For instance, the wealth created by the CEO of Lehmann Brothers. I hope by this point you don’t still think high CEO salaries are always justified, do you?
Right, the engineers who actually do the innovation and who make < the magic $250K number do nothing. In Iron Man Tony Stark does everything by himself, but that’s not the way it is in real life. I have no problem with CEOs getting more money, but they aren’t smarter than they were 30 years ago, despite the fact that the multiplier of what they make vs the average employee has soared.
I don’t believe trickle-down or bubble-up are sound economic policy. Building an environment that helps small businesses is what will best build great national wealth and distributes it better than the government could ever hope.
Laws should not protect mega-corps that hide assets out of the country. It should never favor corporate raiding, it should protect against trusts and dangerous consolidations in the financial businesses. You need to balance free trade with a strong and large middle-class.
Free trade also does not include subsidies for agri-giants and big oil and laws that aid insurance companies. The welfare system has had a good overhaul that has made a big difference. Now it is time to go after the corporate welfare and get them off the public teat too.
The missing factor in the ‘bubble up’ economy idea is Opportunity Cost. The government is not the holder of a big bag of goodies to distribute the people, and it’s just a matter of whether they give the goodies to the poor or the rich. The government has no wealth. The government doesn’t make wealth. The government makes choices about how the wealth of society will be distributed. It reserves for itself the right to take X% of society’s wealth and allocate it where it sees fit.
Thus, every time to spend a dollar of tax money, you must not just consider the benefit you’re going to get for the money, but the opportunity cost represented by what other things the money could have been spent on.
When you hear a politician say they are going to spend X billion dollars to ‘create jobs’, you have to remember exactly what it is they are advocating. They are saying that if we extract a certain amount of money from one part of the economy, and inject it into another, we can create jobs that wouldn’t otherwise exist. They never tell you how many jobs will be lost when they extract all that money in the first place. This little game works because the losses in the wider economy are more diffuse, and harder to pin onto a single factor. And the jobs created are very visible, with government officials issuing press releases and holding ribbon cutting ceremonies and happy articles are written about all the new jobs.
No one writes an article for the young woman who lost her job in the shoe store because the tax increase pushed the small businessman over the edge and caused him to go out of business or scale back workers to make ends meet.
It’s hard to see trickle down. Like the diffuse firings, it happens a little bit in a lot of places. New investment in technology drives down the price of a product, which means the purchasers of those products now have excess money that is used to buy other things or to invest.
And, the tax system doesn’t live in a vacuum. There are many other forces pushing on the economy, making cause and effect hard to see. Incomes are flat in the lower classes in the U.S., but whose to say that trickle-down has failed? Perhaps the U.S.'s focus on the supply side has kept stable incomes from being declining incomes. The U.S. is coming under increasing pressure from foreign labor, illegal immigration drives down labor prices at the low end. Skyrocketing energy prices are dragging wealth out of society. It’s not just the tax structure driving wages.
If you want to see what a ‘bubble-up’ economy looks like, you don’t have to look far. You’ve been living in one. One of the bigger forces on GDP growth in the last few years was the housing boom. The housing boom was a demand-side phenomenon. Driven by low interest rates and the creation of Fannie Mae, Freddie Mac, and the CRA, demand for housing was driven up by the government. The result of the rapid expansion of demand was skyrocketing home prices. That stimulated growth in the construction industry. Jobs were created. As people’s homes went up in value, many took out second mortgages and drove demand even more by buying luxuries, getting home renovations, or spending in some other way.
So did that make society wealthier? Nope. Because the money was borrowed against assets that don’t exist. It turns out that pumping up the construction industry was probably a big mistake, because when housing starts return to normal there will be an oversupply, and companies will go under. All that effort and time building a company, all the knowledge, and the opportunity value of what those people could have been doing had they not been building houses, all gone. What a waste.
Then the borrowed money has to be paid back, since it was borrowed against imaginary assets. So now we’ve got lots of new homes, but no money left to buy other new things or invest in other new businesses, because we now have to pay off all those homes.
In the end, a bubble winds up being destructive because of all the distortions it created while it existed. That’s what you ultimately get with a ‘bubble-up’ economy.
As was said earlier, there are times when a demand side stimulus makes sense, but it’s only temporary, and it’s only to correct a structural defect caused by the business cycle or a changing economy. You’re basically borrowing from the future to safeguard the now. Like all borrowing, there comes a time when you have to stop collecting and start paying back.
For all countries, the trade deficit is equal to the difference between national savings and investment. So for a given quantity of investment (that is, purchases of houses, plant, equipment, cars, etc.), higher savings will produce a higher trade surplus.
Put in another way, if national savings declines, it will come out of some combination of lower investment, lower exports or higher imports.
One way of repressing national savings involves having a higher budget deficit. So if you cut taxes and keep governmental spending the same, the country will have some combination of lower investment and a higher trade deficit.
None of the above is obvious. That’s when the equations come in.
I’m going to divide up national income into “Consumption”, “Investment” and “Exports minus Imports”. Exports add to national income. But some of that consumption and investment consists of stuff imported from abroad, so we have to net out imports as well. As for government purchases, they must be either “Consumption” (spending for now) or “Investment” (spending for later). So I’ll just drop that variable for clarity.
Oookay.
Y = C + I + X - M
Income (aggregate demand) = Consumption + Investment + Exports - Imports.
Now I’ll define something else: Savings. That’s Income-Consumption, the spending that we set aside for later.
S = Y-C.
So far, so intuitive. It’s when we rearrange those 2 equations that we get the surprising result that I indicated above.
S=Y-C=I+X-M
or
S-I = X-M : The gap between savings and investment necessarily equals the trade deficit.
Since the mainstream media forbids the use of equations, you will read about this only obliquely in the business section, if you see it at all.
Conclusion: if you want a smaller trade deficit, you should support higher national savings. One method could involve a lower budget deficit - higher taxes and/or lower spending. As for stimulating savings, automatic savings plans - with an opt-out option - like the 401U proposal deserve a look.
Ok. In my view tax cuts for the rich do precious little for the supply side. I invite those who disagree to present peer-reviewed empirical evidence to the contrary.
If you want one single important element in long run growth I would say, “Technological innovation”.
And if you are intent on tax policy, I would recommend something like 1986 tax reform.
…and let’s not forget the regulatory failures by the government. After all, Fannie and Freddie were started in 1968. This excerpt from today’s NYT’s piece shows that Countrywide thought that Fannie and Freddie were becoming irrelevant in 2004.
Fannie and Freddy were created in 1968, but the rules changes that allowed them to run amok didn’t start until the 1990’s. The housing boom started shortly thereafter.
But your larger point is well taken - there were lots of factors in the housing boom. But I think you’d agree that regardless of the cause, the effect was a demand-side stimulus - just what the OP is calling for. The result was not pretty.
Thank you, Sam, for you’ve just led me to a realization that I’d like to put forth for discussion. It’s never quite struck me this way, so the following is “thinking aloud” rather than a well thought out argument – perhaps this line of thought is familiar to you and you’ll be able to readily and easily tell me where I’m going wrong. With that said…
I notice that early on, your explanation includes the phrase “goods and services”. As it progresses, however, you end up leaving out the “services” part and focus on (tangible) goods. It strikes me that this is – potentially, at any rate – a vast oversight.
It’s commonly said that the U.S. is moving away from being an industrial economy, moving towards something else (often characterized as “service”, “information”, “high-tech”, or even “post-industrial”, which is the moniker I’ll use). That is, as McCain is wontto say, some jobs are gone and just aren’t coming back. (Note: cites are given with no partisan intent; I believe both candidates proclaim the need for “new” directions, be that education, new technology, or what have you.)
The point is that “production” in a post-industrial economy doesn’t consume resources the way you’ve characterized it above. Rather, in the case of information technology, it may very well just be some guys with a couple computers, an idea, and the drive to implement it (witness the genesis of Google). Or, in the case of services, it may be the close-to-minimum wage pool cleaner, burger flipper, etc. Or, in the case of the entertainment industry, it may be actors, writers, musicians, etc.
Clearly, these people are making new “things” that other people want (“things” in quotes to indicate their intangibility). Clearly, if these people were not doing whatever it is that they’re doing, there would be a lesser number of “things” to consume. It seems to me that the primary resources being consumed in these cases are not tangible resources…rather, it is time.
Now, assume the trickle-down stance. How does one invest in these post-industrial workers? Or, rephrased: “what is the most effective way to free up the resource of time (for these people)”? For those at the lower end of the scale, paying less in taxes – a large relative difference, although a minor amount in absolute dollars – would accomplish just that.
Furthermore, there’s a numbers game involved: a cost reduction (e.g., a tax cut) applied at the high end of the scale would free up a large amount of captial, but only affect a small number of people. The same reduction applied to those lower on the scale wouldn’t free up as much capital, but it would affect a huge number of people. If there’s little call to plow capital into production costs, then it seems obviously beneficial to me to distribute a small total (but relatively large) benefit to many.
Now, of course, there’s still a large component of the economy that is not post-industrial to which the above doesn’t apply. And even those areas that do fall into the post-industrial sectors still require some tangible resources. So that’s an issue. And I know I’ve come across breakdowns of the economy by sector; right now, I can’t even think of what terms to google (it’s late and I’m a bit frazzled now). Depending on that split, the above might be utterly misguided, but I wanted to put it out there anyway.
On preview, two things: (1) an exemplar post-industrial worker is Voyager’s engineer. S/he is producing wealth, with very little capital necessary. (2) I suppose you might summarize the above as a different view of your Opportunity Cost. If “tangible resources” is no longer the restrictive bar of production (rather, time for thought is), then distributing opportunity across the broadest range is the best course of action.
This analysis doesn’t get to the root cause of the housing bubble. Yes, the demand increase certainly was the proximate cause of the real estate bubble. However, if that demand was based on rising income instead of cheap credit, it would have been a real estate boom instead of a bubble. From the late 90s on, real interest rates have been very close to zero. This allows creative financing such as interest only loans, and ARMs to be realistically affordable for people. It also drives investment into real estate and equities because interest on bonds and savings return almost nothing.
I don’t believe this for a minute. Rich people got that way by participating somehow in the system which exploits lower-paid, harder-working and more vulnerable others. It’s how capitalism works… wealth created by the labor of the powerless many, funneled by a pre-conceived, coercive system to the powerful few.
I agree with your first paragraph completely. Lower corporate income and capital gains taxes (low, as in zero), an extremely scaled back workmen’s compensation scheme and tort reform in a number of states where the latter two are currently driving jobs away would be a good start.
I don’t get your second paragraph. I’m not aware of any laws that ‘protect’ corporations that decide to move assets out of the country. Ditto for corporate raiders. But I am willing to be educated on these.
Agree on your 3rd paragraph.
I have enjoyed reading the discussion on this post. Especially MeasureForMeasure’s and Sam Stone’s input. Those two guys (women?) are two of my favorites.
But I have to admit I always get puzzled when the conversation gets into the minutae of which knob the government should try and turn this way, or that way, to stimulate this side, or that side, of the supply-demand equation. I love equations and economic complexities as much as most people.
But shouldn’t we make it simple as possible? Isn’t that the best course of action? To make taxes, which are inherently a behavioral modification device, as simple, as understandable and as little prone to political meddling as possible? Because we all know that politicians will inevitably screw it up and start distorting the economy one way or another when they get their hands on those knobs and levers.
Yeah, I re-thought that one this morning, but didn’t feel that the minor correction added much. Like I mentioned, I was kinda frazzled by that point.
If anyone feels the need, substitute lawyers, due diligence fields, marketing departments, think tanks, etc. for the engineers. Any profession that produces intellectual property (e.g., reports, patents, software, etc.) as its primary final product.
That’s not quite right either; as pointed out, intellectual property is often only a stepping stone towards implementation. Or, it may even require resource consumption to produce (e.g., laboratory experiments). But I can’t think of a better way to phrase it, so I’ll leave it as a fuzzy concept that has substance at its core and trust that pedantry won’t dominate.
What you’re essentially describing is the notion of a knowledge worker. The key thing to keep in mind is that training knowledge workers can cost a considerable amount of money.
Consider a lawyer working for a law firm. First, this person needs a law degree and to pass the bar exam. Then they need to become familiar with the way things are done around that firm. To work with a particular client, they need to be familiar with that client’s situation and issues. They also need to be able to find laws that are relevant, and they probably need a support staff to do things like filing, copying, etc. (although this staff can be shared among multiple attorneys). They also need to be paid enough to prevent them from seeking work elsewhere. All of this adds up to a considerable investment.
Hate to break it to you, Sam, but transfers are neutral with respect to market efficiency. That’s right, robbing Peter to pay Paul may sound morally reprehensible, may get everyone irritated (but Paul, of course), but in the end it will not impact market efficiency at all. (In a perfect market…) Don’t kid yourself that there is just one efficient allocation of resources. There are many, many allocations that are effecient. When we make transfers, we travel from one to another, that’s all. Wealthy people, I know, like to think that they got there strictly on their own gumption, and it may be true for some of them, but more likely it is just true for some of their wealth. Transfering wealth is a sticky moral question.
You are right, this is a real consequence and it is sleazy for politicians to not discuss costs along with benefits.
This is why real measures are so important. And real income did not track productivity growth. We are poorer now than we were eight years ago. It did not trickle down.
Please listen to what you’re saying. To me, a better economy is where we get to buy more and work less. An economy that isn’t doing well will fail to meet that goal. This economy has failed to meet that goal. We are working more but buying less. This is easy to see.
All true. But productivity gains went somewhere. Where, do you suppose, they went?
I could not possibly disagree with this statement more. At least, if I understand it the way I think I am understanding.
Are you saying that if, for example, the corporate income tax rate goes from 10% to 40%, for example, and that extra 30% is used to pay for something (in other words, it is taken from ‘Peter’ and given to ‘Paul’) that has absolutely no impact on market efficiency? Or the creation of wealth?
Is that what you are saying? Or am I misunderstanding. I’m perfectly willing for it to be the latter. Just want to be sure.
In general, the benefits of a transfer are exactly met by the costs of it. There is no net benefit/cost to society. I realize now that Sam’s comment about opportunity costs probably indicated this in a different way, and that I am not disagreeing with him in any significant sense.
It will effect market efficiency in the sense that it will leave one point of maximized efficiency to move to another. This “other” point may be the same point or it may be a different one. A one-time transfer in itself will not stop the market from equilibrating. The free market doesn’t “break” or stop working just because some transfer is made, as I’m sure you can imagine if you think about it for a moment. (How would a transfer break the invisible hand?) You can think about it like this: transfers do not destroy wealth. The same amount of money is chasing the same amount of goods and services. Whose money it is has changed, but that’s beside the point. (That’s a moral question.)
Taxes are bad for other reasons. They can discourage consumption or investment. But it is not because they are a transfer. My point is rather narrow and possibly uninteresting, but important. The moral question is “Should we rob Peter to pay Paul, and if so, how much is ok?” while the economic question is “what means do we have at our disposal to do this, and what are its economic effects?” I hope this clarifies.
Ignoring the too-narrow scope of the term, it doesn’t affect the supply side (or trickle down) economics as presented at all, what with its focus on tangible goods/“things” and its consumption vs. production dichotomy. For instance:
There is no “overabundance of supply” when discussing intangible products, nor can there be (beyond the market demand). However, there is certainly consumption of these “things”, intangible though they be.
Sometimes yes, and sometimes no. In many cases you can rent the capital. Want to make a new chip? You don’t need to build a fab, you can send the design off to Taiwan to TSMC to have them make it. if you have a web app, you can rent server space and bandwidth. Microsoft, for example, started very small.
While I’m here, let me mention opportunity cost, since I just published a paper on this subject as applied to engineering. The problem is that it is very difficult to predict how the money will be used. We’d expect that it would be put in an area of greatest expected return, but that may or may not be in funding investments. It could be applied to a psychic return (fancy car, big house) or in risky stock giving a good return at the moment, like sub prime mortgages. So, when you talk about the opportunity cost of a high end tax cut, you need to discount it for nonproductive uses. Low end cuts, on the other hand, can probably be predicted better, since they will be applied to necessities, and thus drive up consumption.
And Sam should read the NY Times article Measure for Measure linked to. The Dems did indeed press Fannie Mae to take more risks, but so did the White House. In fact they were losing market share by not being aggressive enough in buying these crap loans. They definitely screwed up, but it was due in large part to the good old free market.