Tuesday, April 10, 2012

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.


  1. Sanguine? Holistic? I like it better when you mix sex and oil. Did I mention that you should read...if you haven't already done so..."The Seven Fat Years, and How to Do it Again," by Robert L. Bartley? A bit dated but the principles are still right on.

  2. Thanks Fuzzy -- I do not recall you recommending that book. I will have to check into it.

  3. Does the Fat years relate to pornographic sex?

    Dr. D you have hit the nail and looking back on all we have discussed in humor or serious vain...our solutions fit what you say. We - the US is in a global dogfight and Adam Smith's hand will issue the trophy to the winner later. Right now we are in a new type of economy. Lots of cash on the sidelines. Fear of inflation and fear of 4 more years of Obama.

    Yes there has a been a very strong redistribution of income to the very wealthy. There are many reasons for this and one of them was not a diabolical plot to reduce the middle class to poverty. Nor is there a liberal plot to reduce the US to socialism...since for a good measure we already have some of that in the form of some much needed safety nets called medicare and social security..although there is no security in that.

    There has been no real incentive for investment to go towards all of the great things you listed...and without investment there is no movement in that direction, jobs are not created, education flounders because there is no incentive to be better educated ( the 75% i mentioned several blogs back) and money continues to accumulate in the very wealthy.....except the for Apple products that ..despite their cost...seem to be the first choice of even those on food stamps.

    Dr. D ....you have begun to describe the new economy. Please continue on...I believe if we all can get a grip on it then we have a better chance to succeed in it...or at list survive.

  4. Dear LSD. Well, I guess yer right about KE running out of gas – there’s not much chatter for more stimilus . . . except for the nutcases like Krugman et al, who now seem to have been marginalized. Sooooo, does that mean by default SSE will resurface? . . . as you say restructuring and rebalancing are occurring. As a layman (= not macroman), if R&R is occurring, I think it’s not because of any pro-active/rationalized policy decisions but because world markets cannot tolerate any more debt or stimulus . . . they have gorged themselves and are bloated. R&R may be occurring as default only because there is nothing else to do but let the private sector do its thing.

    SSE/trickle down sounds good, and I prefer it to KE, but I think its critics have a valid point: the Reagan SSE/trickle down did not raise all boats despite prolific economic growth – SSE/trickle down did not perform as promised. You say, “ . . . (sic) the poor are better off/better standard of living than 100 years ago,” which is true, but Reagan’s SSE/trickle down did not strengthen/grow the middle class: the wealth gap between low earners and high earners has widened since his administration. And, I agree that SSE/trickle did not cause that – several factors are culpable.

    U.S. pursuit/adoption of SSE/trickle down will underperform ala Reagan – whether Obumer stays in office or not –if the middle class does not grow in numbers and wealth as a result. You mention education only in the context of state-of-the-art infrastructure to support it; for SSE/trickle down to be successful, the middle class of the future must be better educated to fill higher-paying jobs. But, a better educated middle class can only happen if more effective education polices, teachers, and teaching strategies are adopted . . . more than state-of-the-art infrastructure ---- unless that is what you mean.

  5. Thanks to James and Charles,

    Yes I didn't say enough about education. Rich nations will grow only through increases in capital and productivity. Thee is no way that will spread the benefits across society if we don't have cutting edge education.

    The other issue is poverty and distribution of income. Income growth is very cyclical. Poverty has gone up and down in the last 100 years in cycles. Clearly in the long expansion period after 1980 the poverty rate was driven down. That happened again in the 1990s. Some of what we are seeing lately is cyclical and therefore should be improved if and when the economy improves. So the focus must be on growth for both the short-run and the long-run. KE won't do it. It may take a few more years of languishing to get the point across in the USA -- the same point that seems to be registering already in some places in Europe and Asia.

    1. Antti from FinlandApril 12, 2012 at 3:45 PM

      Hi Larry. Can you be more specific which are the "many nations" that have been trying SSE and SSE Policy?

      After reading that agenda, I get mixed feelings, because what I see is being put into practice in "many nations" that claim to be R&R'ing are only the parts that concur with Bill O’Reilly's and Ayn Rand's "hevonsonta".

    2. Thanks Antii, I miss coming to Finland to teach. Nice to hear from you. What gets put into practice I am afraid is a mixture of everything from left to right. When I say that I see SSE Policy I am saying that I see bits and pieces of it. Greece and Italy are trying to reform labor and product markets. China is liberalizing financial flows. Most transforming nations have privatized companies. Countries do try SSE Policy but of course it is mixed in with Keynesian stimulus, austerity, re-regulation and many other things.

  6. Reagan's "trickle down" didn't lift all boats because a D-controlled Congress didn't implement it in its entirety. We'll never know if it would have worked as advertised just as we'll never know if a Fair Tax would ever work. By the time Congress finished tinkering, a Fair Tax wouldn't look much different than what we have today. The rising tide thing only works if EVERYBODY is contributing to the "ocean." Can't do that when 49% contribute nothing.

    "Ask five economists and you'll get five different answers - six if one went to Harvard."

    1. Thanks Fuzzy. That's why Hoover said he wanted a one-armed economist. The world is never a great laboratory to validify Reagan's or anyone else's policies. Too much is going on. It is hard to control for everything. My doctoral thesis tried to estimate the impact of Nixon's Wage and Price Controls. Woowee. Anyway, while it isn't a real scientific test I like to think that the economic expansion of the 1980s did a lot to raise most boats. Aspects of SSE Policy contributed to that expansion....

  7. I see you are on my favorite topic...education. I agree with Charles and this is infrastructure support. More jobs requiring better education will be part of the new economy. We are far from that right now but we can quickly move in that direction. Locally, my Manufacturing Association is trying to convince high school students that they need to get a good high school education that will enable them to qualify for good colleges (not those phony for profits with bogus degrees that live off of FED subsidized tuition) or good training programs. This would replace Florida's misguided voucher and charter alternative as well as it's left over testing requirements from "no child left behind". Fixing the school problem is a much better challenge than creating or saving government jobs through stimulus and flooding the marketplace with cash. Be proactive and prepare for the new economy.

    1. James, one cannot say enough about the importance of education. Growth in income per capital can only come in the USA from increases in capital usage and productivity. The size of the labor force is not going to be a major contributor. If US companies are going to succeed they are going to have to be one step ahead of all those other countries who are doing the same thing. US companies are going to need the best and brightest employees to win. It seems strange that in a country with such a successful university system that we can't produce the world's best pre-college students. If our rich society cannot win at education we need to figure out why.

    2. Typo above....meant to say income per capita.Not income per capital.

  8. Not to disparage teachers, James, but these days, "good high school education" is a bit like "jumbo shrimp" or "military intelligence."

  9. Fuzzy has issued some fighting words to you James. Are you going to take that lying down?