Aggregate Demand and Job Creation
A recent study by the Kaufman institute shows a fascinating account of how new jobs are created by using recent census data. The study basically concludes that most net new jobs are created by firms that are between 1-5 years old, and this got me thinking about how this relates to the aggregate demand issues that are discussed constantly as a cure to unemployment. If we look at these new companies that are growing fast and creating lots of jobs, are these firms really affected by outside aggregate demand issues with the economy as a whole? I am not convinced they are to a significant degree. Some thoughts.
First, what is the demand for a new product that either makes your life much easier or does something cheaper, better, or faster than a current product? I would argue that, regardless of the state of the overall economy, your demand for this new product will still exist. As an example, let’s think about two new companies that have been growing fast recently.
The first one is Groupon, which is exploding in sales and employment. Businesses love Groupon because it drastically lowers the cost to acquire new customers, and consumers like groupon for the large savings they provide. In many cities, businesses have 6 month waiting lists to run their Groupon offer, while on the consumer side many of the offers sell out. So if GDP contracted by 10% next year, would Groupon grow more slowly, or actually grow even faster? I would argue Groupon might grow even faster in a slower economy.
The second example is Kiva, which integrates robots into automating fulfillment processing. This allows companies to fulfill orders faster and cheaper. Regardless of aggregate demand issues, I think companies will implement these systems as the cost savings are so huge and the ROI payback fast. Let’s pretend that GDP decreases by 10% next year. Will Macy’s still buy the Kiva system to automate their e-commerce logistics? I would argue they would buy it regardless, because again, this sort of business is not really affected by aggregate demand type issues – so long as we are not talking about a depression with lots of bankrupt firms.
More examples include the many outsourced logistics companies that are taking over these tasks from other companies. Here again I would argue that, as long as these businesses are in business, they will outsource functions to save money regardless of overall GDP growth rates or declines.
So at this point it would seem strange if someone was advising the government to spend more money on road infrastructure, so that there would be more companies created like those above, which are the source of new jobs. In addition, when these companies do grow, they do have a large affect on demand for other goods and services in the economy. For example, Groupon still needs copying machines, servers, secretaries, accountants, and lots of other services to execute. This is a source of real, sustainable demand as opposed to government created demand that is by nature temporary.
So did I just cherry pick companies that are rare successes in the current economic climate? By looking at the Inc. 500 list, I believe most of the new, fast growing companies that are creating jobs are not affected as much by aggregate demand GDP swings as we might think. As another example, let’s pretend that I invent a colon cancer screening device that costs $10 and is just as good as the current expensive method. What would be the demand for this product? Does the overall aggregate demand in the economy matter at all, in terms of demand for this particular product? I would argue new products and services created by new, fast growing companies are not as affected by aggregate demand issues as much as we might think, and these are the exact firms that create almost all the net new jobs in our economy. Again, any good or service that saves money or does something better/cheaper will always be in demand, even if GDP is contracting. In some cases, demand might even increase as companies struggle with more competition and need to act faster to save their current sales.
So the next obvious question would be why are we not creating these types of fast growing companies that hire lots of people like we were were in earlier economic recoveries? I think the answer to this has a lot to do with the financial crisis and credit availability, which I will address in a future post.
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