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Investing Other People’s Money

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In a letter in today’s Wall Street Journal [2], ZBB Energy president & CEO Eric Apfelbach argues that government subsidies to his firm are justified because his company has a promising future.

Don’t buy it.

If ZBB Energy’s future really is as bright as Mr. Apfelbach says it is, private investors would commit sufficient funds to keep it growing.  The fact that private investors aren’t doing so is strong evidence that ZBB Energy’s future is dimmer than Mr. Apfelbach thinks.

It’s true, as Mr. Apfelbach notes, that private investors are now generally staying on the sidelines.  But they’re doing so for good reasons.  As explained elsewhere in the same edition of the Wall Street Journal by economists Thomas Cooley and Lee Ohanian [3], looming tax increases and other burdensome government interventions make the prospects of future profits throughout the economy quite dreary.

There’s no reason to suppose that ZBB Energy is immune to the enterprise-debilitating viruses being injected into the economy by the mad scientists in Washington.

Here, by the way, are some key passages from the Cooley and Ohanian essay:

The economy did not tank in 1937 because government spending declined. Increases in tax rates, particularly capital income tax rates, and the expansion of unions, were most likely responsible. Unfortunately, these same factors pose a similar threat today.

Here are the facts: Real government spending, measured in 1937 dollars, declined by less than 0.7% of GDP between 1936 and 1937, and then rebounded in 1938. It is implausible that such a small and temporary decline reduced real GDP by nearly 3.5% in 1938 or reduced industrial production by about one-third.

But in 1936, the Roosevelt administration pushed through a tax on corporate profits that were not distributed to shareholders. The sliding scale tax began at 7% if a company retained 1% of its net income, and went to 27% if a company retained 70% of net income. This tax significantly raised the cost of investment, as most investment is financed with a corporation’s own retained earnings.

The tax rate on dividends also rose to 15.98% in 1932 from 10.14% in 1929, and then doubled again by 1936. Research conducted last year by Ellen McGratten of the Federal Reserve Bank of Minneapolis suggests that these increases in capital income taxation can account for much of the 26% decline in business fixed investment that occurred in 1937-1938.

Meanwhile, after the 1935 National Labor Relations Act, union membership rose to about 25% in 1938 from about 12% in 1934. The increase in unionization was fostered by the sit-down strike.

In late 1936 and early 1937, for example, members of the United Auto Workers (UAW) occupied a General Motors auto body plant in Flint, Mich. Without auto bodies, production plummeted, and the company was forced to settle the strike and recognize the union.

Burt Folsom is correct to describe the New Deal as a raw deal [4].