus package will create 2.6 million jobs during the two years of its life. But according to the other version, it will create 7.8 million jobs during the two years of its life, meaning an average of 3.9 million jobs per year. So then, which prediction will turn out to be correct? Alas, the simple answer is that we’ll never figure that out even after the fact.
To understand this part, we conduct the following mental experiment. You are a baker, you worked hard for many years and you saved 60,000 dollars. You are still young so you decide to start your own bakery. You do a little bit of research and learn that in a town a few hundred miles away, the people there consume more cakes than anywhere else in the country. So you go and set up shop in that town.
Your working capital is 60,000 dollars but at the end of the year your accountant says you made sales in the amount of 600,000 dollars and had an operational cash flow of 50,000 dollars. What this means is that you wrote cheques in the amount of 550,000 dollars throughout the year even though your working capital was only 60,000 dollars. And you were able to do all this, hire people to help you and stay in business because you sold cakes throughout the year, and the cash kept flowing into your bank account.
In essence then, you turned your working capital 10 times over during that one year period. And it is this multiplier effect that is so real and so measurable that you could hire 2 people and pay them good salaries to help you produce the cakes at the bakery. Take note of the fact that the 3 of you were paid about 200,000 dollars in salaries which amount to one third of the total sales, and more than three times the working capital.
In a similar fashion, the economy of a country has several levels of money supply, one of which closely resembles the working capital of a company. It is called the M1 money supply, and in a healthy economy where the inflation rate is low and the employment level is close to full, the GDP reaches about 10 times the value of the M1 money supply. This 10 fold turnover of M1 is called the velocity of money for that economy.
And when you inject a stimulus into the economy, you add to the M1 supply which, under normal circumstances, should multiply by 10 as it translates into GDP. This should therefore settle the argument concerning the stimulus package; it says the 787 billion dollars will generate 7.8 million jobs during the 2 years of its life or 3.9 million jobs for each year. Unfortunately it does not mean that because life is more complicated than this. To see why we go back to the earlier story.
When you were a baker and you moved to that town you did not determine the reason why the people consumed more cakes than anywhere else in the country. But now that 7 years have passed and the volume of sales has fallen off, you started to worry. You asked the profound questions and did the extensive research. What you learned was that more than 7 years ago the town was nothing but a small village. For some reason, a huge number of foreign boat people were settled there and as they sponsored more of their relatives, the village grew into a big town.
The newcomers and their children developed a sweet tooth and they went crazy over American cakes. They ate the things like there was no tomorrow but now that the older folks have developed diabetes and the younger ones have discovered other American junk foods, your business has ceased to do well with them. In the meantime, a younger guy who is manufacturing skateboard has moved into town and is doing good business, especially with the new generation of hyphenated Americans.
Even though your working capital has remained steady when measured in stable dollars, you cannot turn it over 10 times and generate the cash flow that you used to generate unless you drop your prices so low that you are left with little or no profit. You see Mister Baker, the multiplier effect is now an illusion that exists only on paper. And where you used to employ two workers, you went down to one worker and then there was only you working at the bakery. And you may soon have to close down the place and go somewhere else.
What this says is that the performance of an economy, like that of a business, cannot be understood by looking only at the amount of money thrown at it. The culture and the mood of the people has a lot to do with the possible outcome. Thus, in times of national crises such as a war when the mood of the people is that of defiance directed against a foreign enemy, the performance of the economy would be different from when the mood of the people is one of disgust directed against their own political class. And a comparison between the two situations is so irrelevant, it is a waste of time and it looks like an exercise in futility. And yet some economists rely simply on such data to do their analyses and draw their conclusions.
Anyway, now that the stimulus package has passed in the United States, what happens to the economy will depend on what happens on the cultural fronts of American life. Because of this, even in hindsight, no one will ever be able to determine how many jobs were created by the money alone and how many were created as a result of the velocity of the money being accelerated by what happens on the cultural fronts.
What is clear, however, is that for the stimulus package to work, a positive approach to life is needed. It is an approach that will nudge the nation into an era of realistic optimism. The people do not need one big project such as the moon landing or the Manhattan project to rally around; all they want during these sober moments is the absolute certainty that there is not a Madoff under every desk ready and willing to swallow the fruit of their labor and send it to friends and family at home and abroad.
Yes, the people want to hear their President clearly say: America first and no more sacrifices because someone wants us to like this one or to hate that one. We paid a heavy price playing this stupid game, we are tired of it and we shall be stupid no more. When we stop hating other people, they will start to respect us and that’s all we need because everything else is a cakewalk for a nation like ours.
When this is done, the stimulus package will prove to be more than adequate to generate the jobs that will be necessary to take the American economy to its full potential.