Demand Side Economics

In the late 1970s Jack Kemp and others started an idea that Ronald Reagan made famous. They called it "Supply-Side Economics", and the general idea is that reducing costs to businesses (i.e. the supply side of the demand/supply equation) would stimulate the economy and result in economic growth. Tax rates were reduced, the economy grew, and Supply-Side Economics was credited for the growth. Since then it was believed that government policies aimed at stimulating the economy in this manner would result in more and more economic growth.

Some who identify themselves as Supply-Side Economists claim that the demand side of the equation doesn't even matter. There will always be demand, they say. Arthur Laffer, one of the most famous of the Supply-Side Economists, says that demand is not a problem. He includes this in a recent book "The End of Prosperity".

Convenient for people like Laffer, another phenomenon that is less often discussed that took place during the same period is the demand side of the equation (i.e. consumer demand). Consumer demand was seemingly insatiable for much of the past three decades. Consumers consumed. They used their savings. They borrowed. When they couldn't borrow anymore, interest rates were lowered, and new ways of borrowing more money were invented. Credit cards were offered to college students and others with little or no credit and even to people with bad credit, and limits were increased. People were permitted to borrow from retirement accounts. Home equity loans were nearly synonymous with ATMs.

This consumer spending by Americans was the root of much of the economic growth over the past several decades not just in the United States but in many other countries as well. In the 80s Japan's economy took off with much of the growth a result of sales to American consumers. In the 90s the Asian Tiger economies took off and in the aughts China's economy grew at double-digit pace every year.

By 2008 American consumers were tapped out. Housing prices had declined so home equity loans could no longer provide a source of funds for consumers. Consumers were also up to their necks in auto loans and credit card balances. When consumer spending declined, businesses stopped selling, and when businesses stopped selling they stopped making profits.

When you talk about economics, a lot of people automatically think of supply and demand. And they'd be right. There is the supply side, and there is the demand side. Both sides are equally important in the equation. 

Bowyer: God Designed Free Market Capitalism

Some often like to start at a conclusion, and then look for facts that support the pre-drawn conclusion. Sometimes they rewrite history to shape the facts so that they support their premise. It’s often said that the Kennedy tax cuts triggered the economic boom of the 1960s. A few clicks of a mouse will tell you that the economy had been booming for years prior to that tax cut. In analyzing the Great Depression these people pick their pet peeve and declare it either as a cause of the Great Depression or a contributor to the elongation.

Christianity experiences something similar. The Bible is such a large and complex book that things can be taken out of context and exaggerated and twisted and spun to the extent that the Bible has been used to support selfishness, hatred, and even war. A good preacher will take a passage from the Bible, a proverb or an entire chapter from an epistle, and teach the message that said scripture intends to teach. A bad preacher will start with his own thought, and then search for scripture references that support what the preacher wants to teach that day.

Hack faux economist Jerry Bowyer commits both errors at the same time. He has been writing some blog entries arguing that the free market model of economics is an economic model designed by God to contribute to the prosperity of mankind. He started off arguing that Adam Smith intended that his “invisible hand” was the actual invisible hand of God himself. In his recent column http://tinyurl.com/4xfajob Bowyer leaves no doubt of his belief that his model of free market economics was designed by God so that mankind could enjoy the fruitfulness of creation.

“God created the world with a plan that free individuals pursuing peaceful commerce would be of benefit to all,” writes Bowyer.

I’m going to get right to the point: there is no evidence whether in economic research or in the Bible that God or some supreme being designed the Universe so that free market capitalism would be a perfect economic system. If Jerry wants to argue that Adam Smith believed that free market economics was designed by God, then he’s free to do so. In fact, it makes not one bit of difference whether Adam Smith thought that free market economics was inspired by God or whether he wore women’s underwear.

But let’s take a look at Jerry’s argument. Jerry writes, “God made a world which is fit for us, and He made us fit for the world.” Indeed He did. I agree with that. But a critical problem arises because a key feature in the mix has been corrupted. When man disobeyed God, man changed, and his relationship with God changed. Man obtained a sinful nature. The Apostle Paul writes, “There is no one righteous, not even one; there is no one who understands; there is no one who seeks God. All have turned away, they have together become worthless; there is no one who does good, not even one.” A key ingredient in God’s utopian economic plan changed significantly.

God’s original plan was to have Adam in the garden tending to the garden and eating the fruits of the trees (except one). But God’s original economic plan changed abruptly. After man’s rebellion (or as Jerry calls it, a “misunderstanding”), God said “Cursed is the ground because of you. Through painful toil you will eat food from it all the days of your life. It will produce thorns and thistles for you and you will eat the plants of the field. By the sweat of your brow you will eat your food until you return to the ground…”

“Painful toil” “all the days of [our] lives” and then we die does not sound how one would describe God’s best economic system God bequeathed upon us to fruitfully enjoy. From a Biblical standpoint, it’s clear that our current economic system is not God’s original plan for us.

With respect to an economic argument, there is no evidence that Adam Smith’s free market economic system was designed by God. There’s no evidence that it wasn’t. But would an economic system designed by God have so many faults and limitations and need so much help from mankind?

Free market economics has unreasonable assumptions like perfect market information, no participant with market power to set prices and no barriers to entry or exit among others. Second, government involvement is necessary for the system to work most efficiently. Institutional infrastructure to enforce contracts, externalities, public goods, police, national defense… Would an all-powerful omnipotent God design an economic system that had so many flaws, unreasonable assumptions and needed so much help from government?

What Jerry is doing here is putting forth a tired argument, and it’s not new. Many politicians purport that God is on their side. The entire Republican Party often tries to claim that God is on their side. It’s a tired argument because it discourages analysis of the actual issues. Jerry declares that free market economics is the economic system designed by God. Who can argue with that? If God is for it, who can be against it? The damage that this argument does is that it discourages careful analysis of free market economics.

Free Market Economics may not be ordained by God, but it’s the best system of economics we’ve got. And careful analysis of the market, its failures, its successes and careful analysis of the effects of government policies are essential in determining the best way to refine the model. Jerry’s argument undermines that. 

A Slave to Figures

They say that if you remain silent then people will think that you’re in idiot, but that if you open your mouth then you remove all doubt. Larry Kudlow has removed all doubt a long time ago. In a recent column http://tinyurl.com/3cax6um Kudlow gives us a glimpse into the depth of his ignorance. This might be failing to see the forest through the trees.

Sometimes economists make the argument that damage caused by natural disasters stimulates economic activity thereby contributing to economic growth. Some argue that the money spent on expenditures to repair said damage would have otherwise been spent on other expenditures thereby resulting in a wash. What both sides of this argument are missing is the very heart of our economy.

What do we want from our economy? Answer: stuff. Why do you get up and go to work? Do you get up and go to work so that the numbers on your bank statement get bigger? No. You do it so that you can have more stuff. You can have a car or a nicer car or a house or buy an x-box or a diamond ring for your sweetheart or take a vacation. The reason we want our GDP figure to be bigger is because a bigger GDP figure represents more stuff we can have. A number on a government report doesn’t do any good for anybody except for a politician who is trying to get re-elected based on the performance of the economy.

So for that reason people think that a bigger GDP figure means a better economy and therefore more prosperity. One thing the GDP figure does not measure is the loss. The expenditures to rebuild the damaged road are included in the GDP figure, but the damage is not included in the GDP figure. Kudlow’s failure to realize that this damage is not included in the GDP figure is his most grievous error.

Kudlow makes the mistake of being a slave to figures. One might consider it failing to see the forest through the trees. 

Stimulus Myths

Genius Jeff Carter writes a column http://tinyurl.com/3uzw4mw that eloquently illustrates some commonly held economic fallacies. I’m going to address these as they occur in his column. 

The first fallacy is that people adjust their behavior to prepare because they believe a future tax increase will result from government borrowing. Way back during the Reagan administration it was believed that people would increase their savings as a result of tax cuts because they believed that taxes would have to be increased in the future. People were surprised when savings didn’t increase. 

This is based on the economic assumption of rational behavior. It is believed that people act rationally. In reality, people don’t act rationally and expect other people to not act rationally either. Oftentimes people count on the fact that other participants in the economy will not act rationally. Back in the late 90s when P/E ratios were going through the roof far beyond what had ever been seen, people knew that the companies behind most of those stocks were not worth what the stock price suggested. But they bought and held such stocks. Why? That’s irrational. The reason they did so was because they expected another investor to act even more irrationally and pay even more for the same stock at a later date. Eventually the bubble burst. 

Another reason people aren’t as a result of government borrowing is because many don’t believe that a tax increase is coming. Talk radio hosts and hack economists like Jeff Carter have convinced many that an increase in taxes results in a decrease in revenue. They’re convinced that a reduction in tax rates will increase revenues. Carter’s suggestion that people are going to change their behavior based on an expectation of a future tax increased as a result of government borrowing is unrealistic. 

Another fallacy is that government borrowing during a recession prohibits businesses from investing. “Let’s say that Peter was going to do something else with the money. Maybe he owns a business and was going to spend $1 on more production. Now he can’t because the government borrowed it.”

This is ridiculous. First of all, the government is borrowing the money in this case, not stealing it. Peter has the option as to whether he wants to put his money into an investment in more production or buy a government bond. If he believes that his investment in more production will reap a healthy return, then he will invest in the production. 

But the fact is that right now businesses are not expanding because they don’t anticipate a return on the investment. Carter writes in his column,“Cash is piling up on corporate balance sheets. Businesses are not expanding. That shows businesses are not investing.” Exactly. Businesses are not investing anyway. Rather than having the cash sitting in a bank account, the government uses the funds hopefully for projects that will benefit society like improving and maintaining infrastructure. 

“Governments cannot invest, they can only spend” is another fallacy brought up by Carter. The fact is that governments do invest. A road is an investment. A road is a capital asset that facilitates production. Let’s face it: the economy wouldn’t be able to function very well without roads. Roads, bridges, ports, dykes and dams, not to mention education and research are all investments.

 Another fallacy that Carter brings up is that the Kennedy tax cuts generated an economic boom. “Two times in the last fifty years have we lowered marginal rates and eliminated deductions. JFK, a Democrat, did it in 1961.” JFK didn’t do it at all. Kennedy proposed tax cuts. The actual tax cuts were signed by President Johnson after Kennedy had been assassinated, and by that time the economy had already been booming for years. 

Carter brings up these fallacies in an attempt to discredit Keynesian stimulus spending. Keynes is dead, he believes.

To evaluate whether Keynesian spending is effective, one must apply it in a clinical setting. With so many inputs and variables that affect economic growth, it’s impossible to tell the exact effect each input has. The only way to do this would to go back in time, change one input and then evaluate the results. This is impossible. But that doesn’t stop us from pondering whether a stimulus can work. 

It is often argued that the benefits of government spending (if any) are more than offset by the reduction in private spending. Those that submit this argument believe that the money supply is fixed, that a dollar spent by government is one dollar less spent by the private sector regardless of whether it is taxed or borrowed. In the long term, that is a valid argument. However, in the short term, it doesn’t hold up.

Jeff Carter already admitted that corporations are not investing. Cash is piling up on corporate balance sheets, he wrote. In the short term, the government can borrow that cash and use it to pay unemployment benefits or teachers or construction workers to build a bridge or public transportation. This reduces unemployment and increases economic activity in the short term. 

Consider the data for economic growth and employment. After the financial crisis the economy shrank and unemployment increased rapidly. A stimulus was implemented in mid-2009, and spending began increasing later that year. As the stimulus was spent, the economy recovered albeit slightly, and the sharply increasing unemployment rate was stabilized. Then in late 2010 and early 2011 as the stimulus funds ran out, economic growth slowed. This is not proof that the stimulus was effective. However, the results do not support the argument that Keynesian stimulus doesn’t have any short term effect at all. 

One question is begging to be asked: Was it worth it? Was it worth accumulating a trillion dollars in extra debt to produce a stimulus that didn't address the causes of the recession, didn't improve our financial position and if anything only produced a temporary minor increase in economic growth? Was it worth it? I think the answer is obvious: HELL NO!!

Cause of Recession

In a recent column found at Townhall Finance http://tinyurl.com/3hox97h one Bill Tatro describes what he believes to be the cause of the current high rates of unemployment: The most significant cause of joblessness and why it will be years before it will be better, he writes, is debt. 

Bill starts off his column by explaining why debt grew so much. “People decided they wanted material possessions instantly, not sometime in the future.” He describes how people wanted cars and vacations and bigger houses and that much of it was financed by debt. [He didn’t mention that low interest rates (thanks Greenspan) made such debt accumulation affordable].

Bill goes on to explain how the economy was boosted by the increased consumer spending. More restaurants, movie theatres and other services in a community to service the consumers led to increased employment [He said that this did not increase manufacturing, but he’s wrong. This also led to increased manufacturing in places like Honduras and China].

Bill explains how spending came to a complete standstill after the housing collapse brought the borrowing and spending to a sudden end. Bill is pessimistic about the future. It is his contention that consumers’ wealth isn’t expected to increase significantly in the near future and that, therefore, he expects the economy and employment to remain in the crapper for a long time.

While Bill missed the fact that low interest rates made the increased spending feasible. He also failed to understand how much manufacturing increased as a result. But, nevertheless, Bill is almost there. He’s right in that consumer spending was a primary engine of the economy for a long time. He’s right that significant reductions in consumer spending are the primary cause of the current economic funk that we’re now experiencing, and he’s right that it will be a long time before consumers recover.

But what he fails to see is that relying on consumer spending as a primary engine of the economy is not sustainable. For decades every time there had been an economic slowdown, you’d hear talk of how to get consumers spending again. Greenspan reduced interest rates and reduced interest rates again and again. Auto loans for 1.9% were common; some were 0% interest. Low mortgage rates. Home equity loans. Consumers were spurred and spurred to spend. Now it’s tapped out.

The solution is not to encourage American consumers to spend even more. There is a huge imbalance in the world economy. Get consumers to spend more or wait until consumer wealth increases so they can spend more is not a sustainable solution. The fact is that the nation’s and the world’s economy cannot be based on an engine that will inevitably result in an imbalance and recession. The world’s economy must adjust and must find a way to progress and grow without depending on American consumers. It’s just not viable in the long term.