FacebookTwitterGoogle+RedditEmail

What is Supply-Side Economics?

by PAUL CRAIG ROBERTS

 

Supply-Side economics was dubbed “Reaganomics” by the media. If you were for Reagan, that meant you were for it. If you were against Reagan, you were against it. That’s as far as public understanding ever went.

Even today three decades later few people beyond economists familiar with macro-economic theory know what it is. Liberals think it means tax cuts for the rich and call it “trickle-down economics.”

Libertarians believe it is a variant of Keynesian economics that fuels consumer spending with federal budget deficits. Conservatives believe it means leaving more money in the pockets of those who earn it. Other people think it means that tax cuts pay for themselves. President Reagan’s vice president, George H.W. Bush, said it is “voodoo economics.”

Supply-side economics is none of these things. It is a theoretical innovation in macro-economics.

The two professional economists who had the first insights into supply-side economics were the University of Chicago trained economist, Norman Ture, and the Canadian economist, Robert Mundell, a Nobel prize-winner in economics.

I knew both. When I was a professor of economics, I reviewed for Mundell scholarly contributions for publication in the prestigious Journal of Political Economy of which he was editor. I served in the US Treasury with Ture.

Supply-side economics corrects a fundamental mistake in Keynesian economics. Most everyone has heard of supply and demand, but Keynesian economics, known as demand management, left out supply.

In Keynesian economics demand is the important element. Supply responds to demand. The way Keynesians saw it, demand needed to be high to maintain full employment. The original Keynesian economists were very sensitive to unemployment and the human suffering associated with the Great Depression. They attributed the depression to insufficient aggregate demand to keep everyone employed, and their economic policy was keyed to insuring sufficient demand.

Keynesians believed that private demand would tend toward insufficiency. To guarantee full employment, Keynesians had the federal government overspend its revenues, thus adding to aggregate demand the amount of the budget deficit. There were two ways to overspend revenues: keep federal spending constant and cut tax revenues or keep tax revenues constant and increase federal spending.

Original Keynesians regarded monetary policy as impotent. They relied on fiscal policy. Later Keynesians, under assault by monetarists such as Milton Friedman, corrected this view. By the time I entered the fray, Keynesians used monetary policy to pump up demand to provide full employment, and fiscal policy in the form of high tax rates to control inflation. The Federal Reserve pumped money into the economy to keep demand and employment high, and fiscal policy took money away in taxes so that inflation remained low. Or at least, this is how it was supposed to work. By the mid-1970s it was obvious that it wasn’t working.

What supply-side economists pointed out to Keynesians is that high tax rates did not control inflation. Instead, high tax rates contributed to inflation.

Keynesians believed that fiscal policy only affected demand. The government could add to aggregate demand by cutting taxes, for example, and running a budget deficit, thus overspending the revenues that taxation drained from the private sector. Or, to fight inflation, the government could raise taxes to drain demand from the private sector and not spend the revenues. But for Keynesians fiscal policy had no effect on aggregate supply.

Supply-side economists pointed out that fiscal policies, such as changes in the marginal rate of taxation, altered relative prices and shifted the aggregate supply curve, not the demand curve. An increase in marginal tax rates–the rate of tax on additional income–reduces the after-tax rate of return (or earnings) from work and investment and results in a lower level of supply. Lowering marginal tax rates increases the rewards to work and investment and, therefore, increases aggregate supply.

The Keynesian policy caused “stagflation” and worsening “Phillips curve” tradeoffs between employment and inflation, because high marginal tax rates caused a reduction in labor input and a reduction in the rate of saving and investment. What was happening was that people and companies were responding to higher demand by raising their prices instead of their output.

Supply-side economics established that fiscal policy shifted the aggregate supply schedule. In his famous economic textbook Nobel economist Paul Samuelson included me and a diagram showing that supply-side economics was an argument that fiscal policy shifted the aggregate supply curve in contrast with the Keynesian emphasis that it shifted the aggregate demand curve. Samuelson declared that the real argument was over the magnitude of the shift.

In other words, the most famous American economist of the 20th century accepted the supply-side theory and said its importance for economic policy depended on its magnitude. Several economists provided empirical evidence of the magnitude, but the disappearance of worsening trade-offs between employment and inflation settled the issue for most.

I myself debated most of the Keynesian Nobel prize-winners before university audiences or before annual meetings of economic associations. When the argument was presented to them, they understood the point and accepted it. I received a standing ovation when I gave the annual State of the Economy address at MIT. The story of how supply-side economics came to be can be found in my book, The Supply-Side Revolution, published by Harvard University Press in 1984. A concise technical statement of the theory can be found under my entry in The New Palgrave Dictionary of Money and Finance, the leading reference work for economics.

There is nothing fly-by-night about supply-side economics. It corrects a Keynesian oversight and puts aggregate supply back into policy considerations. As a member of the congressional staff during 1975-78 working to bring supply-side economics to the fore, my most important allies were three Republicans, Jack Kemp and Marjorie Holt in the House and Orrin Hatch in the Senate, and three Democratic senators, Russell Long, Lloyd Bentsen and Sam Nunn.

Stagflation and worsening trade-offs between inflation and employment resulted from an incorrect economic policy mix that pumped up demand with easy money while restraining real output with high tax rates.
Supply-side economics corrected this mistake, and we have not seen the problem since.

Supply-side economics was a major innovation in macroeconomic theory and economic policy. It was a correction of an oversight, not a magical formula. A quarter century ago before the days of the high speed Internet and US offshore outsourcing, supply-side economics revitalized the economy’s ability to grow without having to pay the price of rising rates of inflation. This battle was fought and won long ago. Re-fighting it is a waste of time and energy in an era of new serious problems.

The George W. Bush regime was faced with no stagflation and no worsening trade-offs between employment and inflation. The Bush administration did not use changes in the marginal rate of taxation to correct a mistaken policy mix or an oversight in economic policy.
Income distribution is a legitimate issue. This is especially the case when offshore production and jobs outsourcing are destroying the American middle class.

I am not a partisan of dubya’s tax cuts. Just as dubya hides behind “freedom and democracy” to wage wars of naked aggression, he hides behind supply-side economics in order to reward his cronies. There seems to be no American value or legitimate principle that the Bush regime is incapable of despoiling.

PAUL CRAIG ROBERTS was Assistant Secretary of the Treasury in the Reagan administration. He was Associate Editor of the Wall Street Journal editorial page and Contributing Editor of National Review. He is coauthor of The Tyranny of Good Intentions.He can be reached at: paulcraigroberts@yahoo.com

 

 

Paul Craig Roberts is a former Assistant Secretary of the US Treasury and Associate Editor of the Wall Street Journal. Roberts’ How the Economy Was Lost is now available from CounterPunch in electronic format. His latest book is The Neoconservative Threat to World Order.

May 02, 2016
Michael Hudson – Gordon Long
Wall Street Has Taken Over the Economy and is Draining It
Paul Street
The Bernie Fade Begins
Louis Yako
Dubai Transit
Bill Quigley
Teacher, Union Leader, Labor Lawyer: Profile of Chris Williams Social Justice Advocate
Patrick Cockburn
Into the Green Zone: Iraq’s Disintegrating Political System
Lawrence Ware
Trump is the Presidential Candidate the Republicans Deserve
Ron Jacobs
On the Frontlines of Peace: the Life of Daniel Berrigan
Ron Forthofer
Just Say No to Corporate Rule
Ralph Nader
The Long-Distance Rebound of Bernie Sanders
Ken Butigan
Remembering Daniel Berrigan, with Gratitude
Nicolas J S Davies
Escalating U.S. Air Strikes Kill Hundreds of Civilians in Mosul, Iraq
Binoy Kampmark
Class, Football, and Blame: the Hillsborough Disaster Inquest
George Wuerthner
The Economic Value of Yellowstone National Park
Rivera Sun
Celebrating Mother Jones
Nyla Ali Khan
Kashmir and Postcolonialism
Mairead Maguire
Drop the Just War Theory
Weekend Edition
April 29, 2016
Friday - Sunday
Andrew Levine
What is the Democratic Party Good For? Absolutely Nothing
Roberto J. González – David Price
Anthropologists Marshalling History: the American Anthropological Association’s Vote on the Academic Boycott of Israeli Institutions
Robert Jacobs
Hanford, Not Fukushima, is the Big Radiological Threat to the West Coast
Ismael Hossein-Zadeh
US Presidential Election: Beyond Lesser Evilism
Dave Lindorff
The Push to Make Sanders the Green Party’s Candidate
Peter Linebaugh
Marymount, Haymarket, Marikana: a Brief Note Towards ‘Completing’ May Day
Ian Fairlie
Chernobyl’s Ongoing Toll: 40,000 More Cancer Deaths?
Pete Dolack
Verizon Sticks it to its Workers Because $45 Billion isn’t Enough
Moshe Adler
May Day: a Trade Agreement to Unite Third World and American Workers
Margaret Kimberley
Dishonoring Harriet Tubman
Deepak Tripathi
The United States, Britain and the European Union
Eva Golinger
My Country, My Love: a Conversation with Gerardo and Adriana of the Cuban Five
Richard Falk
If Obama Visits Hiroshima
Vijay Prashad
Political Violence in Honduras
Paul Krane
Where Gun Control Ought to Start: Disarming the Police
David Anderson
Al Jazeera America: Goodbye to All That Jazz
Rob Hager
Platform Perversity: More From the Campaign That Can’t Strategize
Pat Williams
FDR in Montana
Dave Marsh
Every Day I Read the Book (the Best Music Books of the Last Year)
David Rosen
Job Satisfaction Under Perpetual Stagnation
John Feffer
Big Oil isn’t Going Down Without a Fight
Murray Dobbin
The Canadian / Saudi Arms Deal: More Than Meets the Eye?
Gary Engler
The Devil Capitalism
Brian Cloughley
Is Washington Preparing for War Against Russia?
Manuel E. Yepe
The Big Lies and the Small Lies
Robert Fantina
Vice Presidents, Candidates and History
Mel Gurtov
Sanctions and Defiance in North Korea
Howard Lisnoff
Still the Litmus Test of Worth
Dean Baker
Big Business and the Overtime Rule: Irrational Complaints
FacebookTwitterGoogle+RedditEmail