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Thursday, September 30, 2010

 

Small Business Jobs Act

We live in a time period in which many people love to express their political opinions, devoid of any consideration toward how it will make others feel, or what it will cause others to think about them. We are all “rationally ignorant,” as we have discussed, to varying degrees, but problematically, people are often oblivious to the fact that they are rationally ignorant. Simply, they do not understand that they are not fully (or even well) informed. One of my favorite things about being an economics student is the ability to occasionally stifle people’s political BS with economic evidence. I certainly don’t mean to suggest that economics students know everything; given what I just said, that would be idiotically hypocritical. I only mean that economic theory, which relatively few people have studied, can be a useful tool when analyzing public policy, and since most people don’t understand it, they cannot make an effective argument against it.

Recently, the Small Business Jobs Act was signed into law. The act has two major provisions—first, a tax cut for small businesses, and second, more loans for entrepreneurs and small businesses ($30 billion more, to be precise). Most democrats supported the bill, claiming one of its many benefits will be that more jobs are created. Most republicans, however, argued that the loan fund would promote lending to high-risk borrowers, and compared it to the 2008 bailout of the financial industry.

It does not take an economist to recognize that a tax cut and the ability of a business to take out a loan will mean an increased amount of funds for that business. The money, if the business elects not to hoard it, will probably be spent on either labor or capital. As an isoquant map demonstrates, an increase in either labor or capital, other things constant, will result in the business’s ability to increase production. An increase in labor is synonymous with the creation of jobs, and an increase in capital has a strong tendency to create new jobs, albeit not always in the short run. This apparently is the democrats’ line of thought.

There is no evidence that the republicans contest that. Their concern is that the loans may not be repaid—lending to risky borrowers is a concerning issue. After all, excessive subprime lending was essentially the cause of the current recession, not to mention what necessitated the bailout. And, given the high failure rate of new businesses, an individual emerging business can be called a risky borrower. However, high risk usually implies high return. The Act specifically mentions the purchase of preferred stock as a means of “loaning” funds to small businesses. Small company stock has historically had a higher rate of return than safer, large company stock, even when failed businesses are taken into consideration.

I don’t see any strong parallels between the Small Business Jobs Act and the 2008 bailout. The bailout, which was reactive in nature, poured money into large businesses that almost certainly would have collapsed without the government’s assistance. This act, on the other hand, is proactive in nature, and we have yet to see what becomes of the businesses that take advantage of it. If historical stock prices are an indicator, it is unlikely that the government will lose money on these investments. Plus, a key purpose in the act is to encourage entrepreneurship, and one would be hard pressed to find an economist who would discourage that.

This wannabe economist is giving this round to the democrats. But, like any government action, only time will give a definitive answer of who was right.

Comments:
I like your point about the historic average return on investment in small companies. The Small Business Act seems like a fairly well-thought out piece of legislation designed to spark economic growth at a more local level and in a fairly direct way consistent with traditional private investment. My main concerns are how government officials will determine who is to receive funds and whether this available investment for capital or labor purposes accurately reflects the market cost of that accumulation. For example, if the "loan" amount to buy preferred stock is below the market rate for borrowing, excessively risky and poorly-timed entrepreneurial endeavors may leave the taxpayers with an unusually bad portfolio of small company "stock."
 
Given the nature of this course, perhaps it might be worthwhile to ask if there is an interest group that has asked Congress to pass the legislation in question?
 
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