Again I am tossing in a debate idea in the hopes that I will become more enlightened about this issue. We hear a lot about “supply side economics”, but I rarely hear a peep about its converse. Wasn’t it Henry Ford I who decided that stimulating the demand side of things (which would include but not be limited to increasing employee pay, hiring more workers, increasing benefit levels so as to allow for more discretionary income, etc.) was the best way to get the economy going? Or are there hidden negatives involved in doing so (inflation?).
Henry Ford had enough wits to put together a car assembly line but he didn’t know economics.
Here’s an experiment we can try to test the validity demand-side economics. You pay your kids (an allowance) to do chores around the house: wash dishes, rake leaves, do laundry, etc. Instead of paying them a paltry dollar or two, you pay them hundreds or thousands of dollars for each chore. Now, your kids have enough money to pay off your mortgage!
Demand-Side. It’s like magic.
It’s not that simple.
An economy is operating efficiently when the supply of goods and services meets the demand for goods and services to the extent of the financial capabilities of the people. It’s operating efficiently when capital is flowing to the places that represent the highest value at that point in time, when productive capacity is being built that closely matches the future needs and demands of the population, when people are employed efficiently in jobs that best utilize their skills and abilities, etc.
Now, you can have a situation where you are taxing and regulating the supply side too much, driving up prices, depressing capital investment, and reducing incentives for people to work hard to grow businesses. In that case, supply-side reforms allow the economy to become more productive. Prices fall, new jobs are created, GDP goes up, and that in turn raises the standard of living of all.
You can also have a situation where fear or uncertainty or financial messes reduce demand such that you have an over-production of goods and services. Then companies start laying people off, and you wind up in a recession.
We can talk all day about the causes of recessions and their fixes, but for the purpose of this argument we can say that there are times when you need to fix the supply side, and times when you need to shore up demand.
The danger of any government intervention, whether it be supply side or demand side, is that it distorts the market. Market distortions through government action cause malinvestments and inefficiencies that ultimately reduce the productive capacity of the country and slow the growth of GDP and the rise of the general standard of living.
As a quick example, let’s say that the auto industry is laying off people because production of autos is greater than the current demand for autos. Should you give tax incentives or subsidies to people to buy autos and shore up demand? Well, that depends. Maybe the supply of autos is too great because people don’t want to drive as much. Maybe patterns of work and leisure have caused people to permanently shift their preferences slightly away from autos. Or maybe the auto companies that are hurting are making poor quality autos and people are buying others instead. In those cases, stimulating the demand for those autos is doing a disservice to the country- it’s applying an artificial inducement to re-balance demand with current production. But the money has to come from somewhere, so other people are being taxed to pay for it. The best course of action is to let the market take its course.
But what about a case where you know that the lack of demand is truly temporary? It would suck to allow your auto companies to go bankrupt, only to find that you have a shortage of autos once demand picks up when the economy recovers.
The trick is sorting out the second kind of demand loss from the first. And that’s something government is really bad at doing. That’s why Milton Friedman famously said that the most efficient form of demand-side stimulus would be a helicopter drop of money across the entire population. But governments are influenced by lobbyists, and tend to direct stimulus money at special interests. That causes distortions and inefficiencies.
The moral of the story: only the corporation can be trusted with money, because the company you work for is like your parents, and you are like a child.
You free-market types all make this claim, which can be easily dismissed by real world examples of tightly regulated economies growing at an incredible rate, like China for the past 20 years. A large, powerful company can “distort” the market every bit as much as government interventions can.
Truth is, nobody in the whole world REALLY understands economics, and nobody can make an honest claim to know exactly what will result from X intervention. For example, we know a 0% tax rate is ridiculous, and the same is true for 100%. Every value between the two goes further into a gray area, and the optimal tax rate is not obvious. Also, you can’t simply dismiss the element of morality in economics. Money is a way for people to have power over other people, and that power needs to have at least some oversight, or people will literally enslave other people. Where you decide morality intersects with economics enough to justify regulation or intervention is not necessarily where others would agree the intersection site is.
To the OP, of course you’ve heard of Demand Side Economics. Every time you hear the term “consumer economy” it’s referring to demand-side economics. The demand-side is driving the push for unionization, lower prices, the surge in Chinese imports, and any number of other phenomena.
I wouldn’t be so quick to question Ford’s knowledge of economics, when you apparently don’t know the difference between a few children and a labor market, nor between a household and a goods-producing business.
Demand side economics is just Keynesianism, conventional economic theory that’s been the standard for decades. Supply-side people are the superstars who told us that if you just slash taxes and regulations then the economy will work much better.
Yeah, its called mainstream economics. Its like how nobody talks about how 2+2=4 anymore.
One aspect of mainstream economics is the Keynesian effect of deficit spending. When there is overcapacity in production, you can utilize deficit spending to take up the slack. Enough deficit spending can overheat the economy and cause inflation at the same time that your government is making interest payments on all that deficit spending.
One of the effects of Ronald Reagan’s tax cuts was that it created huge budget deficits and as the government was pouring more money into the economy than it was taking out in the form of taxes. This is probably what created the growth in the economy not any of that other voodoo bullshit.
If it wasn’t for stagflation caused by the oil shock, there would never have been a question about whether there was any legitimacy to supply side economics but in the throes of the oil shock, we reached for the snake oil hoping that it would work. And it turned out that MASSIVE deficit spending (the deficit when Reagan left office was about as large as when Baby Bush left office was the ticket.
I’m not comparing one family’s children to the global “labor market.” I’m comparing parents and children to the typical naive reading of Henry Ford’s economic rationale.
He paid his workers more because because his factory techniques were productive enough that he could afford to pay them more and he was trying to stop employee turnover. Unfortunately, he mixed up the direction of causation and was able to later spout nonsense about paying his workers more so they could have money to buy his cars which was (supposedly) better for the economy.
Sam - do you actually have a real economy example for where supply side economics actually worked in a major economy for the long term? Didn’t work for the Regan era, the Japanese are still mired in their post bubble version, and I’m not sure if you would call what Dubya did “supply side” or not.
Thanks for playing.
Is that you, David Brooks?
He let forth with a flood of “Demand Siders” in this column. I’d never heard the term used by anyone before.
I thought the typical free marketer would say he should pay his workers the least he could get away with, and not pay them more just because he could. After all, in the short term this would increase his profits. Any evidence that turnover was a problem? I believe he specifically said he wanted to pay his workers enough so that they could afford a Ford car - was he lying?
Henry Ford didn’t understand economics? Well, I guess that explains why he ended up living his life in miserable poverty, then. Another mystery solved!
First of all supply side economics is a creation of right-wing ideology not serious economics. Even market-oriented academic economists don’t identify themselves as “supply-side”.
Secondly the central idea of the movement: cut top marginal rates to improve productivity has been largely discredited. The basic idea is that cutting these tax rates will provide a strong boost to investment and worker productivity and therefore boost growth and the evidence for this is weak at best. From a historical pov. productivity growth in the US was higher in 50’s and 60’s with very high marginal tax rates than it was in the 80’s when those tax rates were slashed. Clinton raised those rates and yet productivity growth actually increased in the late 90’s. Bush cut those rates again and clearly economic performance since then hasn’t been impressive.
Having said all this, that doesn’t mean that there is some “demand-side economics” which will work all the time either. Most of the time the economy isn’t demand-constrained and there is about enough demand relative to the potential output. If there is too much demand you get inflation. It’s only during a recession when demand is insufficient that you need expansionary monetary and fiscal policy to stimulate the economy.
As for the supply-side it is extremely important in the long run if you want increase the overall standard of living. However government policies to boost the supply side don’t fall in some clear ideological pigeonhole. You need to make sure that the economy is reasonably business friendly but that doesn’t necessarily mean low taxes. If you have good infrastructure and educated workers, the private sector can thrive even with fairly high taxes; for example the Scandinavian economies are among the most competitive in the world. Low trade barriers and low inflation are probably more important than low taxes.
Sounds like Keynesian economics. But I know little about the subject. Supply side economics, in its current form (giving all the tax breaks to the wealthy/powerful and deregulating them), is not really about economics anyway it is more of an attempt to curry favor with the wealthy and powerful due to ideological and financial reasons. It is no different than the union between leftists and unions, its about currying favor first and economics second.
But focusing on demand is important. China’s domestic markets are supposed to be opening up soon. Making US consumers more stable (feeling they/we won’t be fired tomorrow) will help grow the economy.
I think the best way to compare supply-side/demand-side policies is to think about short-term/long-term problems.
A supply-side friendly policy can potentially increase the long-term economic growth of a nation by creating an environment where business innovation is better rewarded. This does not mean a quick-fix to a troubled economy. Rather, it means creating enough market freedom where people have the right incentives to make better goods with more efficient production techniques. The entire economy, and all the people, could eventually benefit. It just takes a while. The problem is that that’s not ever what “supply-side economics” is billed as in the popular media. Ideological hacks cite it as some sort of panacea, which it absolutely is not. The people who promise short-term benefits from such a supply-side policy are cads. Those who say we would receive higher government revenues immediately, if we would only lower taxes, are ignorant, idiotic, or deliberately dishonest. Unfortunately, such people still have a prominent place, even today, in modern political discourse. Ridiculous, but there it is.
Demand-side policies, in contrast, are typically assumed to be unnecessary.
Demand is often thought to take care of itself. But this simply isn’t true when the economy is suffering deflationary pressure. Demand needs a boost at times like the Depression when prices are dropping, or threatening to drop in the future. Which includes, notably, our current economic crisis. What we desperately need right now, today, even as I write this, is more aggregate demand spurred by our economic authorities. But this is a short-term problem. We don’t need our economic policy-makers to stimulate demand forever. They should do so only until this deflationary cycle is broken, the unemployment rate is dropping quickly, and economic growth is strong again.
China’s economy is, as you say, tightly regulated. But it is nevertheless much less tightly regulated than it was 40 years ago. Their current extraordinary growth is the direct result of liberal reforms.
China is making up for lost ground.
Of course, eventually they will use up all the easy pickings. Eventually their growth will slow. But their growth will plateau more quickly, far short of the productivity level of advanced nations, if they do not implement more market reforms. We don’t have to have perfect knowledge of optimal tax rates or market regulations to have a good idea of a general range. China is still well outside that range. They must reform further, or their growth will stall prematurely.
Japan’s not a good example. The Japanese central bank didn’t play ball. For twenty years, they’ve been making the exact same mistake, keeping their money tighter than it should be. All those fiscal manipulations are for naught if the central bank is pulling in the other direction.
As for Reagan, well, some people make the argument that the supply-side reforms of the 80s did create the foundation for stronger long-term economic growth compared to other advanced nations (keeping in mind that said reforms were also, exactly as Damuri Ajashi noted, big stimulus boosts to demand at the time, in the form of lower taxes/higher deficits.) I mean, I don’t particularly buy the long-term growth argument myself. And even if I did, advanced economies could still quite rationally make a choice for slightly lower economic growth in exchange for more government services in the present.
But the argument from Sumner that I linked is both well thought out and intellectually consistent, which is more than I can say about most of the other things I’ve read that advocate any sort of supply-side position, which is typically Laffer curve nonsense.
And it would explain why most economists are billionares!
Being a good businessman is not the same thing as being a good economist.
I don’t think that’s entirely true. It’s more of a political issue than anything else. Most economics seem to be in agreement about price floors (minimum wage) and ceilings (rent control), industry subsidies and protectionism ultimately being bad for economic growth. But people will still demand those things if they feel it’s in their best interest, regardless of any unintended consequences.
First of all, only businesses are creating wealth because they are the mechanism by which raw materials are converted into the products and services that people value. According to supply-side economic theory, the economy grows when businesses are allowed to create more wealth, more products and employ more people.
So why doesn’t it work (or not work to the satisfaction of Liberal-minded people)?
Well, for one it doesn’t really do anything for people who work in low-skilled jobs, don’t work for successful companies and otherwise don’t add a lot of economic value.
Also, I think there is a tendency for wealth in corporations to trickle up, not down. Most employees tend to get paid market wage for their skills, while the excess value created tends to go to paying bonuses for executives.
Stop thinking about supply and demand side theories, and instead look at policies. Right now we have excess industrial capacity and lots of capital available for investment., but not enough demand to cause companies to hire more workers or for banks to lend money. St this point in time we need to think of ways to increase demand by raising minimum wage, govt investment in long term assets (bridges, dams, schools), extending unemployment, etc.
In the future we may need to do something different when the conditions call for it. What we have done is the worst possible thing: deficit spending in good times and now the unability to spend while we are in a doldrum.
You do realize supply side economics is political bullshit, right?
Its a combination of basic economics combined with partisan wishful thinking.
Yes, there are market failures due to monopoly, lack of information, and other causes. Market distortions can be caused by all sorts of things. No doubt about it.
I’m not an anarchist. I’m not even a hard-core libertarian that believes government should completely stay out of the economy. I believe that government’s role is to maximize freedom and make sure markets are functioning correctly. That’s why I support government interventions that correct honest-to-God market failures.
It’s when government goes farther and tries to actually manipulate well-functioning markets in order to ‘improve’ them that it starts screwing things up.
Exactly my point. Which is why it’s generally better to just it alone and allow it to adjust itself. The reason the free market works is because it has negative feedback control loops built into it. No one has to control it, just like no one has to control an ecosystem. If things get out of whack, they self-correct. No one person can make a pencil let alone a car, and yet we make pencils and cars every day, generally in exactly the right quantities, and we distribute them exactly where they need to go. We do all this without a grand pencil czar, because the market transmits the information required to those who need to know it and adjusts when things get out of whack. The information required to make these decisions is distributed in the minds of thousands of people. It does not exist in any central location.
This is why government can’t out-perform a properly functioning market. It doesn’t have the information needed to make good decisions, and it can’t keep up to speed with changes in supply and demand.
I never said anything about tax rates. I was answering a question about ‘supply side’ vs ‘demand side’ in general. I wasn’t making a Laffer-curve argument or suggesting any optimum tax rates. I wasn’t even talking about taxes, really. I was thinking more along the lines of helping the supply side by removing barriers to production. Hell, you can have ‘supply side’ reforms by simply making government more efficient - say, through regulatory streamlining or even hiring more inspectors so that you can reduce permiting delays.
And that would be why you have laws and a constitution. These are better tools for addressing actual civil rights issues. Social programs would be the next best way to do that. The worst way is to manipulate the market through the power of government to make it more egalitarian.
If the market creates externalities, it’s acceptable for the government to create policies which correct for those externalities. According to many economists on both the left and right, you can actually make the market more efficient by adding taxes (“Pigouvian Taxes” if you want to look it up), if the taxes rebalance the market to force it to account for the cost of the externalities. That’s partially the argument behind carbon taxes.
But if a market is free, and all participants are absorbing the costs of transaction and all of them have the information needed to make good decisions, then the government shouldn’t inject itself into the middle in order to force some kind of social change. For example, if one person works harder than another, and as a result starts accumulating wealth faster than the other person, it’s not the government’s business to interfere in the actual market to remove the harder working person’s advantage. All that does is destroy efficiency. But that’s what government does when it imposes price ceilings, or sets quotas, or erects trade barriers.
I think the use of these terms is somewhat unfortunate because they’re ill-defined and politically loaded. I would not consider the drive for unionization to be ‘demand-side economics’. For the purposes of this discussion I assume we’re talking about government policies that are intended to stimulate the economy. ‘Supply side’ policies would seek to stimulate the economy by reducing barriers to business growth, while ‘demand side’ would be government policies seeking to increase the demand for goods and services.
To me, ‘Supply side’ policies are effective any time business is being hindered excessively by regulation or non-competitive taxes. They can work in good times or bad. "Demand side’ policies are specifically useful during times of abnormal, temporary short-term decline in demand, and their sole goal should be to correct for distortions in the market caused by recession, natural disaster, bubbles popping or other problems where it’s believed that the reduction in demand is greater than it will be in the near future. You don’t need them when you have full employment and reasonable levels of consumer spending.