Last week I mentioned supply-side economics as one solution to the tradeoff between inflation and unemployment. I promised to say more about supply-side policy this week.
If your memory is as bad as mine, it won't hurt either of us to review a bit here. Thanks to a guy named John Maynard Keynes and a Paul Krugman band of Keynesians, the dominant view of the economy focuses on spending or what we often refer to as demand for goods and services. The essence of demand-side macroeconomics is that policymakers can attack only one problem at a time.
If they want to reduce the unemployment rate, they use demand-side (AD) policy to ramp up spending. If they want to reduce the inflation rate, they do the opposite. Last week I lamented the situation when both inflation and unemployment are too high. What can the policymaker do then? Attacking inflation with AD policy makes inflation worse. Trying to reduce unemployment makes inflation worse.
What a dilemma! Talk about being between a rock and a hard place. Last week I offered supply-side (AS) economic policy as a way out of this dilemma. Today I have to back up and explain my point.
Let's start with the criticism of supply-side economics. Famous economists labelled it "Voodoo Economics". You have to admit, that's pretty bad. Can you imagine the President telling the voters that he is going to use Voodoo Economics to solve our problems?
Why call it Voodoo? Maybe snake oil would be better? No matter what you call it, the communication is that there is no theory or no history to support the notion of a policy that radically differs from the usual AD policy. If it ain't D it ain't nothing. We know D. It might not be perfect but we know it.
So what's the big difference? The difference stems from an understanding of basic economics. Basic economics posits that we can explain price and quantity sold with a simple model that focuses on supply and demand. Think of two very different situations.
If everyone wants more candy and we express that by going to stores and buying more candy, this is the kind of situation that could lead to a shortage and eventually a rise in prices and output.
If instead the key change is that firms decide that this March is a wonderful time to supply more candy to stores, then we might have a glut of candy and an ensuing drop in price and increase in quantity sold.
Clearly, economics says that a rise in supply has effects that are very different from a rise in demand.
Back to macro. From the beginning of macroeconomic thinking we thought of AD as the driver of the economy. Then someone came along and started talking about AS. Wow. Crazy. But why not? If we can speak about supply in microeconomic markets, why can't we use the same ideas in macro?
There's not a lot more to say. If the current situation of the economy is high inflation AND high unemployment, AD policy is not ideal. The tradeoffs can be very painful. Why not try AS policy? Why not have a policy designed to encourage and motivate firms to produce more? If that policy works, then we will observe firms bringing more output of goods and services to the marketplace. The glut should heal the rising inflation rate while simultaneously reducing unemployment. No tradeoff there!
How do we do this magic? We focus on the AS curve. Two basic forces will increase AS -- lower business costs and higher business productivity. With that logical basis we focus our policy tools away from trying to get people to spend more and instead focus on ways to use policy tools to limit business costs and raise business productivity.
What are business costs? Easy -- the wage rate, taxes on labor, the cost of capital which include prices of plant and equipment, costs imposed by government regulations, and other costs incurred by companies.
What is business productivity? Business productivity rises when a firm does anything that makes it possible to produce more output with the same amount of inputs. Giving workers better machines could do that. So could better training. Better business practices would have the same effects.
Notice the stark difference between AD and AS policy. AS policy might be less well known but in times when AD policy is hampered by tradeoffs, it might not be a bad time to whip up a little Voodoo.
Dear LSD. Ah-h-h-h-h, memories of Reaganomics, trickle-down, and G.H.W. Bush’s ‘voodoo economics’ quote during the ’80 R POTUS primaries campaign against Reagan. Despite the successes of Reagan’s and Trump’s economic policies critics of supply-side emphasize the growing federal deficits, increased income inequality and lack of growth. Ironically, Keynesian economics produces similar resultz . . . so, who ya gunna call? Obviously, lefty folkz prefer prim’n de ol pump/profligate spend’n requir’n heavy taxation whereas righty folkz prefer “responsibile fiscal/monetary” policies ‘n lower taxes/regulation. It’s a kuriosity that despite Reagan’s/Trump’s economic successes some folkz still adhere to the former: A weal hed-skratcher.
ReplyDeleteIn order for trickle down/supply-side to lift all boatz the economy needz more than wut supply-side offerz, such as better edukation to match learning with skills that a techno-transitioning economy needz (‘n git de unionz out’a edukation), ferin policies that pursue fair global trade, ‘n immigration policies that don’t dilute the earning potential of ‘murikan citizenz—to cite a few. Voo-doo by its own self simply won’t doo.
‘appy ‘our only an ‘our + 45 away! Cheerz!