Supply-Side Economics
Case & Fair, chapter 18, pp. 395-398
“plus”
History
• “Supply-side economics” begins to appear in
the late 1970s but comes fully into public
attention during the first Reagan
administration.
• Several advisors of Reagan call themselves
advocates of “supply-side economics” and it
soon is also called “Reaganomics”.
• “Supply-side” is juxtaposed to “Keynesian”
economics.
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
demand
– 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 ISLM 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
So….
• Keynesian economics was always
concerned with both demand and supply!
• Therefore the classification of Keynesian
economics as demand-side is
questionable.
Supply-side?
• Yet, the “supply-siders” policy
recommendations are focused on stimulating
“supply”
• 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
revenues.
• 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
expected
– 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
work)
• 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.:
Wage
rate
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.:
Wage
rate
Labor supplied
Therefore:
• The argument about the positive effects of
lower taxes on individual effort seem only
applicable to certain workers but not to lots of
others.
• 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
Investment
But….
• 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 neoliberal 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
investment
• 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
constraints
– 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) 
Y
Y
IS - LM
• Rightward shift in IS curve > leftward shift in
LM’
LM curve  Y
LM
IS’
IS
Y
AS & AD
• Rightward shift in Aggregate Demand function
 Y , reduction in costs  AS  Y
Price
Level
AD’
AS
AG’
AD
Y
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
Y
IS - LM
• Rightward shift in IS curve < leftward shift in
LM curve  Y
LM’
LM
IS’
IS
Y
AS & AD
• Leftward shift in Aggregate Demand function
  Y > reduction in costs ( AS  Y)
AD’
Price
Level
AS
AS’
AD
Y
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.
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