15 March 2013

The Gap Between Wall Street and Main Street - real, rational, and reason for policy

Pundits like to pundificate about the odd disconnect between Main Street and Wall Street. They're aghast that the stock market could rise while the "real" economy as represented by job growth and unemployment is still doing so poorly. There is nothing irrational about this.

A stock goes up with the value of future earnings. At least three things make that rise: lower interest rates, higher sales, and lower costs.

A bad economy will lead the Federal Reserve to lower interest rates, so on that count a bad economy actually does drive up the stock market. While a bad economy drives down sales, it is worth remembering that many of the big companies sell more of their product abroad than domestically. So, even a bad national economy may have limited impact on overall sales.

Finally, and most importantly, a company's senior management is committed to profits. They are not committed to any particular product line or market or work force. They want to make a profit. If they have to layoff people to sustain profits, they will. If they have to outsource to sustain or raise profits, they will. If they have to shift their marketing to foreign countries, they will.If they have to create new products or discontinue old ones, they will.  Profits can rise in good times or bad and there is nothing irrational about that.  And it is good. It is wonderful that companies focus on creating profits: profits are the measure of the gap between the value of things we use as inputs (from raw materials to labor and capital) and the value of what we produce as outputs (the products and services the community is happy to buy).

It is easy to dismiss this as evil but it's worth remembering that an entrepreneur who starts a business and doubles his profits to $200,000 from the previous year has no obligation to anyone to hire another $50,000 a year employee (who will cost him roughly all his $100,000 gain in profits). It is not the business of businesses to create jobs. That is a side effect of creating value (valuable products and services for customers and equity value for owners).

Which is why it is silly to think that businesses will create jobs and lift an economy out of a recession. This is just one reason that Keynes was right about the need for government intervention. It is not just in bad times that governments need to spend to stimulate the economy. Only governments - as representatives of the community - can be depended on to make the investments necessary to make employees more valuable. Businesses are simply - and rightfully - focused on making their stock and their products more valuable. Communities and the individuals in them have to focus on making their people more valuable and productive.

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