Supply-side economics

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.

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 Keynsian economics failed to explain the stagflation of the 1970s and failed to provide a clear solution for the series of recessions which occured in the wake of the oil crisis in 1973.

Supply-side economics grew out of monetarists critiques of Keynesian economics, and instead focused on encouraging investement, 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. A production-centred macroeconomic world view was behind the writing of both classical economists Karl Marx and Adam Smith, despite the fact that in modern times the ideas of both these authors are seen as being complete opposites. However, in contrast to the modern Keynesian world view, these authors actually focused on the means of production (as opposed to the effects of demand).

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 Reaganomics was only partially based on supply-side economics.

Fiscal policy theory

Supply side economics holds that increased taxation steadily reduces economic trade between economic participants within a nation. 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.

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policy should be to target a specific value of money irrespective of the quantity of money than must be created or withdrawn by the central bank to achieve this target.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

Critics of the supply-side economics theory maintain that in the 1980's it was 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.

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.

Critics of supply side economics cite this as proof that it has failed as a theory, while its supporters argue that the failure to balance the budget was the result of insufficiently aggressive budget cutting.

After the emergence of supply-side economics, economists using Supply Side Theory began advocating a flat-tax system. 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.

Criticism of

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 George W. Bush Sr. as President continued the policies begun by Ronald Reagan, and lost in his re-election bid, to no small extent, because he was perceived by many in his own party of having allowed a tax increase.

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 of date back to FDR's criticism of Herbert Hoover's economic policies.

Supply side economics has been critiqued from the right as well, 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 anomolies 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 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.

External links

Supply Side Proponents:

More at: Reaganomics

Supply Side Critiques: