Republican supply side theology

This week a reader forwarded me an e-mail that a Republican-minded friend of his had sent him arguing, in relatively broad strokes, how “supply side” economics had “proven” to be the most effective way of fostering economic growth in this country.  For the uninitiated, supply side economics is the cornerstone of contemporary Republican economic philosophy and suggests that the economy will grow when taxes and government spending are cut and as “intrusive” government regulations on private sector businesses are reduced.  It’s a reasonable theory, but the weight of the evidence (economics, like other social sciences, rarely, if ever “prove” things) suggests that the claims of supply-siders are at best overblown, and, at worst, harmful to both aggregate economic growth and, especially, the middle and working classes.

Nevertheless, Republicans cling to supply side economics in the same way that most cling to the notion that global climate change is exclusively a result of “natural causes.”  Rather than simply arguing for the benefits of a sound monetary policy and the role of sensible government interventions in our mixed economy, let me tackle the problems with the arguments made in favor of supply side economics.

Argument #1: The strong growth of the economy from 1983-1988 proves that supply side economic policies under Ronald Reagan were the key to prosperity.

As with global climate change, the factors influencing an economy are complex and it is simplistic to pull out just one factor and promote it as the exclusive cause of success or failure.  Lower taxes may have contributed to prosperity during those years, but so did successful monetary policy and traditional Keynesian deficit spending.

The most important factor in moving away from the macro-economic instability and “stagflation” of the 1970s was the role played by Paul Volcker (a Carter appointee) as chair of Federal Reserve bank.  As chairman, his initial policies were designed to engineer a sharp rise in interest rates — something antithetical to the principles of supply side economics.  His policies, however, served to tame inflation rates in a much more effective way than any fiscal policy could.

Another reason for growth in the mid-eighties was actually Keynesian (a bad word for supply-siders, who only associate Keynesianism with government spending) in nature.  Under Reagan, taxes were cut and spending was greatly increased — much of it going to the military build-up that “ended the Cold War” (maybe I’ll tackle that Republican myth  another time).   Deficits can certainly cause problems in the long run, but, in the shorter term, they can be an important tool in reviving a moribund economy – whether your last name is Reagan or Obama.

Argument #2: The Obama-led stimulus package “held back” a more robust recovery.

“Where did the stimulus money go?” is one of the great cries of Republicans these days.  It must have been wasted, right?

Not exactly — but on the other hand it did not really provide much stimulus either.  Why?  The temporary increase in federal government spending during the first years of the Obama presidency were almost completely offset by spending cuts at the state and local level during those years.  So, in the aggregate, it was practically a wash.

What the stimulus did do was prevent a bad situation from getting worse.  There’s pretty strong evidence for this, such as the consensus of the non-partisan Congressional Budget Office, but I think the best point of comparison is to examine how the United States has fared compared to other countries that have suffered similar financial sector- led economic meltdowns.  As a chart on this site chart shows, the U.S. is pretty much in the middle of the pack when it comes to comes its recovery — which makes sense given the middle-of-the-road fiscal approach to the recovery.

Argument #3: What about the how those irresponsible Europeans and how their debt problems caused their economies to fall apart?

This just plays into the current Republican narrative without looking at the facts.  I can almost see Paul Krugman tearing his hair out every time he hears it.  Of the three big problem economies in Europe thus far, Spain, Ireland, and Greece, only one, Greece, can trace its economic woes to its profligate government spending.  Ireland suffered a private sector financial collapse much like ours and Spain was actually running a surplus when it’s economy fell apart.  That leaves Greece, which was running major deficits AND had other huge structural problems in its economy that made the future of  economic growth look feeble.  Unfortunately for the Greeks, the “solution” to the problem that has been forced upon them has included deep, immediate spending cuts that have sent their economy tumbling even further, causing an even worse crisis.

European supply side austerity hasn’t been limited to Greece.  Two years ago Republicans celebrated the sound decision of the British government to cut spending during the current economic downturn.  What’s happened in the interim?  Looking at past and projected economic growth in the U.S. and Britain since then reveals that U.S. growth is about 50% higher.

Argument #4: Yeah, well, they should all just cut taxes because it will actually raise revenue…

In the short run, this argument is just plain silly — like saying that someone will lose weight if they would just eat desert more often.  In the longer run, though, it is worth thinking about — can lowering taxes now create more growth that eventually results in a broader tax base?

Maybe, but, as always, there are other factors to consider.  First, here’s a graph of economic growth over the last fifty years.  Can you tell when tax rates were higher or lower (hint: there is no apparent relationship with growth rates)?

Second, cutting taxes without cutting spending can actually hurt economic growth by increasing the deficit and creating upward pressure on interest rates (which is actually not a problem these days because interest rates are at near historic lows).  This is why modest tax increases under the first two years of the Clinton administration (before Republicans took charge in Congress — sorry Newt!) likely helped jump-start the economic boom of the nineties.

Argument #5: Right — so we should cut taxes and spending!

This is an honest and fair argument, and might even lead to higher long-term economic growth (or it might not, as the earlier chart of economic growth suggests).  The problem is that cutting spending means making deep cuts to programs that people really like.  Medicare, Social Security, and Medicaid payments make up over 40% of the budget, and only a small percentage of the population really wants to make major cuts in these programs.  Sadly, when people say they want to cut government spending they usually have in mind welfare, food stamps, and foreign aid, which only make up a small (think lower single digits) part of the budget.

Personally, I think Democrats should be make clear that there are quality-of-life expenditures for which it is worth sacrificing a little bit of economic growth.  Of course, given that the federal spending is a smaller part of the U.S. economy than any other country in the developed world — and many of those other countries are just as wealthy as us — well, we’re not exactly on the road to a socialist utopia.

Argument #6: Yes we are, Obama is a socialist and trying to recreate America in his image

Actually, the number of civilian federal government employees has remained largely unchanged since Obama took office.  The average American is also paying less taxes.  New government regulations on the private sector have been passed at a slower rate than under a similar point under President Bush.

Argument #7: Whatever, we’re headed down the same economic path as North Korea and Cuba

I give up.  How about something less controversial?  Wanna talk about health care?


Posted on March 23, 2012, in Uncategorized. Bookmark the permalink. Leave a comment.

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