MILLIONAIRE’S ISLAND: A Simple Example Of Why ‘Rich People’ Don’t Create Jobs

Business Insider: Henry Blodget
December 15, 2011 8:39 AM
by Henry Blodget
MILLIONAIRE’S ISLAND: A Simple Example Of Why ‘Rich People’ Don’t Create Jobs

As everyone in this country keeps blaming everyone else for our high unemployment rate, one assertion gets repeated so often that it is now regarded as fact:

Rich people create jobs.

Specifically, the argument goes, entrepreneurs and investors create jobs.

So if we want to create more jobs, the argument continues, we need to cut taxes on entrepreneurs and investors—to increase their incentive to create jobs.

Now, I’m an entrepreneur, and Business Insider employs about 75 people, up from zero four years ago. So if this assertion were true, I’d happily espouse it. It would make me feel great, believing that I had created all those jobs. And it would make me feel perfectly justified in paying historically low tax rates. (After all, I created these jobs!).

Unfortunately, as I explained in detail here, this assertion is wrong: Entrepreneurs and investors actually don’t create jobs, at least not by themselves. What creates jobs is a healthy economic ecosystem, of which entrepreneurs and investors are only parts. The more important part of the job-creation engine is a huge base of people and companies with plentiful disposable income. Specifically, millions upon millions of customers with money to spend.

Without our generous readers and sponsors and dedicated team, all the jobs I “created” at BI would immediately cease to exist (including mine). I’m patient and determined, but I’m not Sisyphus. And our investors are good people, but they’re also, justifiably, impatient (they, too, have clients to serve and jobs to keep). And I certainly couldn’t produce BI by myself. So if BI hadn’t quickly gained traction with readers and sponsors and hired a great team, my investors and I would have switched the lights off. And all those jobs would have gone “poof.”

Without healthy customers, in other words, entrepreneurs and investors can create prototypes, or do R&D, but they can’t create self-sustaining jobs. To create self-sustaining jobs, companies need to sell their products and services into a marketplace that 1) wants them, and 2) can afford them. The marketplace also needs laws, law-enforcement, property rights, transportation systems, resources, rules, and other attributes of healthy free-market economies that help companies and society function. Without all those things, entrepreneurs and investors can’t create jack.

To illustrate this, let’s run through a simple example. Let’s create a fictional economy called “Millionaire’s Island…”

MILLIONAIRE’S ISLAND

Let’s assume that, before we get there, Millionaire’s Island is an unspoiled wilderness. And let’s start our experiment by picking up “the 1%”—the Americans in the top-percentile of wage earners—and putting them all on the island.

Let’s allow the 1% to take their savings with them. So some of these folks will arrive with enormous wealth, and others will have very modest means. The island’s residents will also be a highly skilled and educated bunch: Most of the 1% are doctors, lawyers, bankers, business-owners, hedge-fund managers, and so on.

In 2010, there were about 1.4 million one-percenters in the U.S., and they each made a minimum of $380,000 a year. So our island’s population will be the size of a mid-sized American city. And the total wealth on the island will amount to one-third of the wealth of the entire United States.

(That’s how much of the wealth the top 1% of the country owns—see chart at right).

What will happen?

Well, first there will be a massive grab for all of the island’s resources. This will probably lead to years of violence and wars, in which many of the island’s new residents will be killed off.

(Such is life without property rights.)

But maybe, to skip this step, we can keep our property rights and just peacefully divide the island’s resources upon arrival—say, according to net worth. In this case the super-rich 0.1% would end up owning the vast majority of the island and the rest of the 1% would end up with some scraps.

Provided the 1% don’t kill each other off dividing up resources, the island will then progress to the next phase of economic development: The rush to satisfy basic needs.

These needs would include:

Food
Clothes
Shelter
Basic services (health, legal, banking, plumbing, construction, garbage disposal, tailoring, cooking, dry-cleaning, cleaning, undertaking, etc.)
Government (including police and judicial system)
(Yes, we’ll need some government. Given how much so many people seem to hate the idea of government, however, we’ll fund it with a simple, low, “fair” flat tax. That will let the super-rich keep more of their earnings than they currently do—and, thus, according to the theory, have an incentive to create more jobs.)

Now, if the island’s economy is closed—no imports or exports—most of the people on the island will probably soon die of starvation, because 1.4 million people can’t immediately feed themselves without a fully developed agriculture system. But let’s pretend that there’s a food source that will keep everyone alive indefinitely and that control of this food source does not fall into the hands of a greedy monopolist who can charge, say, $1 million for a banana.

(If a billionaire were starving and there was nothing else to eat, the billionaire might just pay $1 million for a banana. As a result, the food monopolist would quickly amass all the wealth on the island. And the monopolist would enjoy this wealth right up until the time the rest of the island stormed his mansion, chopped off his head, and redistributed his property. It is true that “life is not fair”—another mantra that is often used to justify the extreme inequality that has developed in the U.S. in the past 30 years—but there’s only so much inequality society can take.).

So let’s say the island’s food needs are taken care of. Then it’s on to the other basic necessities.

Among the island’s residents will be lots wealthy entrepreneurs and investors, many of whom made it into the 1% by selling companies or investing money. And there will also be “poor” entrepreneurs who are willing to take more risk in the hope of getting rich.

These entrepreneurs and investors will start founding and funding companies. These new companies will hire some of the island’s other residents to provide their products and services. And the jobs for these residents (and the entrepreneurs) will be self-sustaining—as long as the employees are paid enough to buy basic necessities from other companies.

If the employees are not paid living wages—if, instead, all the entrepreneurs and investors try to maximize every cent of profit by paying employees as little as possible—the new jobs will not be self-sustaining.

Why not?

Because as soon as the less-wealthy people on the island run through their savings, the money to pay for basic necessities will disappear. The new companies that had been formed to provide houses, clothes, services, and so forth will go bust, and all the jobs will disappear (no customers = no companies = no jobs). The economy will collapse, and the island will be thrown into anarchy.

Importantly, this collapse will happen even if the wealth of the island as a whole still adds up to trillions. If the wealth and income is concentrated only in the hands of a privileged few, there will be no money for the less privileged to pay for any products and services produced by these few. Thus, there will be no point in the rich people producing any products and services beyond what they need to feed and clothe themselves (because no one will be able to buy the products and services). And, therefore, there will be very few jobs.

(The super-rich will probably have to throw everyone else a bone and give them means to clothe and house themselves or risk getting their heads chopped off, but this bone could take the form of indentured servitude. But the economy would not grow, and products and services would not improve. Instead, the super-rich would just sit on their money, which, most certainly would not “trickle down.”)

So this is the first example of why it is silly to think that “entrepreneurs and investors” create the jobs in our economy. Entrepreneurs and investors start and fund companies, which is important. But what actually creates self-sustaining jobs and a growing economy is customers who want and can pay for companies’ products and services. Without these customers, there’s no job creation.

And what, in a healthy economy, enables customers to pay for products and services? The customers’ own jobs—jobs that pay the customers enough to be able to afford to buy products and services.

[Before moving on to a final point, we should note an amusing side-effect of the economy on Millionaire’s Island. To provide for its population’s basic necessities, our island economy will create the need for a lot of jobs that the 1% aren’t used to doing.

Specifically, a bunch of the folks who were making, say, $1 million a year as bankers or lawyers prior to moving to the island would have no choice but to become construction workers or sewer cleaners or undertakers or firemen, because otherwise those jobs just won’t get done. The good news for these former bankers will be that, since no one on the island will want or know how to do those jobs, they’ll probably be able to charge immense amounts for doing them. So as they’re pumping crap out of a billionaire’s cesspool, the former bankers will be able to take comfort in the fact that they’re being paid millions to do it. At least until another former banker comes along who does it for less. Which probably won’t take long.

Also amusing will be the fact that there will be an absolute glut of banking, legal, doctoring, and investing talent on the island, which should drive the price and compensation for these services to the floor. So the 1% will get a taste of what it’s like to have their skill-sets and professions become so commoditized that they can’t make a living doing them anymore. They might even have to sign up for re-training programs!]

Anyway, the satisfaction of basic needs will create a lot of jobs in our island economy. And as long as the islands’ employers pay their employees enough to live on and save something, everything will be fine.

So, what will happen once the basic needs have been met?

Companies will be founded that do more than satisfy basic needs.

The new companies will produce products that people want, but don’t necessarily need.

Like iPads.

Steve Jobs, the inventor of the iPad, has been heralded as an amazing job-creator in our own economy, because some 60,000 people now work at Apple making products like the iPad. But did Steve Jobs really singlehandedly create all those jobs? Of course not. If there hadn’t been hundreds of millions of people on the planet with enough disposable income to buy iPhones and iPads, Apple wouldn’t have been able to sell them. What created Apple’s jobs was the combination of products that people wanted and people who could afford to pay for them.

But maybe among the island companies founded by the entrepreneurs and investors, there will be an island Apple, Inc. And this Apple will make products that are so magical and amazing that everyone will immediately want them.

And how many jobs will this island Apple create?

It depends on how many of the island’s residents can afford to buy the iPads after taking care of their more pressing needs.

If everyone on the island has enough income to afford an iPad after paying for food, shelter, and clothes, then the island Apple Inc. might sell 1.4 million iPads (one per person). And that level of demand for iPads would create a lot of jobs making, distributing, selling, and servicing iPads—jobs that would last as long as the demand for the iPads lasted.

But what if the island’s income and resources were not so equally distributed?

What if, instead of everyone on the island having enough disposable income to buy an iPad, only, say, 25% of the island’s residents had enough disposable income to afford an iPad?

(This, by the way, is probably a reasonable estimate of the percentage of American households that could afford to buy an iPad. About 25% of American taxpayers make more than $67,000 a year. And by the time you get through with food, clothes, shelter, utilities, transportation, taxes, et al, you probably couldn’t afford iPads for everyone in the family on much less than that).

If only 25% of the island’s residents could afford to buy iPads, then the island Apple could only sell about 350,000 of them. And that would create a lot fewer jobs than the production, sales, and service of 1.4 million iPads.

And this gets to the important point.

The iPad is the same.

But the number of jobs created by the iPad is different depending on the number of customers who want and can afford to buy it.

So, again, crediting the entrepreneurs and investors who created the iPad with singlehandedly “creating jobs” is unfair to every other participant in the economy. It’s the overall health of the ecosystem—the combination of entrepreneurs, investors, laws, law-enforcement, transportation, and, most of all, wide distribution of wealth—that creates the jobs, not entrepreneurs and investors.

THE MORAL OF THE STORY

Yes, life is not fair. Yes, some people will always have more and others will always have less. Yes, capitalism is the best economic system in the world. Yes, entrepreneurs and investors are an important part of the economic job-creation engine.

But the moral of the story is that we’re all in this together.

Our jobs are not created by a special, privileged handful of rich people (entrepreneurs and investors), much less a handful of rich people who have to be even better incentivized if our economy is to get back on track. Our jobs are created and sustained by the amazing economic ecosystem in which we all have the privilege and good fortune of existing.

If we continue to concentrate the wealth of this ecosystem in the hands of fewer and fewer participants, the health of the ecosystem will not improve. On the contrary, it will deteriorate further.

We do not need to further incentivize entrepreneurs and investors to start companies—they already have plenty of incentives to do so.

What we do need to do is find ways to give our vast middle class more purchasing power again.

What are some of those ways?

Well, modestly shifting the tax burden toward rich people would help. (Modestly, not wildly. No one sensible is talking about raising top bracket income tax rates back to 70%-90% again. We can start by just nudging the top bracket back to, say, 39%, and raising taxes on dividends and capital gains).

Reducing household debts through mortgage restructurings would also help.

And so would rebuilding our manufacturing base.

And so would doing something that could be accomplished outside of government influence: Companies could voluntarily reduce their profit margins and pay people more.

Wait, what?

Yes. Instead of continuing to increase their profit margins above today’s already record levels, companies could decide to shift their emphasis from “serving customers and increasing shareholder value” to “serving customers and increasing shareholder value and providing a good living to as many employees as they can.

Wow, that last one sounds crazy. But it isn’t. Our companies have become so phenomenally profitable and efficient that wages in our economy recently hit an all-time low as a percentage of GDP (see chart above). Perhaps it’s time our companies started voluntarily sharing more of the vast wealth they have created with their employees.

SEE ALSO:
Finally, A Rich American Destroys The Myth That Rich People Create Jobs
23 Mind-Blowing Facts About Income Inequality In America

Please follow Business Insider on Twitter and Facebook.

Join the conversation about this story »

See Also:

Finally, A Rich American Destroys The Fiction That Rich People Create The Jobs
No, Entrepreneurs Like Steve Jobs Do Not ‘Create Jobs’ By Inventing Products Like The iPhone
The Next President Will Only Have 100 Days To Address The Jobs Crises