Thursday, 27 November 2014

Why Doesn't Ed Miliband Offer The Kind Of Help That Will Actually Be Helpful?

Ed Miliband is drumming up support for his party in the pre-election campaign by promising financial help to small businesses to enable them to hire more staff. He is, not for the first time, confused. Post-tax incomes of businesses are not the primary determiner of employment levels. Employment wisdom is simple: if the output for additional staff has a value that covers their salaries then an employer should employ them. If not, then they shouldn't. This rule applies irrespective of whether you're a high street kebab shop or a multi-national corporation. Ed Miliband's financial incentives won't help raise employment levels.

To see why; suppose you've just eaten a nice big two-course meal in a restaurant, and the proprietor comes and offers you a free dessert. If you're stuffed, and you care more about your health and comfort than capitalising on a freebie, you will politely decline the proprietor's kind offer. Your optimum level of food consumption does not depend on whether you've paid for your food or not - it depends on your body's metabolism. Just as you will not take on more food unless your body needs it, similarly you will not take on more staff unless they bring a value that covers their salaries. If they will, then you don't need Ed Miliband's supplements - they would be better spent elsewhere; and if they won’t then Ed Miliband's supplements will not go towards raising employment levels.

This is why, rather than governments getting involved, it is much better if banks loan to small businesses of their own volition. A bank will lend if the borrower's ultimate gain from spending the money enables him or her to pay back the loan with interest. A government won't have anything like the same kind of risk signals, nor the incentive for prudence, as it is spending other people's money, not its own. Miliband’s claim that tax cuts for small businesses will help increase employment is a sure-fire vote winner. But like many sure-fire vote winners, it is fallacious.

What would work better would be large tax cuts for middle and low earners. You see, unlike rich people who delay spending and consume higher end products (Ferraris, yachts, swimming pools, £500 handbags, etc), middle and low earners are likely to increase their spending, which will increase employment. The exact same wisdom applies to minimum wage laws too. Instead of a minimum wage law that creates unemployment, hikes up prices and places an unfair burden on employers of low-skilled workers, the government could simply reduce the tax burden of low earners.

The answer to the question - Why Doesn't Ed Miliband Offer the Kind Of Help That Will Actually Be Helpful? - is that the helpful way is less of a headline grabbing vote-winner, so it's one he's unlikely to pursue with the same enthusiasm.

* Picture courtesy of