Thursday, February 7, 2013

Capillary Action in micro-economics

Trickle Down Economic Stimulation can be declared dead. The “Capillary Action” on value creation and financial gain that occurs in every business eliminates any chance for economic stimulation in Trickle Down theories.

Trickle Down Economic Stimulation suggests that if tax breaks are given to established business owners, then their investments in the communities and business and in increasing payrolls will allow the value of those tax breaks to trickle down to the citizens who are at lower income levels of the economy, of the community and of the state. The problem is that established businesses are successful in drawing all that value back up into the owners’ controls (discretion, management). The citizens at lower income levels do not see appreciable increases in their well-being. My illustration begins with a stalk of celery.

You might recall Capillary Action from a second-grader’s science project. A cut stalk of celery is placed in a dish of colored water. Over time the color of the water and the water itself flows up hill into the celery and its leaves. (Yes, water is flowing up hill!!) This process is nicely explained at the webpage.

“Capillary action is important for moving water (and all of the things that are dissolved in it) around. It is defined as the movement of water within the spaces of a porous material due to the forces of adhesion, cohesion, and surface tension.

“Capillary action occurs because water is sticky, thanks to the forces of cohesion (water molecules like to stay close together) and adhesion (water molecules are attracted and stick to other substances). Adhesion of water to the walls of a vessel will cause an upward force on the liquid at the edges and result in a meniscus, which turns upward. The surface tension acts to hold the surface intact. Capillary action occurs when the adhesion to the walls is stronger than the cohesive forces between the liquid molecules. The height to which capillary action will take water in a uniform circular tube . . . is limited by surface tension and, of course, gravity.

“Plants and trees couldn't thrive without capillary action. Plants put down roots into the soil, which are capable of carrying water from the soil up into the plant. Water, which contains dissolved nutrients, gets inside the roots and starts climbing up the plant tissue. As water molecule #1 starts climbing, it pulls along water molecule #2, which, of course, is dragging water molecule #3, and so on.”

All businesses in our market economy do a similar thing with value creation (as the water) and financial gain (the color of money).

For instance, a fast food franchise owner invests in real estate, in a license from the national franchise chain, in the supplies, equipment and food, along with other tangibles. The owner builds a business (analogously a stalk of celery). Employees are then hired to take all these tangibles (inputs and capital) and to create value for the business. Labor creates value -- this is a widely understood principle of economics. So the minimum wage front-counter staff conduct the business with the customers, and while these individuals are paid (let’s say) nine dollars per hour they might on average be creating for the business 15 dollars of value per hour.

If any employee is not creating more value than what is received in wages or salary, then that employee needs to be eliminated, fired. No business can survive if employees are creating less value for the business than their paychecks.

So in our example, the lowest paid employees could be creating six dollars per hour in value above the hourly wages they are paid. If not into their paychecks, where does that $6 in value go? Part of this excess value pays for the inputs and capital that allowed the employee to create any value at all. Beyond this, for a business to succeed some value must also translate into reserves for the health of the business (possibly future maintenance of equipment and business expansion), and some of the value must translate into profits. In a sense then the excess value is “flowing up hill” to the owner who decides how to manage any marginal profit.

Imagine now that a second tier of employees who are paid a little better should be creating larger flows of value for the business. Imagine a tier of low-level managers paid even better and producing even greater flows of value for the business. Plus a higher tier of managers could be producing greater and greater flows of value. And the business owner may be then profiting from all of this value creation. Then again, as a franchise, the owner will need to share profits “up hill” with the national chain. So by this example, we see that Capillary Action is drawing value creation and financial gain to the apex of each business across the whole of the economy.

Economic stimulation by Trickle Down methods supposes that if business owners are provided tax incentives and tax breaks, then they will invest more and hire more people and by these investments and hires the economy over all will be strengthened. Yet we can see that the Capillary Action works counter to any Trickle Down effect. For every drop of value that may Trickle Down, the owners are highly likely to absorb it back up their businesses, since the Capillary Action is constantly at work while growth in investment and hiring are not constant. Those on the lower part of the ladders are not having their financial situations improved. They are more accurately enabling the businesses to better absorb any value creation, or the abilities of the lower paid employees allow the businesses to better absorb any “trickle down.”

Under this model of the micro-economy, what is more suitable for improving more people’s financial situations is to enable more people to become owners. If the numbers of businesses are increasing in the economy with owners seeing success by Capillary Action, then those extra numbers of owners will have their financial situations improve. How can the social systems and government create structures and supports that better allow lower earning employees to take the risks involved in starting more businesses? Does the Affordable Care Act and its vision for a Health Insurance Exchange address some risks that have prevented people from opening new businesses?

If former employees are becoming owners, then businesses may realize a tightened market in the labor pool and move to pay greater amounts to attract employees who can create value for the businesses. Then could employees too see improvements in their financial situations.

Finally, we may come to realize that Job Creators are not the business owners. Successful business owners have incentives to keep their number of employees at a level that fits the business opportunities. Business owners should not be creating more jobs simply because of tax breaks or tax incentives. They will likely create more jobs once demand increases. So the Job Creator in a market economy is actually Heightened Consumer Demand, which becomes all the easier to envision when more people’s financial situations are improving. With more business owners achieving improved financial situations and with employees seeing their financial situations improving, then all of those improvements can feed into Heightened Consumer Demand and will grow the market. Trickle Down Stimulation does not exist in a business model where Capillary Action in constantly drawing value up.

All my best,
Auntie Greed