[Beskargam]

so learning about economics this semester, lots of fun. doing economic theory now, and seeing as how there are lots of bright minds here, is supply side economic theory valid? or is it completely bogus? iv seen some of the criticism and support for it.

[Mustang19]

is supply side economic theory valid?

Not entirely.

Both "demand" and "supply" side theories are overly simplistic in their literal sense. There isn't any necessary disagreement between the two approaches, however, just a difference in emphasis.

The simplest way to describe the two theories is that supply siders generally believe that the economy grows fastest with little or no government intervention while demand siders generally believe that an unregulated market will regularly enter periods where aggregate demand is insufficient (such as recessions or depressions) and government intervention is necessary to correct this. Before critiquing either theory I'll discuss what they mean. You can skip the next paragraph if you just want to hear about supply siders. Not saying you haven't learned this stuff, just making sure we're on the same page.

The most important example of demand side theory is Keynesianism or Keynesian Economics; Keynesian economics was largely elaborated in John Maynard Keynes' General Theory of Employment, Interest and Money published in 1936. Demand siders believe that a sufficient level of aggregate demand in the economy is important to sustaining growth. Aggregate demand is the total demand for goods and services in an economy at a given price level; demand is the desire to own something and the ability and willingness to pay for it. Aggregate demand is calculated using the exact same formula as the consumption approach used to calculate GDP: Consumer spending + Investment + Government spending + Exports - Imports. Keynes believed that in some situations aggregate demand (AD) in an economy regularly rises and falls during the business cycle and government should stabilize AD by taxing more and cutting government spending when it is too high during a boom (this is called countercyclical fiscal policy) and lowering taxes, raising government spending and running a government budget deficit (procyclical fiscal policy) when AD is too low. Keynesians believe low unemployment and high GDP growth are seen at the crest of this business cycle while high unemployment and low or negative GDP growth are seen at the trough. An example of some elements of Keynesianism in practice is the recent financial crisis when economic stimulus spending was dispatched and high government deficits were run to raise AD to combat unemployment and declining GDP in 2008-2009.

Okay, now on to supply side economics which has an entirely different focus. The "bibles" of this school are probably The Way the World Works by Jude Wanniski published in 1978 and The Foundations of Supply-Side Economics by Victor Canto published in 1983. Supply siders believe that the most effective way to boost economic growth is to lower barriers and disincentives that hinder the production of the supply of goods and services in an economy. They also tend to believe that the economy functions optimally with minimal government regulation and taxation. In practice they advocate less government regulation of the economy of all kinds, no tariffs or subsides (in other words, they support free trade), and perhaps most importantly a flat tax model- that is, a tax system where all income tax brackets are the same or close to it. For instance, in the United States someone making over $1 million a year pays about 30% of that income annually in taxes after progressing their way through all the tax brackets while someone making $30,000 a year pays around 10%. A supply sider would want everyone to pay the same, lowest possible percent- let's say 20% or whatever core government functions require to stay funded- of their total income in taxes because they believe requiring the rich to pay more reduces their incentive to work and supply the economy with goods. Supply siders also sometimes point to the Laffer Curve- a curve that supposedly shows that beyond a certain point higher taxes reduce government revenue because they reduce economic production so greatly that not enough wealth is left to tax to compensate. Supply siders believe that a flatter tax model and all the aforementioned policies they support will increase economic growth.

"Reaganomics" became a popular term during Ronald Reagan's 1980 presidential campaign as you know; it is a supply side ideology. Sorry- a supply side theory. One of Reagan's advisers told him that if he cut taxes, economic production and the available taxable wealth would increase so much that the tax cuts would quickly pay for themselves. The economy did do well in the 80s, but it's not clear if Reagan had anything to do with it, and rather than tax cuts paying for themselves the government got itself deeply into debt. Even the Wall Street Journal admitted in 2003 that Reagan's tax cuts did not pay for themselves.

The main problems with original Keynesianism- some of which later revisions of the theory were developed to correct- include it's oversimplification of the economy, it's disregard for monetary policy, it's trust in human rationality, it's inapplicability to stagflation scenarios, it's empirically unsupported position that high saving rates are bad for growth, and the theory's inability to completely explain malinvestment and financial crises.

Supply side economics has many flaws as well. There's the aforementioned failure of the Laffer Curve, although one can reject Reagan's claims about this and still be a supply sider. Important problems include a failure to explain malinvestment and the business cycle and it's assumption that human's expectations are rational and informed. Supply side economics also fails to acknowledge that government spending in areas like infrastructure, research, and education can increase economic productivity. Another common criticism is that supply side theory lacks scientific merit and is mainly used as a way to justify less taxes for rich people.

Whether an economic theory is scientifically correct and useful for making predictions is a separate issue from whether it is normatively "good".

If you ask me, Mainstream economics is probably the most valid approach out there from a scientific, positivist standpoint minus it's rational expectation theory. It is a suitably boring and non-ideological approach. But it's not a matter of completely valid or invalid; no accepted theory thoroughly explains the economy or is able to reliably predict economic events. It helps to study them all and see which parts are useful.

Economics gets really complicated after the 200 level. But as long as you like math it should be fun. Hope I helped you a bit.

[Unknown Target]

I have seen so much talk, and one of the things that really sticks out to me is this; that the system that is predominantly endorsed by the system, is endorsed with such fervor by so many people in the system (university, politicians, CEOs, economists, etc), to the point which reasonable doubt is impossible.

This is further exacerbated by how awful current economics is to explain to someone. It usually takes massive, multipage documents to get simple points across. I'd like the thought that if I can't draw where my money is with a crayon on a napkin, it's probably too complicated.

[Mongoose]

That was some really good reading, Mustang.

[Nuke]

i like that thing they do with the shrunken heads.

[Mustang19]

Thanks Mongoose. 

Yeah, economics is a beast. That wall of text up there barely scratches the surface of the question. And UT, there are all kinds of economists and plenty of heterodox ones. There are tons of Marxist economists and professors in any decent sized university if that's what you're looking for.

[Beskargam]

hmmm thx! covered both of those and monetarist (idk how to spell it) theory just today. its interesting but i suck at math haha. monetarist tho seems to not take into account any outside influences on the economy. such as rising gas prices now.

and from what iv learned and from what you said it sounds like supply side can work, but that it might be more temporary/short term. in that deregulation leads to businesses not doing welll . . .ethical practices, but giving a short boost to production.

and does what does moderneconomic theory state the answer/solution would have been to the stagflation of the 70s? in the US that is

[Mustang19]

hmmm thx! covered both of those and monetarist (idk how to spell it) theory just today. its interesting but i suck at math haha. monetarist tho seems to not take into account any outside influences on the economy. such as rising gas prices now.

Not directly maybe, but a monetarist would get concerned if, say, price increases affect inflation. Just because something isn't directly addressed in a theory doesn't mean it isn't indirectly taken into account through other variables.

and from what iv learned and from what you said it sounds like supply side can work, but that it might be more temporary/short term. in that deregulation leads to businesses not doing welll . . .ethical practices, but giving a short boost to production.

I don't know about that. Probably the most common criticism of supply side theory comes from people concerned about the effect of tax cuts on sustaining government spending on popular programs like social security and medicare/medicaid.

and does what does moderneconomic theory state the answer/solution would have been to the stagflation of the 70s? in the US that is

Stagflation resulted from a variety of factors that weren't necessarily under the government's control. For example, rising oil prices were a big part of it. Several middle eastern countries formed OPEC in the 70s to cut production in order to raise the price of oil, bringing oil producers more profits. This reduction in the oil supply did raise prices but it also trashed the world economy. One solution proposed at the time was to militarily occupy the middle east to bring oil production back up, although of course that never panned out.

There was also already inflationary pressure on the US dollar which eventually brought down the Bretton Woods system, although this is it's own discussion. In short, after dropping the gold standard and ending the Bretton Woods arrangement, Nixon implemented wage and price controls in 1971 to stem high inflation; these controls were only partially successful at best in slowing inflation. With the aforementioned oil crisis beginning in 1973, the cost of production inputs rose even more and growth slowed. Reduced production meant a reduced supply of goods, raising the prices even more.Thus the 70s saw cost-push inflation. Price increases due mainly to increasing costs are called cost-push inflation while price increases due to rising demand are called demand-push inflation.

Stagflation ended around 1980 with a combination of a high central bank interest rate to fight inflation and large government deficits to stimulate the economy under Reagan. Inflation returned to more reasonable levels and the economy saw strong growth. Paul Volcker, the chairman of the Federal Reserve at the time, referred to this policy as "priming the pump"- raise the discount rate to reduce inflation before fiscal stimulus brings the economy back into gear. Reaganomics, supply side policies and tax cuts may have had something to do with the return to growth as well. I can't speak for "modern economic theory", but priming the pump and deregulation may have helped end stagflation.

[Beskargam]

heh learning a lot. whats the Bretton Woods system tho? havent talked about that at all in class. so the raised discount rate as well the the tightened money supply brought the inflation down while sending the economy into a worse recession. then the deregulation served to help end said recession and bring about economic regrowth?

in your opinion are wage control and price ceilings good?

btw thankx for all the information.

[Mustang19]

heh learning a lot. whats the Bretton Woods system tho? havent talked about that at all in class.

The Bretton Woods system came into being after World War II when the former western allies agreed to peg the value of their currencies at a fixed exchange rate to the dollar, which in turn was pegged to gold at the rate of $35 per ounce. The main motivation behind this was finding a way to avoid the currency wars of the 1930s where countries devalued their money to improve their export position in a very destructive competition. The United States also wanted to improve it's purchasing power in world trade by maintaining a strong dollar while the rest of the world needed dollars after destruction of it's economies during World War II; these countries didn't have much choice given the severe devaluation of their currencies during the war, so they went along.

Bretton Woods ended up creating a system of triangular trade in the 50s and 60s. The US imported raw materials from developing nations at a large profit and spent dollars importing European goods as well. The Europeans ended up using these dollars to import raw materials from the developing world. Everyone depended on the dollar and the US guaranteed monetary stability.

Bretton Woods could not work in the long run though. Running a current account deficit always reduces the value of a currency, yet the United States was trying to maintain a strong dollar while doing just this. Kennedy and Johnson weathered multiple crises where the value of the dollar nearly collapsed. By 1971 a great amount of dollars was being printed to finance the Vietnam War and social programs. US government gold reserves were being rapidly depleted. There was too much inflationary pressure on the dollar for the system to be maintained. When investors began selling off billions of dollars of American assets it was clear that the US could not continue running a current account deficit. Nixon unilaterally ended controvertibility between government gold reserves and the dollar to reduce the US current account imbalance and slow inflation. This policy together with the 90 day wage/price controls and a 10% tariff was called the "Nixon Shock" and greatly increased the value of gold relative to the dollar. By 1976 all major world currencies were floating- having a value determined by the market- rather than pegged, and the Bretton Woods system had effectively ceased to exist. The US began running a trade deficit - a situation where national imports exceed exports - for the first time, which it maintains to this day.

so the raised discount rate as well the the tightened money supply brought the inflation down while sending the economy into a worse recession. then the deregulation served to help end said recession and bring about economic regrowth?

The discount rate is the interest rate that the federal reserve charges banks that borrow money from it; a higher discount rate means these banks will have to pay more interest back to the fed, discouraging them from borrowing money from the fed and therefore tightening the money supply. So "lower discount rate" and "tightened money supply" are really the same thing. So yes, a higher discount rate led to a tighter supply of money and brought down inflation although it also contributed to the mild 1980 recession. Deregulation helped to end the recession but the budget deficit under Reagan stimulated the economy and helped end the recession as well. However deregulation, particularly of savings and loans institutions, contributed to a second, deeper recession in 1982. It wasn't until 1983 that the real economic boom began.

Just note that none of these questions have a hard-and-fast answer. Nothing in economics can be spoken of in terms of cause-and-effect with certainty as is possible in other sciences and the answers I'm giving are just some common interpretations.

in your opinion are wage control and price ceilings good?

btw thankx for all the information.

No problem.

Wage controls and price ceilings are usually meant as a social welfare measure to keep down prices. Rising wages can increase demand prompting price increases, so capping wages might be able to reduce inflation. From the standpoint of economic growth though these measures are more likely to interfere with market functioning and reduce allocative efficiency though. Wage and price caps hinder the market's ability to adjust to economic conditions which creates it's own problems. Although Nixon's price controls were popular among voters during the 90 days they were in place they were ineffective in combating inflation in the long run and ended up creating shortages. Your interpretation of "good" may vary. I don't think it ended up helping growth.

[Beskargam]

ok that answered pretty much every question I had and more. Thank you very much sir!

[Unknown Target]

I wish it was acceptable to sticky a thread like this.

What do you mean by "heterodox" economists? People against the current ideology?

What would you see as possible results of these economic trends? Ways to avoid or create these results?

What about theoretically better systems?

I realize that asking an economist for their thoughts on the future are just that - thoughts on the future. But I'd like to hear what you have to say on it Mustang19, you seem to have a firm grip of these things, at least, much firmer than I.

[General Battuta]

Heterodox economists are those who stand outside the current neoclassical school, usually on three different grounds. Marxists and those other guys (Bobists or something) critique the neoclassical view of labor markets, Austrian School dudes and way out there Keynesians criticize the idea of supply-demand market clearing equilibria, and lots of people reject the neoclassical model of the rational individual actor.

[Mustang19]

ok that answered pretty much every question I had and more. Thank you very much sir!

Glad I could help you out. Good luck with your studies!

I wish it was acceptable to sticky a thread like this.

What do you mean by "heterodox" economists? People against the current ideology?

What would you see as possible results of these economic trends? Ways to avoid or create these results?

What about theoretically better systems?

I realize that asking an economist for their thoughts on the future are just that - thoughts on the future. But I'd like to hear what you have to say on it Mustang19, you seem to have a firm grip of these things, at least, much firmer than I.

Thanks UT. With time, the Wall Street Journal and Wikipedia you can become an internet economics expert too.

What Battuta said. Heterodox economics is a broad term for any theory which differs greatly from the mainstream one. You shouldn't really call it an "ideology", because economics is supposed to be a science. An economic theory need not contain value judgements, just an explanation of how the economy works.

What would you see as possible results of these economic trends? Ways to avoid or create these results?

Sorry, I'm a little confused. Which economic trends are you talking about? Stagflation? I think that was largely due to the rise in oil prices post-1973, the adjustment out of Bretton Woods, the Fed's unpredictable rate changes which reduced faith in the dollar, government money-printing to finance spending, and diminishing returns on capital investment over time. Stagflation was also self-sustaining because wages continually rose to match prices, pushing up prices as well, which prompted wage increases and so on. Inflation, especially volatile inflation, hinders the market's pricing mechanism- price changes due to market conditions are hard to distinguish from price changes from inflation. It also discourages investment because inflation can eat away at investment returns. So the high but not extreme inflation seen in the 70s will slow economic growth a little bit, but countries can sustain high inflation of 10-20% for long periods of time without really dramatic effect. The most worrisome thing about inflation is often that it is a sign of other economic problems. Ways to avoid stagflation might be to reduce national dependence on volatile commodities like oil, allow currencies to float (have their value determined by the market rather than impose fixed exchange rates), keep fed funds rate changes small and predictable to allow the market to foresee them, use the federal funds rate to control inflation (keep it high when inflation is high), and don't run government budget deficits in normal times (not war or recession).

Also note that I've been using the words federal funds rate, discount rate and interest rate interchangeably, although they are not quite the same thing.

What about theoretically better systems?

Again this really depends on what you mean by "better". In theory the best utilitarian economy is the one that is structured to grow the fastest even at the expense of present welfare, because every time growth adds to production this addition basically lasts forever. Once the extra utility from this additional production adds up exponentially to the point where it surpasses welfare opportunity costs this extra ever-increasing marginal utility integrated over long enough time is mathematically infinite. Basically, economic and technological growth is important because it's the only thing that lasts.

A growth-maximizing economy might look something like one of the better-run European countries such as Switzerland. Financial controls prevent the worst cases of speculation while government spending in areas like education and infrastructure boost productivity. At the same time labor regulation, state ownership and the social safety net are toned down. The biggest criticisms you typically hear about "the European system" are typically that generous government pensions allowing a low retirement age means less people in the work force, and labor regulation meant to ensure job security makes it harder for business to fire employees. These policy differences can mean a fraction of a percentage point less annual growth. Switzerland is an example of a European country that is still pretty capitalism-friendly, and this is part of the reason why their economy is very innovative and productive. Labor regulation is lax and you don't get full pension till 65. There are economies like China and the Soviet Union which have grown faster in the short run, but it's not clear if this can be sustained with an unimpressive rate of technological innovation.

Maintaining a high savings rate is also important to growth as income kept in bank deposits or other interest-bearing financial instruments gets lent out to firms to expand production, effectively transferring production from consumer goods to capital goods every time you deposit savings. Government can greatly increase savings by running large budget surpluses to build up savings; China's government does this and along with their economy's high corporate household and private savings this greatly increases the Chinese growth rate.

But usually when people talk about making a "better system" they're talking about present welfare because talking about helping people in immediate, tangible ways makes people feel warm and fuzzy more so than calculus. In that sense democratic socialism (something like an even further left Scandinavia) is probably the way to go given current society. Just enough of a market system to maintain a comfortable development level but secure jobs for everyone, with a shorter hours and workplace democracy, and zero-sum status competition minimized through more equal incomes. From a more political science standpoint, worker ownership of firms also cuts down on vote-buying by the wealthy as workers collectively own the profits of their firm. Maybe less developed countries are better off with neoliberalism until they reach an adequate level of development. But beyond a certain point increasing GDP per capita doesn't really make people happier and qualitative factors like healthcare and working conditions are more important for that.

As for the future? Well let's just say the world will look pretty much the same throughout our lifespans. Developing world incomes will continue to level out with the first world. This is due to what's called the catch-up effect: poor countries grow more rapidly than rich ones as they have a higher labor-to-capital ratio, increasing capital productivity, and they gain production technology rapidly by adopting it from advanced economies. As average income levels out population will once more become important for geopolitical power, which is good for India and China. One prediction I'm comfortable making is that the under regulated US financial system will continue to trash the world economy at regular intervals as it has been doing every 10 years now starting in 1929 then happening in 1980, 1991, 2001, and 2008. The US has lately been infected with a malignant strain of free market dogma which might be good for itself but is definitely bad for anyone linked to it through trade - in other words, almost the entire rest of the world. Fortunately America's relative decline may have a stabilizing effect.