Supply-Side Economics

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					Supply-Side Economics

Case & Fair, chapter 18, pp. 395-398
• “Supply-side economics” begins to appear in
  the late 1970s but comes fully into public
  attention during the first Reagan
• Several advisors of Reagan call themselves
  advocates of “supply-side economics” and it
  soon is also called “Reaganomics”.
• “Supply-side” is juxtaposed to “Keynesian”
What is “Supply-side Economics”?

• Supply-side versus demand-side?
• The name suggests a preoccupation with
  “supply” or production
• The implied demand-side would seem to
  suggest a preoccupation with demand.
• Implication: Keynesian economics was a
  “demand-side” economics
      Keynesianism & Demand
• What might be viewed as making Keynesian
  economics a demand-side economics?
  – Centrality of analysis of aggregate demand
  – Centrality of the consumption function in aggregate
  – Notion that the wage is not just cost but “demand”
  – Idea of wrapping capitalist development around
    rising wages, or rising demand.
  – Fiscal &Monetary policy aimed at affecting
    aggregate “demand”
       Keynesianism & Supply
• But what of supply in Keynesian economics? Is
  it neglected or ignored?
  – No, the central issue is the level of overall output,
    I.e., national production, GNP
  – No, in both the Keynesian cross model and the IS-
    LM model we have seen “Y” and increases in “Y”
    are generally the object of policy and appear on the
    horizontal axis.
  – No, the productivity deals of the Keynesian era were
    signed in production, between workers and capital
• Keynesian economics was always
  concerned with both demand and supply!
• Therefore the classification of Keynesian
  economics as demand-side is
• Yet, the “supply-siders” policy
  recommendations are focused on stimulating
• At level of individuals:
   – Tax cuts to increase the incentive to work
   – Anti-welfare cuts in expenditure to increase work
• At the level of the firm:
   – Deregulation to cut costs, raise profits and
     encourage investment
                Tax cuts - I
• Supply-siders argue that high tax rates
  undermine people’s incentive to work
• Therefore, lowering tax rates will increase the
  incentive to work
• Which will result in more work, higher output
  and thus a larger economy
• From which a lower tax rate would draw more
• E.g., Laffer Curve
            Tax cuts - II
• Laffer Curve
          Tax rate

                     Tax Revenues (dollars)
                 Tax cuts - III
• Problems with Laffer’s argument
  – First, those with high income got it by working
    hard,not slacking, so reduction in tax rates not likely
    to produce more work.
  – Second, those with very little income either don’t
    pay taxes or pay so little that little incentive can be
  – Third, many mature income earners might work
    less, rather than more…..
               Labor Supply
• While labor supply is often portrayed for
  simplicity’s sake in terms of an upward sloping
  curve, (increases in wages bring forth more
• In fact, studies have shown that a great many
  mature income earners are on the backward
  sloping part of a backward bending supply
  curve ….
      Backward-bending labor
           supply curve
• E.g.:

                        Labor supplied
          Lowering taxes…..

• Now, for workers in this situation, lower
  tax rates mean higher wages
• Higher wages will means Less rather
  than More work!
      Effects of Lower Taxes:
     raises wages, reduces work
• E.g.:

                          Labor supplied
• The argument about the positive effects of
  lower taxes on individual effort seem only
  applicable to certain workers but not to lots of
• As a result the argument really turns on the
  effects of any reductions in the taxes on firms,
  which would lower costs, and according to
  micro theory increase supply, and in macro
  theory shift the MEC curve up:
                  Taxes & MEC

• Any reduction of corporate taxes that
  reduce cost will also raise expected profits.

  Interest rate


• An upward shift in the MEC curve, for a
  given interest rate will raise investment
  – Raising supply/production/income
  – Raise aggregate “demand” !
• Is this a “supply-side” effect or a
  “demand-side” effect?
       Market vs Government

• A second, very common, description of
  supply-side economics saw it as a neo-
  liberal favoring of the market against the
  Keynesian preoccupation with
  government intervention.
• Unfortunately, while neolib’s embraced
  supply-side economics so did some
  “liberal” Keynesians
        Liberal Supply-siders
• E.g., Lester Thurow of MIT
• Thurow embraced supply-side economics in his
  book The Zero-Sum Society.
• Argued government intervention to stimulate
  investment and output, R&D, technological
  change and higher productivity.
• Accentuation of a very Keynesian theme.
        Supply-side & Growth
• The emphasis of supply-side economics on
  “supply”, “output” etc. resembles the
  traditional preoccupations of growth theory
  that we studied earlier.
• Production functions: Q = f(K, L)
• Growth models, e.g.,
  S = TP, S = I
  MP/TP =  , TP/TP = /
• Growth function of savings, technology
        Crisis of Keynesian Era
• Given the centrality of conflicts in
  “production” to the crisis of Keynesianism
• It is not surprising “supply-side” should focus
  on production
• Crisis of “productivity deal”
   – Wage acceleration
   – Productivity growth slowdown and fall
• Crisis of subordination of production to
  consumption, wage increases, profit declines.
From Consumption to Investment

• Supply-side objective:
   – Reverse rise in wages at expense of profits
   – Shift resources from wages to profits
   – Shift resources from consumption to
• Imposition of poverty as goad to work
• Liberation of business profits and investment
  from public imposed constraints
       Attack on Consumption
• Attack on wages
  – Union busting, beginning with PATCO
  – Chapter 11 bankruptcy to bust unions
  – High unemployment to increase threat of job loss
• Attack on non-wage income
  – Gut welfare, food stamps, legal aid
  – Reduce social security
• Attack on work conditions
  – Deregulation of safety, environmental laws
       Program for Investment
• Cut costs to raise profits:
  – Cut wages
  – Deregulation of safety, environmental
  – Cut business taxes
  – Looser legal framework, less anti-trust
• Channel more savings to business
  – Cut social security, or, government surplus
            Reagan Program
• Four planks:
  –   1. Cut taxes
  –   2. Deregulate
  –   3. Reduce size of government
  –   4. Tight money (to fight inflation)
• Budget proposal:
  – Cut taxes
  – Cut expenditures even more
                Tax Cuts
• Kemp-Roth tax cut plan
  – 10%, across the board, cut of income taxes
  – Cut marginal rates for higher incomes from
    70 to 50%
  – Cut marginal rates for lower incomes from
    14 to 10%
• Faster corporate depreciation write-offs
      Expenditure Changes
• Expenditure Cuts
  – Food stamps, child nutrition, trade
    adjustment assistance, education, retraining
    aid, public service jobs for unemployed,
    regulation enforcement
• Expenditure Increases
  – Big build-up in defense expenditures
  – Star-wars, anti-ICBM laser defense network
          Macro effects - I
• Fiscal Policy
  – Expenditure Cuts would reduce aggregate
    demand and Y
  – Expenditure Increases would raise aggregate
    demand and Y
  – Tax cuts would raise aggregate demand
  – Reduction in transfer payments would cut
    aggregate demand
          Macro effects - II
• Monetary Policy
  – Tight money (Carter appointee Volcker
    continues imposition of tight money)
  – Direct attack on consumption
  – But also attack on investment
  – Higher rates in US mean higher rates abroad
  – Overall impact: contractionary
                Net Effects?
• Intentions:
  – Offset negative effects with positive effects
  – Offset negative impact on consumption with positive
    impact on investment
  – Upward shift in C + I + G ( C?, G < I)  Y
  – Rightward shift in IS curve > leftward shift in LM
    curve  Y
  – Rightward shift in Aggregate Demand function 
    Y , reduction in costs  AS  Y
            Keynesian Cross
• Upward shift in C + I + G ( C?, G < I) 

                   IS - LM
• Rightward shift in IS curve > leftward shift in
  LM curve  Y                                   LM’



                   AS & AD
• Rightward shift in Aggregate Demand function
   Y , reduction in costs  AS  Y


                     AG’                    AD
      What Really Happened?

• The Contractionary effects of tight
  money dramatically offset stimulatory
  fiscal policy, producing a depression
            Keynesian Cross
• Upward shift in C + I + G (G < I, C)  Y

                   IS - LM
• Rightward shift in IS curve < leftward shift in
  LM curve  Y                            LM’


                   AS & AD
• Leftward shift in Aggregate Demand function
    Y > reduction in costs ( AS  Y)

                      AS’                   AD
          Reversal of Course
• Given the depression triggered and its global
  dimensions as high interest rates undercut
  consumption and investment everywhere and
  created int’l debt crisis….
• Volcker reversed course, allowed money supply
  to expand (somewhat) lowering interest rates
  and stimulating consumption and investment.
• This generated recovery 1982-89.