The Trickle Around Effect

We've all heard of the trickle down effect, made popular in the Reagan era. The concept is that if you give someone extra money, he will spend it, and the person he spends the money on will have more money and so on, until everyone gets a piece. This concept is also debated in the race to fix the economy, as the goal of both tax breaks or stimulus bills is to put more money into the hands of the people so that they can spread it around.

Because the economy is the way it is, and perhaps because we are nearing the end of winter, people are starting to get edgy. I have heard stories of the "shrinking middle class" (newsflash, if the Kindle is Amazon's best selling product, the middle class is fine). People are suspicious and angry about "fat cats" on Wall Street making millions of dollars. Some of this anger is justified, given that taxpayer money bailed these people out.

However, I would like to explain why, when no bailout is applicable, fat cats and high corporate profits are not a problem for any of us.

First of all, in a free market the price of goods are set by supply and demand. There may be some resentment against corporations about the price of the goods or services we acquire from them. However, when there is no unethical behavior (lying), the price is the price. If a company sets a price for a product unreasonably high, eventually they will have to lower it as the market adjusts.

Now, on to corporate profits.

There are essentially a limited number of things that a company can do with their net income (bottom line after tax). It doesn't matter if their profit margin is 1% or 100%, a company's net income is good for everyone.

One way a company may spend their net income is to give raises and bonuses to their executives. If you remember the trickle down effect noted above, this is a good thing. If you are particularly upset about executive pay (I have blogged on that before), then I suggest you consider the company using its income to give raises to the meat and potatoes employees. A company that has a net loss or bad year is not going to give as good of raises to ANY employee, executive or entry level. The other good thing about a company using income to doll out raises and bonuses, is that the different levels will spend differently, thereby affecting different areas of the economy. An entry level employee may buy a TV or a bike or start building a deck. An executive may buy a vacation home, a yacht, or a luxury car. All these industries need customers.

But what, you say, if the employees throw the money into savings? Well, this is also an option for the company - to throw their net income into savings. Whether on the individual or corporate scale, people put money into banks that pay ridiculously low interest rates. These banks loan the money out to others at higher interest rates. Although the money is borrowed, the money goes towards a variety of expansion projects - from funding new business to building and purchasing houses, and sometimes to getting that yacht. Once again, even though the money is technically being saved, it is actually being spent by someone else, thus helping the economy.

One thing companies are expected to do with their income is to pay out dividends. A portion of the income is passed on to stockholders, who include anyone from the chief officers (go back up to the bonus paragraph) to individual shareholders who own less than 1,000 shares each, to retirement accounts and 401(k)'s that contain some form of the company stock. Just think about investments, because we all have a stake in the stock market in some way - like this: any time a company succeeds, you get a little richer!

The final thing the company can do is reinvest the earnings. They may do this by expanding their assets, such as purchasing a new world headquarters, streamlining their fleet of trucks, or opening an office in Detroit. In each case, this reinvestment results in jobs for someone, either within the company, or perhaps at the truck company they purchase from. Another thing they can do to invest is to purchase companies that would fit within their business model. Once again, they grow the company, expanding jobs, and an "exec" at a mom and pop business retires with a hefty pension based on the deal.

So, you see, although there is a lot of animosity towards "corporate earnings" and CEO's, because our economy is linked we all succeed together or fail together. I call this the trickle around effect, because what goes around comes around. If we want to be employed, to expect raises, and to be able to meet our full potential in earnings and as human beings, we must be respectful of the institutions that allow us to do that. Those institutions are our employers and the corporations that help to keep America running and goods priced low.

Don't bite the hand that feeds you.