Pro: Supply-side economics worked wonders for Reagan; Obama should give it a shot

Reuters

A local newspaper headline announces bankruptcy in Stockton, California June 27, 2012. Stockton, a city of nearly 300,000 about 85 miles east of San Francisco in the Central Valley, will become the largest U.S. city to seek Chapter 9 protection from its creditors after its leaders approved a budget based on the city filing for bankruptcy.

Article Highlights

  • The real test of any economic theory is, does it work?

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  • Supply-side economics is summed up in the phrase from “The Field of Dreams”: “Build it and they will come.”

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  • The result of Reagan’s supply-side economics in 1980 was 12 years of sustained economic growth in a row.

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WASHINGTON — EDITOR’S NOTE: The writer is addressing the question, “Could supply-side economics help the economy?”

Supply-side economics is summed up in the phrase from “The Field of Dreams”: “Build it and they will come.”

The “build” in this case is entrepreneurs and businesses producing more goods and services at lower cost, which consumers will then buy. Encouraging the production process fosters economic growth by satisfying the wants and needs of more people at decreasing cost, from sewing machines and automobiles—the first industries to use mass production to lower costs and increase output—to computers and cell phones and athletic shoes and cartons of yogurt.

Increase the range and supply of goods, the supply-sider says, and demand—the other critical part of the economic equation—will take care of itself.

Others, like the followers of British economist John Maynard Keynes, disagree. They say it’s the demand for products and services that fosters innovation and growth—demand created by individuals or the government, it doesn’t matter. In fact, since government has lots of money, it can stimulate growth faster by spending it quicker. Indeed, the more, the better.

The supply-sider sees this formula as wrong-headed. The marketplace, as opposed to government, knows best where economic effort should go to satisfy demand based on consumer tastes. Producers who get their goods and services out there at the lowest cost, will get the biggest rewards—as will consumers.

So the top economic priority is making sure producers are free to expand capacity to produce more, and install new technologies that will produce those goods faster and cheaper or even create entirely new products and services.

That’s why supply-siders favor various kinds of economic deregulation—so investment is free to go where it can do the most good—and like tax cuts, especially cuts in capital gains and in marginal tax rates on higher income brackets.

That’s not because they think rich people should have more money. It’s because people with higher incomes are more likely to capitalize their savings as investments aimed at bringing a lucrative return, whether it’s expanding their own business (as when a dry cleaner opens a new store and hires new workers to run it) or someone else’s.

Some call this “trickle down” economics. It’s really “let the capital flow economics," and it’s what stimulates new businesses, new technologies, new jobs and bigger paychecks for everyone.
"The real test of any economic theory is, does it work?" -Arthur Herman
The real test of any economic theory is, does it work? President Obama and his advisers tried the Keynesian “stimulus” formula to get the country back on track after the 2007-8 recession. The result has been the slowest economic recovery in modern history.

In 1980, by contrast, President Ronald Reagan self-consciously tried the supply-side formula for the first time by rolling back regulations; imposing capital gains and personal income tax cuts; and making it clear America was back in business again.

The result was 12 years of sustained economic growth in a row—the longest unbroken expansion in American history—with an average GNP growth rate of 3.2 percent. Twenty-one million jobs were created; even government revenues rose—a paradox created by the fact that the increased economic activity generated more taxable income.

Will a new round of tax-cuts revive this economy? The evidence seems clear, but the Keynesians will still be unhappy. They admit economic growth happened in the Reagan years, but insist it was the “wrong” kind of growth because it was aimed at satisfying fleeting consumer tastes, instead of creating new infrastructure or green jobs or something.

This reminds me of the scene in a Woody Allen movie, when a woman tells him her doctor says she’s been having the wrong kind of orgasm. “Really?” he replies. “I’ve never had the wrong kind. My worst one was right on the money.”

Right now, Americans are ready for some growth that’s on the money.

Arthur Herman is a visiting scholar at the American Enterprise Institute. Readers may write to him at AEI, 1150 17th Street NW, Washington, D.C. 20036; website: www.aei.org.

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About the Author

 

Arthur
Herman
  • Arthur Herman is a historian and author of the Pulitzer Prize finalist Gandhi and Churchill: The Epic Rivalry That Destroyed an Empire and Forged Our Age (Bantam, 2008), the Mountbatten Prize–nominated To Rule the Waves: How the British Navy Shaped the Modern World (HarperCollins, 2005), the New York Times bestseller How the Scots Invented the Modern World (Three Rivers Press, 2001), and many articles on foreign and military policy. At AEI, Dr. Herman authored a new book that traces the mobilization of American industry, technology, and material production over the course of World War II.
  • Email: arthur.herman@aei.org
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