Supply-side economics
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The neutrality of this article is disputed. Supply-side economics is a school of economic thought popularised in the 1970s by the ideas of Robert Mundell, Art Laffer and Jude Wanniski. The term was coined by Wanniski in 1975. In 1983 economist Victor Canto, a disciple of Arthur Laffer, published The Foundations of Supply-Side Economics.
Supply-side economics was principally a response to perceived failings of Keynesian ideas that had steadily risen to dominance following the Great Depression. In particular Keynesian economics failed to explain the stagflation of the 1970s and failed to provide a clear solution for the series of recessions which occurred in the wake of the oil crisis in 1973.
Supply-side economics grew out of monetarist's critiques of Keynesian economics, and instead focused on encouraging investment, which they asserted was the basis of classical economics. In particular the notion that production or supply is the key to economic prosperity and that consumption or demand is merely a secondary consequence. In classical times this idea had been summarised in Say's Law of economics.
Like many conservative versions of economics, many supply-side followers claim that they are merely reinstating classical economics. (See Keynesianism for a discussion on Keynes and the classical critiques of his theory) A production-centred world view was behind the writing of classical economists as disparate as both Karl Marx and Adam Smith. In contrast to the modern Keynsian world view these authors actually focused on the means of production (as opposed to the effects of demand). By appealing to Say's Law supply-side economics such as Jude Wanniski seek to return the emphasis of macro-economic analysis to these classical traditions.
Supply-side supporters broke with Friedman and Lucas in that they argued that tax cutting alone would be sufficient to grow GDP and balance the budget. Supported by the powerful editorial pages of the Wall Street Journal and the Washington Times, supply-side economics became a force in public policy starting in the early 1980's.
In the United States commentators frequently equate supply-side economics with Reaganomics. The fiscal policies of Ronald Reagan were largely based on supply-side economics while his monetary policies were based on Monetarism. Hence, while Reaganomics was only partially based on supply-side economics, it was enough for Jude Wanniski to cite Kemp and Reagan as the great advocates for supply side economics in politics and to repeatedly praise their leadership.
Fiscal policy theory
Supply side economics holds that increased taxation steadily reduces economic trade between economic participants within a nation and that it discourages investment. Taxes act as a type of trade barrier that causes economic participants to revert to less efficient means of satisfying their needs. As such higher taxation leads to lower economic efficiency. The idea is illustrated by the Laffer curve.
Crucial to the operation of supply-side theory is the expansion of free trade and free movement of capital. It is argued that free capital movement, in addition to the classical reasoning of comparative advantage, frequently allows an economic expansion. Lowering tax barriers to trade provides to the domestic economy all the advantages that the international economy gets from lower tarriff barriers.
Supply-side economists have less to say on the effects of governments spending. Jude Wanniski is to some extent almost indifferent to the effects of government debt. Of course under a floating fiat monetary system interest rates are typically regulated so there is no automatic market pricing to transparently signal crediters views on the nature or level of government debt.
According to Mundell "Fiscal discipline is a learned behavior."
Monetary policy theory
Supply siders advocate that monetary policy should be based on a price rule. The aim of monetary policy should be to target a specific value of money irrespective of the quantity of money than must be created or withdrawn by the central bank to achieve this target.
Typically Supply Siders view gold as the best unit of account with which to measure the price of "fiat" money, which is defined as a money supply not directly limited by specie or hard assets. Hence the purest Supply Siders are in general advocates of a gold standard.
Supply Side economists assert that the value of money is purely dictated by the supply and demand for money. In a fiat money system the government has a legislated monopoly on the supply of base money. Hence it has complete control over the value of money. Any decline in the value of money (or appreciation) is hence viewed as the result of errant central bank policy.
By way of contrast Monetarism is typically focused on targeting the quantity of money in circulation rather than directly targeting the value of that money, whilst Keynesians are focused on the concept of aggregate demand and the targeting of interest rates.
USA Fiscal Experience
In 1981 supply-side economist Robert Mundell, in 1999 to win the Nobel prize for "for his analysis of monetary and fiscal policy under different exchange rate regimes and his analysis of optimum currency areas", told Ronald Reagan that theory predicted that by cutting upper bracket taxation rates, and by lowering rates on capital gains, it would be possible to raise government revenues while cutting taxes. Subsequent budget years did not bear out this prediction, and between 1986 and 1994 a series of tax restructurings and tax increases were passed which raised the percentage of GDP taken as federal taxes to the same level that it had been in 1980. David Stockman, the self-proclaimed supply side Budget Director under Reagan later admitted that the "Rosy Scenario" which he used to justify the predictions was "cooked" and "So the supply-side formula was the only way to get a tax policy that was really 'trickle down.' Supply-side is 'trickle-down' theory." Critics of supply side economics, cited this as proof that the theory had failed, and that the lack of academic credentials by movement leaders such as Jude Wanniski and Robert Bartley show that the theories were bankrupt. Mundell in his Nobel prize lecture countered that the success of price stabilty was proof that the supply-side revolution had worked. The continuing debate over supply-side policies tends to focus on the massive federal and current account deficits that have accumulated in the US since 1980.
Proponents of supply-side economics, such as Canto, argue that this is because of insufficient fiscal discipline - where as critics, such as Solow of MIT and Friedman of the University of Chicago, argue that supply-side economics is garden variety "vulgar Keynesianism", and that tax cuts unmatched by spending cuts and financed by borrowing is within the realm of standard theory. However, the results have eluded both sides of the debate: in supply side theory revenues should have shot up, which they did not, and in classical monetarism, the price stability of the period beginning in 1982 should not have occurred given M1 growth. (For a fuller discussion of the uncoupling of money supply to inflation see Monetarism), where as classical Keynesian theory predicts higher long term interest rates based on standard models - instead, interest rates have continued to generational lows in the US and Europe.
After the emergence of supply-side economics, economists using Supply Side Theory began advocating a flat-tax system, most prominently Arthur Laffer developer of the Laffer Curve, and Jude Wanniski who coined the term "supply side economics". While generally associated with conservative politics, such as former Presidential candidate Steve Forbes, flat tax systems based on Value Add Taxes have been proposed by liberal economists and by at least one Democratic Presidential Candidate.
The paradigm of a tax system which rewards investment over consumption was accepted across the political spectrum, and no plan not rooted in supply-side economic theories has been advanced since 1982 which had any serious chance of passage into law. In 1986, a tax overhaul, described by Mundell as "the completion of the supply-side revolution" was drafted, largely by Democrats in congress. It included increases in payroll taxes, decreases in top marginal rates, and increases in capital gains taxes. Combined with the mortgage interest deduction and the regressive effects of state taxation - which has increased dramatically, it produces closer to a flat tax effect. Proponents, such as Mundell and Laffer, point to the dramatic rise in the stock market as being a sign that this tax overhaul was effective, although they note that the hike in capgains may be more trouble than it was worth. Critics, such as economist Bradford J. DeLong point to the dramatic increase in disparity of wealth as being proof that the result was merely to create "bad productivity".
Criticisms
When vying for the Republican party presidential nominee for the 1980 election, George H.W. Bush derided Ronald Reagan's policy of supply-side economics as "voodoo economics". However, later he seemed to endorse these policies, and is speculated by some to have lost in his re-election bid for allowing tax increases.
Both Reagonomics and supply-side economics have been described with derision as "trickle down economics". The implication being that it represents a set of policies that merely benefits the rich and that the poor are left with the crumbs. These criticisms date back to FDR's criticism of Herbert Hoover's economic policies.
Supply side economics has been critiqued from the right as well, for example hard gold standard advocates, such as the Mises institute, have argued that there is no such thing as a dollar, merely a specific quantity of gold. Therefore, according to this view, the entire central bank mechanism which supply-side economics advocates is a needless fiction which creates anomalies in the price of commodities.
More vehement critiques of supply side economics dismiss the entire project as a complete failure which is "out of touch with reality" and a mere trojan horse for reducing marginal tax rates on upper income brackets. These critiques are found in Samuel Bowles work, which argues that real productivity fell under supply-side taxation regimes on a unit-worker basis. Paul Krugman, of MIT, called supply-side economics "Peddling Prosperity" and dismissed it as being unworthy of serious economists in a 1994 book written for the general audience.
Some History through supply-side economics
Supply-side economics is seen by some as a powerful method of explaining past economic events. The Great Depression, according to theorists such as the aforementioned Jude Wanniski, was begun by the stock market crash of 1929, and greatly exacerbated by the anti-trade Smoot-Hawley Tariff Act of 1930 and a variety of tax increases. The market crash, in turn, was caused by anticipation of the Smoot-Hawley act which would pass the following year.
Many economic events which have been widely debated can be explained with supply-side principles. The rapid price inflation after World War II is generally attributed to "pent-up demand", but supply-siders hold it to be the result of FDR's revaluation of gold during the 1930's. Because prices were soon controlled by wartime wage-and-price controls, the full effect of this weakening of the dollar was not felt until the lifting of the controls.
The 1952 and '58 recessions are blamed on Eisenhower's obsession with balancing the budget and his belief that creating monetary liquidity would create prosperity. The JFK tax plan, passed after his death, reduced marginal tax rates from 91% to 65%, and unleashed a prosperity which lasted until 1971.
In that year, Nixon closed the window for gold convertability. The value of gold, and the dollar, was no longer fixed. The prices of everything started to go up. Supply-siders like Mundell maintain that the Arab oil embargo of 1973 had more to do with the weakening dollar than the Yom Kippur War. The world plunged into inflationary recession, and nobody did anything about it.
Reagan's presidency began with the Kemp-Roth tax cuts, which were 25% across-the-board. But the Federal Reserve insisted on an overly tight monetary policy on the advice of monetarists like Milton Friedman, driving interest rates up to ridiculous levels. The price of gold fell, and the U.S. plunged into deflationary recession. It ended only when Fed chairman Paul Volcker pumped some liquidity into the system to deal with the Mexican financial crisis, which stopped the deflation. The tax cuts kicked in, and everything went along smoothly.
The 1986 tax reform in the U.S. contained a provision which raised the capital gains tax from 20% to 28%. This was the first in a series of factors which led to the 1990-91 recession. The others were the Bush 1990 tax hike, the oil price runup from the first Gulf War, and more monetary blundering by the Fed.
He delivered. His 1993 tax increase was not greeted by supply-siders, but it left the capgains rate unchanged. It is the capital gains tax which most encourages or discourages entrepreneurship and growth. Clinton signed onto NAFTA, which lower barriers to trade, and approved the '96 Telecommunications Act, welfare reform, and the '97 tax cut. These were shrewd measures, which led to a boom.
The bust has its roots in the Fed's policy. The Fed has always seemed to err against inflation, so it hiked rates several times despite the falling prices of gold, oil, metals, and other commodities, early indicators of deflation and an unstable dollar. Then when oil jumped up a bit, the Fed saw red and hiked rates again and again. Then the markets tumbled, and everything went to economic hell in a political handbasket.
Bush was elected, and he cut taxes, but the economy refused to improve. Why? He was running deficits, increasing defence spending, etc.; it seemed to be Reagan redux. However, not all tax cuts are created equal. Essentially, his cuts were based around expanded credits rather than dramatically lower rates. The 2003 tax plan was much more supply-side in nature, and sure enough GDP grew at 8.2% annualized a few quarters later.
External links
- Supply Side Proponents:
- http://www.robertmundell.net/NobelLecture/nobel5.asp Mundell's Nobel Prize Lecture claiming that Supply Side Economics was responsible for growth, price stability and the collapse of the Soviet Union.
- http://www.wanniski.com/ssu.asp
- http://www.wanniski.com/showarticle.asp?articleid=2803
- http://www.washtimes.com/commentary/20031108-111533-9600r.htm
- http://www.polyconomics.com/searchbase/12-15-00.html
- http://www.ashbrook.org/events/lecture/2002/reynolds.html
- Also, Reaganomics
- Supply Side Critiques:
| Macroeconomic schools |
| Keynesian economics | Monetarism | New classical economics | New Keynesian economics | Austrian School | supply-side economics |