Supply-Side Economics' Maraschino Cherry

If you want to get a liberal's blood boiling, simply mention the phrase Supply-Side Economics at the next cocktail party. Be extra careful not to toss in additional synonyms, such as Reaganomics, Voodoo or Trickle-down economics, because his fuse might pop. Should I find myself at such a party, I would try to play peacemaker by asking the party attendees to consider the possibility that both the Left and Right share the same core economic defect: free trade. In other words, nearly all schools of economics amount to Voodoo. The logic behind this position lies in rejecting the Quantity Theory of Money (QTM), which in turn means micro, macro, and international (free trade) theory are found to be faulty and lie at the heart of our decline.

So before you get to upset by hearing Reaganomics mentioned again after all these years, keep in mind the traditional Keynesian model had come unglued in the 70s due to stagflation. I can still recall my father wondering if the entire economy was going to melt down with interest rates approaching 17%. No one seemed to have convincing explanations, nor knew what the right move was to protect yourself. But now that I've finally completed my own model, I've become curious as to how Supply-Side would fit into my own thinking. With a bit of research it quickly became apparent that the Mundell-Fleming model of an "open" (free trade) economy lies at the heart of the Supply-Side theory. Having walked around a superstore and flipped over numerous goods to examine the country of origin label only to find the vast majority to be imports, I could not help but wonder what Supply Siders held of trade deficits. In other words, if American industry is fleeing overseas, doesn't this mean the vanishing "Supplier" which they had so energetically hoped to revitalize with their policies amounts to the model's failure?

I think I may have found a partial answer to this question in Brian Domitrovic's eloquent book, the Econoclasts which chronicles the birth and rise of Supply-Side Economics. On page 262, Domitrovic notes that Robert Bartley considered a trade deficit a "maraschino cherry on top." In other words, a trade deficit is a bonus.

The description was brief and Mr. Robert Bartley is no longer with us, so I will try to tread lightly. Assuming I correctly understand his position, then my response would be that Supply Sider's have forgotten to consider the unemployed American maraschino producer. One less supplier. But, why stop there? Let's import some whip cream, ice cream, serving dishes, spoons, table clothes, table, chairs, brick and mortar. We end up with the same result of less suppliers. Unless I'm missing something, the model from my perspective fails (see link below for full tech discussion of free trade). Also along these lines of thinking, Domitrovic on page 287 notes that Mundell was happy to see the Euro's creation. Since I have outlined already my critique of the Euro as a dysfunctional form of free trade in the essay "Fair Trade Fantasy" I will leave it to the reader to refer to it (see link below).

When I read of the cherry analogy, it reminded me of a common textbook side bar which tells of Federic Bastiat's (1800s) satire of candle makers who call for the closing of curtains to protect their businesses. This of course is an attack on protectionism that in my opinion fails, because Bastiat does not take his logic to final conclusion should all goods be supplied by mother nature (a Garden of Eden scenario). No one would be employed, nor is there a role for domestic money in his superficial analogy. Bastiat's Garden of Eden is ulimately the economic Inferno because he simply seemed to be happy with cheap imports without consequences.

In spite of what I see as a foundational error (as with all schools), it is quite possible that the Supply-Siders still got some things right. Though I'm not a tax expert or an account, I felt a thought experiment on excessive taxation "on the rich" supplier is perhaps worth pondering before we draw to a close (feel free to point out an error here). Imagine a factory with $100Million in output that needs a 10% profit (markup of $10 Million above cost of production) to keep the wheels spinning and stay in good standing with his banker. If this company was to be taxed at say 80% of profits, then the factory owner would have to clip on $50 Million in markups to achieve the needed $10M in the clear. This means the buying public just took a 40% hit in their buying power for this particular company's output. In short, taxing the rich in effect amounts to taxing Joe consumer. As a result, a rapid reduction in such rates might have resulted in a significant reduction in mark ups and at least momentarily acted as a brake to run away inflation, along with a change in public perception. With that said, I'll be the first to admit inflation theory is very tricky business, and that I've not managed yet to convince myself that anyone has a sound theory for inflation (besides the obvious practice of turning on the printing presses which in practice doesn't really happen). I've turned over many stones to date hoping to have an epiphany regarding inflation to no avail. I've considered markups on goods or interest rates (neither or which are retired by extinguishing credit/debt), exports (less goods against production workers), property tax dynamics, 30 year loans, you name it. Nothing yet stands out as the real culprit. So in this regard, I feel the Supply Siders should be given some wiggle room because they faced the most difficult problem in economics. But when all is said and done, and if I am correct that the foundation is flawed, we cannot turn to Supply Siders to stop our decline, because free trade is the root problem. Cheap imported cherries will prove to be very bitter in the end.

Van Geldstone



Keynesian did not come "unglued" at all

It shows when an economy is at full potential, inflation will happen and stall out the economy. Nothing unusual at all about it. Keynesian works and by the math it does.

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Your comment is correct, but mine was meant to address a different point (i.e. economy not a full empl). Take a look at Note the comment about Keynes macro and the implication. Rising unemployment with rising inflation wasn't suppose to be possible under mainstream Keynes as I understood (thus my "unglued" comment). It meant that the 70s exposed a big theoretical flaw in mainstream Keynesianism that had no answer. Unless my memory fails me, most textbooks make this argument. Of course there are many disagreements about what Keynes was really saying thus the many spins in the form of Post Keynesians, New Keynesian, neoclassical synthesis, etc. best regards

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