WEBVTT NOTE The Liquidation Phase: A Corporate View 1 00:00:00.000 --> 00:00:08.480 We changed the title slightly to liquidation phase and profit margins, and one thing before we begin, 2 00:00:08.480 --> 00:00:18.240 it's a hundred years next year, 2012, of the publication of Mises's first book. 3 00:00:18.240 --> 00:00:23.280 So for you guys who are doing reading groups, you might want to get started now so you can end in 2012. 4 00:00:23.280 --> 00:00:28.880 Okay, so Harry had a brilliant idea, and I said, wow, that's a brilliant idea. 5 00:00:28.880 --> 00:00:34.880 and he said, no, this is just something everyone knows and so maybe, I don't know, we'll find out. 6 00:00:34.880 --> 00:00:42.880 So the popular press has asked which economic policy is the best to alleviate the recession 7 00:00:42.880 --> 00:00:48.880 and actually I think that question is miscast and it really should be 8 00:00:48.880 --> 00:00:54.880 which economic policy best converts malinvestments in economically viable capital structures. 9 00:00:54.880 --> 00:01:03.380 And so the liquidation phase is necessary then to realign the capital structure. 10 00:01:03.380 --> 00:01:10.380 So Austrians then have long said that the solution of this is, well, you just liquidate the malinvested capital, 11 00:01:10.380 --> 00:01:17.380 but what does this actually mean? What do we mean by liquidate the malinvested capital? 12 00:01:17.380 --> 00:01:23.880 How do companies do this? What is it like from their point of view? 13 00:01:23.880 --> 00:01:32.400 So, at the extreme, it's through bankruptcy that some of these businesses that have capital, 14 00:01:32.400 --> 00:01:38.200 they get broken up, they sell it off, it gets passed from inefficient uses to more efficient 15 00:01:38.200 --> 00:01:42.360 uses and that's the standard story that we've been doing so far. 16 00:01:42.360 --> 00:01:49.040 However, not all businesses fail during the liquidation phase. 17 00:01:49.040 --> 00:01:56.180 How do the firms that are accumulating losses but not yet ready to fold, how do they convert 18 00:01:56.180 --> 00:02:00.200 their malinvested capital into profitable structures? 19 00:02:00.200 --> 00:02:02.040 That's the question that we're asking. 20 00:02:02.040 --> 00:02:08.160 It's in this context that we're going to turn to look at the point of view from the business 21 00:02:08.160 --> 00:02:09.480 or the firm. 22 00:02:09.480 --> 00:02:16.320 So what we argue is the firm is trying to get back to break even, and we call it getting 23 00:02:16.320 --> 00:02:17.640 to break even. 24 00:02:17.640 --> 00:02:22.660 So consider a business with the following situation. It manufactures a product in which 25 00:02:22.660 --> 00:02:29.660 the gross margin is 25%. Now what this means that labor and material constitutes 75% of 26 00:02:29.660 --> 00:02:34.580 the cost of production, its variable cost. Now as long as the business is able to meet 27 00:02:34.580 --> 00:02:39.420 its variable cost, it's going to stay in business. If the firm is not able to cover its variable 28 00:02:39.420 --> 00:02:46.420 cost, it crosses the shutdown point and stops. So if the remaining 25% then only covers its 29 00:02:46.420 --> 00:02:52.720 only covers its fixed costs, its overhead, it will break even. So when a business accumulates 30 00:02:52.720 --> 00:02:58.700 revenue above fixed and variable costs, it begins to make profits. And this is our crossover 31 00:02:58.700 --> 00:03:04.980 point. This is our break-even point. So let's take an example. Let's assume that our business 32 00:03:04.980 --> 00:03:11.540 has fixed costs the overhead of $10,000 a month. This means that a firm must earn revenues 33 00:03:11.540 --> 00:03:21.540 $40,000 a month just to break even. So $30,000 pays for labor and material. The $10,000 then pays the overhead. 34 00:03:21.540 --> 00:03:32.540 Now, let's assume that the economy is in a downturn and the firm is losing money. So let's just pick a number, $2,000 a month. 35 00:03:32.540 --> 00:03:38.540 The business is able to cover its variable costs, but it's not breaking even. 36 00:03:38.540 --> 00:03:50.540 So this problem can be viewed either as having insufficient sales or having excessive overhead, fixed cost, right? One of the two, or a combination of the two, right? 37 00:03:50.540 --> 00:04:01.540 So if the business could magically expand sales, it would have to first create more product, which means the variable costs would then increase. 38 00:04:01.540 --> 00:04:12.540 So, in this example, the gross margin is 25% and let's assume the marginal, that the marginal, the margin, gross margin and the costs are held constant. 39 00:04:12.540 --> 00:04:28.540 So therefore, in order to cover the monthly shortfall of $2,000, the firm would have to increase sales by $8,000, in which 6,000 or 75% goes to variable costs. 40 00:04:28.540 --> 00:04:38.540 So, this comes to our government policy. The need for politicians is to do something, right? 41 00:04:38.540 --> 00:04:45.540 And as the recession grows, their need to do something grows. So there are two broad 42 00:04:45.540 --> 00:04:51.540 approaches for active fiscal policy to alleviating a recession, increasing spending or cutting 43 00:04:51.540 --> 00:04:57.180 taxes. Now, the Keynesians have argued that the best policy to cure a recession is to 44 00:04:57.180 --> 00:05:00.260 Stimulate Aggregate Demand. 45 00:05:00.260 --> 00:05:02.740 So suppose that the government chooses 46 00:05:02.740 --> 00:05:05.980 to stimulate aggregate demand by directly increasing 47 00:05:05.980 --> 00:05:09.300 the purchase of consumer goods. 48 00:05:09.300 --> 00:05:12.300 So they're just going to go out and just start buying stuff. 49 00:05:12.300 --> 00:05:15.740 So if the firm has experienced a $2,000 shortfall, 50 00:05:15.740 --> 00:05:17.820 then the amount needed in additional sales 51 00:05:17.820 --> 00:05:23.140 is $8,000, assuming that the costs are constant 52 00:05:23.140 --> 00:05:26.460 and the growth margin's at 25%. 53 00:05:26.460 --> 00:05:33.080 To turn the malinvestment into sustainable capital structure, it will take $8,000 of 54 00:05:33.080 --> 00:05:44.080 direct and sustained government purchases. Or, to get the same effect, it will only take 55 00:05:44.080 --> 00:05:52.580 a reduction of taxes of $2,000. Thus, in general, the tax cut approach places a lower burden 56 00:05:52.580 --> 00:05:57.180 on the Government or the Taxpayer. 57 00:05:57.180 --> 00:06:06.420 So in our paper then, what we discuss are the four categories of government spending. 58 00:06:06.420 --> 00:06:15.180 And the first one is grants, where the government will grant money to institutions, say universities 59 00:06:15.180 --> 00:06:18.420 perhaps, they like those sorts of things. 60 00:06:18.420 --> 00:06:23.860 And we talk about the malinvestment and the Kantian effects and the relative price adjustments 61 00:06:23.860 --> 00:06:29.260 that then occur and how then this will cause extra distortions and when that spending stops 62 00:06:29.260 --> 00:06:32.260 then all of those malinvestments have to get rolled back. 63 00:06:32.260 --> 00:06:36.940 And if we have heterogeneity of capital with capital specificity, how that becomes very 64 00:06:36.940 --> 00:06:40.580 difficult then to roll that back sometimes. 65 00:06:40.580 --> 00:06:46.700 Then we talk about the cash directly to consumers where Bush will give you a tax rebate back 66 00:06:46.700 --> 00:06:53.580 in 2001 and 2008, and people were like, hey, I can go spend a new TV, what are the impacts 67 00:06:53.580 --> 00:07:01.460 of that? And we have these same distortional problems. Then we have government contracts 68 00:07:01.460 --> 00:07:07.780 to businesses, where they just hire firms to do different things, and how that's distortionary. 69 00:07:07.780 --> 00:07:17.540 and then tax cuts and the reduction of regulation and so in this we then started thinking about 70 00:07:17.540 --> 00:07:24.620 how to talk about this advantage and this is what we've just labeled the Austrian multiplier 71 00:07:24.620 --> 00:07:32.260 and this is where I'm going to hand it off to my partner in crime, Harry, it's relatively 72 00:07:32.260 --> 00:07:36.140 simple though I lived through this because I was in the metal manufacturing business 73 00:07:36.140 --> 00:07:51.020 Through the recession of 78, 82, 90, and 2000, I learned really quickly that you can get a lot more money cutting costs than you can increasing sales. 74 00:07:51.020 --> 00:08:05.700 And so we thought, well, okay, if we're going to assume an Austrian multiplier of 25%, you can get three to four times more money into your business by cutting costs rather than increasing sales. 75 00:08:05.700 --> 00:08:09.060 and the concept is, is what can government do? 76 00:08:09.060 --> 00:08:14.340 So he said, first of all, enable the firm to operate profitably 77 00:08:14.340 --> 00:08:17.220 without expanding sales by 8,000. 78 00:08:17.220 --> 00:08:20.780 Okay, two, Keynesian economics recommends stimulating sales, 79 00:08:20.780 --> 00:08:23.220 but they must stimulate sales 80 00:08:23.220 --> 00:08:26.300 by four times the amount of the losses. 81 00:08:26.300 --> 00:08:31.460 Okay, so the stimulation is much greater than the cost, cutting cost. 82 00:08:31.460 --> 00:08:37.020 If costs could be lowered by $2,000 by kind taxes and regulation, the government could 83 00:08:37.020 --> 00:08:39.300 operate profitably. 84 00:08:39.300 --> 00:08:41.300 That means no laying people off. 85 00:08:41.300 --> 00:08:42.300 I've had to do that. 86 00:08:42.300 --> 00:08:45.580 That's not a real pleasant experience, I'll tell you. 87 00:08:45.580 --> 00:08:51.200 If you take a look in 1990, Wall Street Journal reported that the Bush administration, a good 88 00:08:51.200 --> 00:08:58.220 Republican conservative administration following libertarian economics, increased regulation, 89 00:08:58.220 --> 00:09:03.220 the cost of regulation of business by $200 billion. 90 00:09:03.220 --> 00:09:06.540 Had they repealed that under this model, 91 00:09:06.540 --> 00:09:08.540 it would have been a trillion dollar stimulus 92 00:09:08.540 --> 00:09:12.180 to the economy without any unemployment. 93 00:09:12.180 --> 00:09:14.740 You see, lowering those cost of regulation and taxes 94 00:09:14.740 --> 00:09:16.800 brings down the break-even point, 95 00:09:16.800 --> 00:09:19.540 allows you to operate much more efficiently. 96 00:09:19.540 --> 00:09:21.380 OK, this would mean that the company would not 97 00:09:21.380 --> 00:09:23.920 have to cut the internal structure of the firm. 98 00:09:23.920 --> 00:09:26.660 When you lay people off, you're actually 99 00:09:26.660 --> 00:09:32.860 Closing off your options, because as you lay people off, when you have the expansion, you have to go back and hire them again. 100 00:09:32.860 --> 00:09:39.220 So there's no problem cutting into the internal structure of the firm. 101 00:09:39.220 --> 00:09:42.740 The multiplier is bigger, four to one. 102 00:09:42.740 --> 00:09:48.020 It does not interfere with the internal structure of the firm, and thus does not imply 103 00:09:48.020 --> 00:09:51.600 additional malinvestments, because what's happening is you're cutting costs. 104 00:09:51.600 --> 00:09:54.800 You're not increasing malinvestments by increasing government 105 00:09:54.800 --> 00:10:02.560 demand, it does not cut the production capacity of the firm, and while the Keynesian Multiplier 106 00:10:02.560 --> 00:10:07.960 is specific to a small number of firms where the government money comes, the stimulus applied, 107 00:10:07.960 --> 00:10:13.080 where the stimulus is applied, the Austrian Multiplier is across the board. 108 00:10:13.080 --> 00:10:14.080 All businesses benefit. 109 00:10:14.080 --> 00:10:19.280 I mean, for example, if we could get rid of the affirmative action, if we could get rid 110 00:10:19.280 --> 00:10:25.900 of all those lawsuits, all the rest of that stuff. Everybody benefits right away. It goes 111 00:10:25.900 --> 00:10:33.300 right to the bottom lines. Okay? So this approach may actually eliminate many of the inefficiencies 112 00:10:33.300 --> 00:10:39.860 of government taxation and regulation, thereby leading to increased productivity. And we 113 00:10:39.860 --> 00:10:45.300 call this the Austrian multiplier. And when Paul and I were talking about it, Paul was 114 00:10:45.300 --> 00:10:49.940 Paul's helping me with a chapter of a book that I have coming out called, It Didn't Have 115 00:10:49.940 --> 00:10:56.180 to Be This Way, The Principles of Austrian Economics Applied, Create Peace and Prosperity. 116 00:10:56.180 --> 00:11:00.060 We're talking about it, and I saw Paul, it's very simple, when we went through this problem 117 00:11:00.060 --> 00:11:04.980 in my stamping company, we just did A, B, C, D, and sure enough, we pulled it out. In 118 00:11:04.980 --> 00:11:09.580 fact, I actually made more money in recessions than I did in booms, because what happened, 119 00:11:09.580 --> 00:11:14.220 My cost of steel fell faster than my sales did. 120 00:11:14.220 --> 00:11:17.700 I always looked at the account and I said, how come we're making money now when your 121 00:11:17.700 --> 00:11:19.300 cost of steel are going down? 122 00:11:19.300 --> 00:11:25.340 So the question is, is that, I think, at the end of this, is that the advantages are from 123 00:11:25.340 --> 00:11:27.700 a political standpoint. 124 00:11:27.700 --> 00:11:32.200 And I think we have to, remember, we have to argue out there in politics about what? 125 00:11:32.200 --> 00:11:35.700 You guys are cruel, you're hard-hearted, you're all the rest of it. 126 00:11:35.700 --> 00:12:05.700 In this way we can say, hey look, depending on the firm's gross profit margin, depends on the multiplier, we're actually much more effective in stimulating the economy by cutting government regulation, cutting taxation, and cutting the, and I guess you could probably argue if we could at least in Michigan pass a right to work law, maybe we could track some of that industry back by lowering cost and getting rid of a lot of these union contracts 127 00:12:05.700 --> 00:12:21.980 The Austrian multiplayer may also lead to increased tax revenue by increasing the profitability 128 00:12:21.980 --> 00:12:24.340 of business and lead to less unemployment. 129 00:12:24.340 --> 00:12:27.180 That would be among government workers. 130 00:12:27.180 --> 00:12:31.420 Unemployment means lower income and lower social security tax collections, which is 131 00:12:31.420 --> 00:12:34.220 one of the major problems that they're facing. 132 00:12:34.220 --> 00:12:40.220 In addition, it would lead to lower government deficits and future debt service payments by government. 133 00:12:40.220 --> 00:12:44.220 Remember, your children, the big problem is everybody says, oh, we can borrow the money. 134 00:12:44.220 --> 00:12:47.220 I said, yeah, the problem is the interest payment. 135 00:12:47.220 --> 00:12:49.220 Five minutes left. 136 00:12:49.220 --> 00:12:57.220 Finally, it presents a rationale for cutting government taxes, spending and regulation during the liquidation phase of the business cycle 137 00:12:57.220 --> 00:13:05.220 as a much quicker way to overcome the malinvestment crisis without causing substantial unemployment and additional malinvestment. 138 00:13:05.220 --> 00:13:14.220 And Paul, I guess we've got a few more minutes, but anyway, we'll leave more time for questions. 139 00:13:14.220 --> 00:13:23.220 But I've seen this work. I've seen it work. And so I think the Austrians have a much stronger case to present in this. 140 00:13:23.220 --> 00:13:28.060 in this and our multiplier is far higher because it would get a skin that depends on whatever 141 00:13:28.060 --> 00:13:29.060 business you're in. 142 00:13:29.060 --> 00:13:31.700 Paul, do you want to finish up? 143 00:13:31.700 --> 00:13:36.920 I'll just say that if you want a copy of the paper, we're going to send it to Joe and to 144 00:13:36.920 --> 00:13:42.140 Jeff Tucker and they'll put it up as a working paper or you can email us and we'll email 145 00:13:42.140 --> 00:13:43.940 you a copy of the paper. 146 00:13:43.940 --> 00:13:44.940 We appreciate feedback. 147 00:13:44.940 --> 00:13:45.500 Thanks.