New Age of Supply-Side Economics Part II.

Last week I spent some time trying to convince you that the Age of KE (Keynesian Economics) was being replaced by a new Age of SSE (Supply-Side Economics). I had so much fun bonking KE on the head that I ran out of juice and could not get to the best part – convincing you that SSE and SSE Policy are not evil monsters born of Bill O’Reilly and Ayn Rand but are legitimate policy options already being considered and tried in many nations. In fact, polite people these days are stressing policies of restructuring and/or rebalancing and these are really buzz words for SSE Policy. To bring all this out of the closet, let’s make a big point here:

            SSE Policy =  Restructuring

            SSE Policy =  Rebalancing

I feel a lot better now. I hope you do too.

But let’s start from the beginning. In a recent post I emphasized that economics is generally a discussion about demand and supply. It hardly makes any sense to talk only about demand. If you want to discuss procreation you talk about males and females. It makes no sense to focus on just one sex. As they say – it takes two to Tango. So the first thing to note here is that macro can and should focus on both of these main parts of markets – demand and supply. This is exciting stuff, eh? But it shouldn’t be. Why did macroeconomics survive for about 60 years ignoring SSE and SSE Policy?

This reminds me of the Internet joke that is going around now about the mother whose tiny daughter asks her what a virgin is. After stammering around for quite a while saying embarrassing things about sex to a five year old the mother takes a breath and the daughter asks her a second question. Mom, if that is what virgin means, what is extra virgin? Apparently her first question was about olive oil. It was not about sex.

That joke actually has nothing to do with this post but I have learned from experience that my readership improves proportionally to the number of times I write the words sex or oil prices.

The supply curve represents the actions of business firms as they decide how much to produce. Firms tend to supply more (and hire more workers) whenever their leaders envision a future with product prices and worker productivity rising relative to business costs. This is the kind of time period when firms see better returns on their investment. This kind of sanguine future supports the risks of investing in more capital, labor, and technology. It works in reverse too. If the macroeconomic environment is expected to be typified by wages and other business costs rising faster than product prices and productivity, firms are not going to buy more equipment, hire more labor, or otherwise invest in output expansion. They might, in that case, plan to reduce output.

Consider where we find the US and much of the world’s economy in early 2012. Huge government debt creates worry about riskiness of finance and is retarding company investments. Huge overhangs of money create a worry of future inflation and the eventual proportional increases in wages and business costs. So long as monetary and fiscal stimulus remain stretched it is hard to persuade business firms to produce more. Add to that a number of new government regulatory bodies producing literally thousands of pages of new business regulations. 

It is not surprising to find that the supply curve is hiding in the corner. It might sound backward to Keynesians – but one way to juice up the nation’s output is to convince these firms that wage inflation or interest rate escalation is not around the corner. Or convince these firms that the government is going to take firm control over the nation’s debts and will quickly clarify the details of regulatory compliance. Such a prudent macroeconomic policy would – therefore – lead to more certainty and optimism on the part of business firms and should cause them to hire more workers and produce more. 

So there’s your first SSE Policy—focus attention on reversing stimulus from the Fed and from the Government. Focus policy on reducing the uncertainty of future regulations.  

Reversing stimulus and regulatory burdens, however, are just the tip of the iceberg when it comes to SSE Policy. SSE is a holistic attitude toward economic well-being. This attitude recognizes that economic well-being comes from companies that create more and better jobs. And those companies exist and thrive when they compete, manage, and innovate as they meet existing and new needs of the world’s citizens. We somehow delude ourselves into thinking that somehow government manufactures economic welfare. Blackberry and Nokia are two recent examples of many. Samsung and Hyundai also offer testimony to the importance of companies. I admit that at some point in the history of these firms a government might have had some influence over their development. But the reality today is that no government can save Blackberry and Nokia from the ferocious surge of competition unleashed by Apple products. And no global electronics or auto producers can safely laugh off the challenge from Samsung and Hyundai. Firms come and go. The best ones meet the demands of the public. The best ones create employment opportunities and income growth.  

This holistic attitude has no room for KE. Instead it provides the kind of national atmosphere that strengthens competitive response. This agenda has at least the following components:

• •       Increasing national saving so that firms will find ample funds with low cost of capital
• •       A more flexible labor market that builds and motivates a skilled labor force and allows firms to flexibly hire and fire workers
• •       Laws and regulations that promote and facilitate innovation and entrepreneurship
• •       Low tax rates on income and removal of barriers that impede investment and the process of translating scientific advancement into new products and services
• •       State of the art infrastructure that supports all of the above with respect to communication, transportation, scientific research, education, training, etc.

My KE friends worry that the above list ignores one important thing – income distribution. The above looks like another party for the rich. Most of the ideas above seem to fit a trickle down story that the rich benefit directly greatly from a SSE Policy and only a few crumbs get dispersed to everyone else. Some of my KE friends would say that we have tried some of these things in the past and the poor get farther and farther behind. To my KE friends I would say that you are wrong for a couple of reasons. First the lives of most poor people in America today are infinitely better than what they were 100 years ago. The benefits of income and general living standards (including health, safety, etc) came because business firms have grown and provided millions of jobs and increases in real incomes.

Second, if the rich have benefited disproportionately in the last 10-20 years – it is not because we did too much of the above SSE Programs – but because we did too little. The US economy is in a global competitive dogfight that shows no signs of abating. Instead of unleashing our resources our corporate-government elite sat in private meetings off-microphone and restrained our companies. Corporatism reins in America as witnessed by the penchant for bailing out huge corporations. Meanwhile we become less and less able to unleash furious competition as we piss and moan and fight among ourselves about bailing out this group or that one. America is a great country with great people. A strong and clear SSE Policy is all we have to stay in the race.