The ABCs of the Supply Side Economics Myth

Supply side economics has been used by the political right to justify giving preference to the wealthy in the form of tax breaks and related incentives. The concept is that if there is product or service available they (meaning consumers) will buy them. Further, the supply of goods and services will force prices downward and more products or services will be purchased, thus stimulating the economy. The slogan often heard is tax breaks for the job creators – i.e. the business owners. But, the real job creator are you and me every time we spend a dollar. This is the real undergirding factor of job creation.


The problem is that business owners respond to the demand for their products and services. Admittedly, some products and services are either insensitive to the general economy and others thrive in a down economy. But for the most part demand for goods and services decline with an economic downturn. For these business owners whose demand declines in the downturn the obvious and best strategy is for them to cut their costs. Some costs are variable and can be reduced such as inventory and labor, other costs are fixed and cannot be cut, such as debt repayment and utilities. Cutting the variable costs may ensure the viability of the enterprise, and even permit it to prosper, albeit less robustly, in the down economy. When the firm cannot cover its fixed costs it will not be long for this world. This is an application of micro-economic theory for the firm. The aggregate effect across the economy of firms cutting their variable costs is to further weaken the economy. Unemployment rises and the demand for raw goods or services enhancing the slowdown.


The role of government in a recession is not to follow micro-economic strategies and cut expenses to balance the budget, but rather to enact a macro-economic strategy to stimulate the economy. Thus the government’s strategy should be countercyclical. That is, to provide an economic stimulus in a down economy and counter-stimulus actions in a heated economy. Balancing the budget or cutting expenses is exactly the wrong thing to do in a downturn. Stimulant actions include expanding unemployment benefits, lowering taxes on lower and middle income families (i.e. those with a very high propensity to spend the additional monies available to them), and fund government projects such as infrastructure improvements.


We have just experienced the worst recession since the Great Depression of the 1930s. In fact it has been called the “Great Recession.” It was not a normal business cycle recession which is characterized by a few quarters of downturn followed by economic growth. Business cycle recessions are typically self-correcting. A government stimulus package can shorten it if it seems unduly long or deep. But, what we experienced in 2008 was a debt recession. Wealth was wiped out for almost all Americans. For low and middle income families housing prices tumbled and people owed more on their mortgages than their homes were worth. Investments in retirement programs lost up to a 1/3 of their value. In short the balance sheet of most Americans took a severe tumble and those balance sheets needed to heal before there could be a recovery.


Part of the recovery came from the modest stimulus package under the leadership of the Obama administration and the Democratic controlled 111th Congress passed in 2009. It was a 787 billion dollar 10 year plan with a focus on the first three years. The stimulus included increases in unemployment payments, tax cuts and expansion of federal contracts, grants and loans. This was a good start, but less than needed and was followed by austerity moves leading up to the Sequestration implemented in 2013 under the then conservatively controlled House and Senate. This was clearly three steps forward, then two backward. On another front, the task of stimulating the economy fell on the Federal Reserve and monetary policy. The Fed began a massive purchase of government securities forcing down interest rates, which have been at historic lows ever since. This could have two effects. The first being to encourage business owners to take out loans and expand their businesses. This is something like trying to push something with a sting. Business owners in a recession, especially one as deep as this one are looking to cut costs, not take on fixed cost obligations. The other impact of the Fed’s action was to bolster the stock market. With interest rates at practically zero, the stock market was the only place to put excess funds, with which major corporations were loaded. This had the effect of helping re-establish retirement funds and other investments ravaged by the collapse of the financial 2008. In short, the long recession we have slogged through and which we are slowly emerging from could have been shortened by enlightened fiscal policy that the conservative congress placed secondary to addressing the national debt – i.e. cutting costs, austerity moves including the Sequester.


Finally, the national debt is a problem, and it will need to be addressed. But it should be addressed in good times, during economic expansion, not during periods of economic downturn. Some argue that the debt places a substantial drag on the economy, and it can have some negative impact. But much more an economic limiter is income inequality. When sufficient income does not flow to the lower and middle classes that have a much higher propensity to spend the extra monies, the economy suffers.


One last comment. Some have argued over the years, including this one, that a businessperson in the Whitehouse would know how to stimulate the economy and create jobs. For example, this is being said about Donald Trump and the same was said about Mitt Romney and the MBA credentialed George W. Bush. Don’t fall for this logic. Businessmen and women live in a micro-economic world. They are not accustomed to operating effectively in a macro-economic environment. It is counter-intuitive for them. Businesspeople have a narrow focus which serves them well in their micro-economic world. But, for the leadership of the United States and to a large extent the world, we need someone with a broader framework and interest.

                                                                                                                                                                                                                                                          Sam Gould

                                                                                                                                                                                                                                                          September, 2016