Effect of subsidies on employment

 

[go to accompanying letter]

 

Assume [1]

(i) that the total amount spent on investment is constant.

(ii) that wage-earners and profit-makers save the same proportion of income, so that the "expenditure multiplier" is the same in all circumstances. Then with the given expenditure on investment there must be a fixed expenditure of money on consumption goods,--i.e. [b] that amount which the "expenditure multiplier" demands.

(iii) that the money wage-rate received by workers remains constant.

Suppose now that a given tax per unit of profit made in consumption industries is imposed and a subsidy per man employed in industries producing consumption goods is paid, this subsidy per man being continually adjusted so that it just uses the whole of the tax per unit of profit (i.e. if employment increases the subsidy per unit of employment must fall.)

We are now faced with a situation in which (a) total expenditure on consumption goods remains constant, (b) a tax per unit of profit in consumption industries is being levied, and (c) a subsidy per unit of employment in consumption industries is being paid. This must lead to increased employment in consumption industries; for, if it did not, producers would have an incentive to produce more. For if output remained the same, the price of consumption goods would be unchanged because total expenditure is constant, whereas the subsidy per unit of employment will reduce marginal prime costs, and the tax per unit of profit will not raise marginal prime costs. As output increases, the price of consumption goods will fall, since total expenditure on consumption is constant; total profits will fall and total wages will rise, since total income is constant and there is greater employment at a given wage-rate. As employment increases, therefore, the tax per unit of profit will raise less revenue, because total profits fall; and the subsidy per unit of employment will fall both because total revenue falls and because there is a larger volume of employment to be subsidized. But this means only that the increase in employment will not be as great as might appear at first sight; there must be some increase in employment [c] , for otherwise this counterbalancing fall in revenue and in the subsidy per unit of employment would not occur.

Let us now modify the above by assuming that the profit-tax & employment-subsidy is applied to all industries (investment & consumption), retaining the assumptions (i) that total expenditure on investment is constant, & (ii) that the multiplier is unaffected by transfers to labour so that money expenditure on consumption is also constant, & (iii) that the money wage-rate is constant. Then there will be an increase in employment in investment industries as well as in consumption industries; for more machines will be produced and sold at a lower price per machine for the same total amount of money <for +> for the same reason that in the previous argument more consumption goods were sold at a lower price per unit.

Let us now modify the assumption that wage-earners & profit-makers save the same proportion of income, retaining (i) the assumption that total expenditure on investment is constant & (ii) that the money wage rate is fixed. Since according to the previous argument the tax-subsidy arrangement will transfer income from profits to wage earners, & since wage-earners spend a larger proportion of income than [d] profit makers, & since a total expenditure on investment is constant, there will be a rise in expenditure on consumption. Thus in this case the increase in employment will be greater than in the previous argument, because there will now be an increase in incomes. The price of consumption goods will not fall as much as before, so that employment in these industries will be greater than before; this argument is strengthened by the fact that profits in consumption industries will not fall as much as before because of the increased expenditure on consumption, so that tax revenue will not fall off so much and a larger subsidy per unit of employment can therefore be paid.

Let us now modify the assumption that expenditure on investment is constant, and assume instead that the rate of interest is constant, retaining the assumption that the money wage-rate is constant. The question boils down to this:--Will total money expenditure on investment rise, in which case the increase in employment will be greater than by the previous argument, because total incomes will rise still more? Or will total money expenditure on investment remain constant, in which case the previous arguments need no modification? Or will total money expenditure on investment fall, in which case the increase in employment will be less than according to the previous argument & may indeed turn into a decrease of employment, if the incentive to spend money on investment is greatly reduced? Let us assume that the tax per unit of profit is also levied per unit of income obtained as interest on debt fixed in terms of money (e.g. on interest on government debt.) Then if the rate of interest is 5% & the tax per unit of profit-interest income is 50%, this reduces the net yield on government securities to % as well as reducing the net yield on a machine which is expected to give a certain rate of yield on its cost by 50% as well. In other words there is no decrease in the incentive to borrow money at 5% to spend on investment unless the gross yield on a capital development (i.e. the marginal efficiency of a machine without making allowance for the tax on its yield) has fallen. Will the gross expected rate of yield on the cost of a machine have fallen, i.e. will the gross expected yield on a machine have fallen or will the present cost of a machine have risen? The present price in the market (i.e. cost to the investor) of a machine will have fallen, because, as we have argued, there will be a greater number of machines selling at a lower cost per unit, unless we can find other reasons for believing that this is not true. This in itself will raise the gross marginal efficiency of a machine and will tend to increase the expenditure of money on investment. The gross expected yield on a new machine will not have fallen, except because there is an increased output of machines which may lead people to expect lower yields in the future. (This does not allow for an irrational change in confidence due to the tax per unit of profit; but there is no rational reason why the gross yield on machines should be expected to be lower except because of their greater rate of output.) We can conclude therefore that expenditure on investment may be greater than we previously concluded, because the present price of machines is lower; & may be less than we previously concluded, because the present rate of output of machines being greater may lead to an expectation of lower yields. But in no case will the number of machines produced & so employment in investment industries fail to increase, because the only reason tending to reduce expenditure on machines at a given rate of interest is the fact that their output is greater. There might, however, conceivably be a fall in total expenditure on machines, because the fall in the price at which machines will be sold due to the profit-tax & employment-subsidy allows a slightly greater output of machines to be sold for a smaller total amount of money. It is therefore just conceivable that if the gross marginal efficiency schedule is very inelastic, because a small increase in output of machines assures a very large fall in expected yield on them, & if the multiplier is very large, there may be a fall in money expenditure on investment leading to so large a fall in expenditure on consumption that there is a net diminution in employment. But for this to be true the inelasticity of the marginal efficiency of capital schedule has got to be so important that it offsets (a.) the certain increase in employment in investment industries, (b.) the rise in the marginal efficiency schedule due to the fact that the price of machines is lower, (c) the tendency for consumption to increase because of the effect of the tax-subsidy in transferring income from profits to wages and (d.) the fact that with the tax-subsidy in consumption industries the volume of employment in these industries will increase even if there is no rise--or even a slight fall--in total expenditure on consumption.

  1. 1. Refers to Harrod, The Trade Cycle ( 1936:8 ), pp. 230-32.
    1. a. AN, five pages on five numbered leaves, is in file HP IV-745-767/12.

      b. Ms: «ie.» (in all occurrences. This is normalized throughout the note without further warning).

      c. Ms: «increase employment».

      d. Ms: «that».


Welcome page

top of page

Return to index of this section

Go to previous page

Go to next page