Saturday, June 15, 2013

Supply side dogma

I came upon two excellent articles yesterday that attack supply side economic dogma. But before I get to that, I want to run through a small thought experiment using my friend Will. He has built a company from the ground up, Dirt Cheap Computers. Basically, it is him (along with me at times) and he builds and repairs computers and networks. Will's tax rate really doesn't affect how much he works. He would certainly like to keep more of the money he earns but if the government lowered his tax rate, Will wouldn't start working more because he was suddenly making more per hour. A primary reason for this is that like most small business owners, Will is already working as much as he can. He is constrained by the number of people around who want to do business with him. He can just announce that he's going to work 10 more hours per week, but they won't be paid hours. He needs customers.

What this shows is that business profits depend upon demand and not supply. Will has tried supplying a cheaper and cheaper service and what he's learned is that it doesn't really bring in many more customers. But conservatives in the economic policy debate don't seem to understand this basic fact that all small business owners understand. It is like they got their economic education fromField of Dreams, "If you build it, they will come." Well, that just isn't true. If people have no expendable income, they will not go to Disney Land. After 30 years of supply side economics—the idea that giving the rich more money will cause economic expansion—I am amazed that we continue to discuss it. Supply side economics is a lie. It doesn't work.

Neera Tanden wrote a great article over at Democracy Journal, Burying Supply-Side Once and for All. In it she explained exactly how and why supply side economics is supposed to work and why it does not. Basically, it all comes down to Will's demand problem. If the government wants to make small business owners like Will more successful, it should provide poor people with more money so they can buy things like computers or at least computer repairs. If all my discussions of economics confuse you, I highly recommend reading her article. It is a great primer on the subject.

The second article is by Dylan Matthews of Wonk Blog, Do Low Taxes on the Rich Leave the Middle-Class With Lower Wages? As usual with Ezra Klein's bunch, Matthews took forever in answering the question. But the result was quite interesting. It was based upon a paper by Saez, Piketty and Stantcheva. The answer is yes, of course, but the question is why. Their theory is that supply side policies make it so.

As Tanden noted, cutting the taxes of the rich does not cause them to go out and work more. But Saez et al claim that lower taxes do cause the rich to makemore. Think about it. You are the Vice President of Sales for some corporation. Your taxes are cut in half. You have a big incentive not to work more but to negotiate a better salary. Since productivity doesn't go up because of reduced taxes, the higher salaries have to come from the other workers. The pie is no bigger, so everyone at the bottom just gets less. In practice, they don't actually get less; historically we've just seen wages of those in the poorer classes stagnate while all the productivity gains go to those at the top.

When supply side economics first came into bloom almost 35 years ago, proponents called it "trickle down" economics. The idea was that if you gave the rich a lot of money, much of it would trickle down to the poorer classes. You don't hear people talking about that anymore because that absolutely has not happened. But the whole of supply side economics has been shown to be a scam. And yet it continues. Tanden has an explanation for that:

It's probably not a coincidence that the biggest beneficiaries of supply-side policies happen to be the same wealthy Americans who bankroll the Republican Party, along with the conservative media and think-tank infrastructure. But I don't think this is simply a story of bad-faith arguments driven by cynical self-interest. The fact is that there's something quite seductive about the idea that the best way to stimulate growth is to give yourself a tax cut. And if you happen to be an affluent conservative, there's also something very appealing about a theory that says that your work and your savings are principally responsible for driving the economy forward. In other words, policy arguments in favor of tax cuts for the rich to induce more wealth generation neatly coincide with and reinforce a world view that holds that individuals become rich only through their own prowess, not because of the investments of others, or heaven forbid, the luck of the draw.

And it only gets worse. The greater the income inequality gets, the more political power the rich get. As I note almost daily on this blog, the Democratic Party is almost as beholden to the rich as the Republican Party. But it is the Republican Party alone that holds onto the long discredited supply side dogma. And they will continue to do so. That's why we all need to understand it and counter it wherever it shows up.

(Cross-posted at Frankly Curious.)

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  • Keynes misunderstood Says law of supply and demand. He summarised Says as meaning "Supply creates its own demand" All Says meant was that demand for a product creates demand for similar products. Keynes did not seem to understand that Says meant that the product that spurs that economic growth was one already in demand. Please tell your economic professors to teach truth rather than engineered propaganda.

    By Anonymous Anonymous, at 11:38 PM  

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