Friday, May 7, 2010

Supply-side economics and the deficit.

Much of the recent discussion about supply-side economics has focused on its purported failure to reduce the deficit.

Such criticism is misplaced for many reasons which I'll discuss over the coming weeks. But today I want to discuss what supply-side economics is, what it says about the economy, and its track record.

Like every school of economic thought, supply-side economics is centered on prescriptions for fighting recession and unemployment.

Unlike the Keynesian and monetarist schools, both of which focus on raising consumption (i.e. demand) via either government spending or monetary stimulus, the supply-side model centers on production. Hearkening back to the classical economics that dominated from the 1700s to the 1930s, supply-side economics argues for sound money, ideally fixed in value against a stable commodity such as gold, and for removing barriers to production such as excessive tax rates, tariffs or regulation.

As a school of thought focused on fighting recession, supply-side economics is agnostic on the question of government spending. On its own terms, SSE has a very good record of reducing unemployment, cutting inflation, raising stock values, and increasing GDP.

A byproduct of those successes has been a general rise in government revenue over the past 30 years.

If your objective was to "starve the beast," the 30-year run of supply-side economics has been a colossal failure. Government revenue has poured in, almost without fail, despite lower tax rates.

So why are deficits still a problem?

Obviously, spending is a factor. But my primary answer is economic mismanagement.

You'll note in the chart above two big divots, coinciding with the recessions of 2001-03 and 2008-10. When the economy contracts, revenue falls. And, governments tend to spend more during contractions, so the deficit catches it coming and going.

These big revenue dips coincided with increased deficits, erasing the 2000 surplus and spiking again after 2007.

In this sense then, deficits are a symptom; recession is the disease.

The question isn't, why hasn't supply-side economics eliminated deficits? The question is, if SSE is so good at spurring growth, why have we had two sizable recessions this decade?

My answer in a future post.

A footnote: In the latter chart, note the deficit's fall from 2004-2007 after the big 2003 tax cut. While the subsequent recession blew the deficit to kingdom come, to the extent that tax cut spurred growth, it helped bring down the deficit.

Another footnote: thanks to Christopher Chantrill for his indispensable and

1 comment:

  1. Supply Side is not 'agnostic' on the issue of government spending. Supply side is the economics of production. 'Spending' by the government per se is not stimulative.
    There is no serious study produced by anyone that shows that spending is stimulative to economic growth. The myth that it is stimulative is a politicised misunderstanding of Keynes and it is directly opposed to supply side theory in that it discourages investment though the implied threat of higher taxes to pay for larger deficits. The only kind of spending that has ever produced real growth, is the investment in asset maintenance and creation. That is the only kind of spending that can ever pay for itself. That is the only kind of spending that creates growth. Conflating the idea of spending on consumption or for any purpose that does itself provide the basis for paying the debt incurred to support the spending, is the principle conservative misunderstanding that makes them incapable of rebuting the demand paradigm. If you structure tax reduction or governement spending for the purpose of consumption spending you will discourage investment and reduce growth. Only tax reduction that creates incentive to spend on investment will create growth. If you can't make that distinction then you can't tell what parts of the latest compromise tax bill is stimulative and what part is anti-stimulative. Borrowing to support unemployment is anti-stimulative. Social Security one year reduction of employee contribution is anti-stimulative. The Obama wage earners tax cut is anti-stiulative. The make work pay subsidy is anit-stimulative. Borrowing subsidize all maner of ethanol genocide and green insanity is anti-stimulative. If the spending does not create an incentive to invest in assets or to maintain existing assets from waste then it is not a supply side idea. Spending itslef is a demand side ideal that has never worked, has never been supported by any study or historical experience and is obvious nonsense on its face. How can you suggest that supply side is agnostic on the issue?