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Maybe Supply-Side Economics Deserves a Second Look

Tyler Cowen is a Bloomberg View columnist. He is a professor of economics at George Mason University and writes for the blog Marginal Revolution. His books include “Average Is Over: Powering America Beyond the Age of the Great Stagnation.”
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Since the Great Recession, macroeconomic discussion has been dominated by discussions of aggregate demand, and how to create more of it through monetary and fiscal policies. That has led to a strange state of affairs where those topics still dominate the debate, even though they've done most of the job economics expects of them: The U.S. is fairly close to full employment and seeing continued positive momentum. Supposed remedies such as making interest rates negative, with the goal of accelerating monetary circulation, seem better suited to 2010 than 2016.

Maybe it’s time to start paying more attention to other approaches, specifically those based on the supply side. Supply-side economics has been discredited since the Bush tax cuts failed to boost economic growth, but there is another way of thinking about the problem. It is not enough for funds to be left in the hands of the wealthy; rather they must be invested in risk-bearing equity capital, focused on innovation.   

So argues Edward Conard in his new book, "The Upside of Inequality: How Good Intentions Undermine the Middle Class." Think of it as a revamp of supply-side economics but with the concept of risk-bearing at the core, a fitting perspective for an author who was a founding partner of the private equity firm Bain Capital and a former business associate of Mitt Romney.

QuickTake Secular Stagnation

In this view, traditional demand stimulus is at best defensive in nature. It may limit further collapse, but it won’t much revitalize risk-taking. For Conard, “Weak demand is not a cause in and of itself. It is a symptom of a shortage of equity willing and able to bear risk.” 

You may recall that the iPhone made its debut in 2007, and it sold very well during the tough economic times that followed.  Had there been more innovations of import, a simultaneous growth of production and market demand could have been self-validating and pulled the economy out of recession more quickly.

This framework makes Conard a revisionist on the U.S. trade deficit. The traditional story is that Americans buy goods from, say, East Asia, and the sellers respond by investing those dollars back in the U.S., a win-win situation. Conard believes that analysis would hold only if people who accumulate cash from foreign transactions invest their funds into risky, innovative enterprises.

But too often they buy government securities, and so Conard views the U.S. trade deficit as something that makes the government bigger without making the economy more dynamic. This confounds the traditional libertarian defense of free trade by indicating that we are not really getting market-oriented investments when the funds return.

So how can we stop savings from being deployed in too risk-averse a manner? To provide my own personal list, let's target the bureaucratization of society, excess regulation, the high cost of moving talented labor into cities with building restrictions and thus expensive rents, overly cautious financial intermediaries (most capital isn’t venture capital), policy instability and a general fear of the future all may choke off entrepreneurship. 

Keynesian economics focuses on sticky nominal wages as one obstacle to increasing production, but especially these days that seems like only one small part of a much bigger story. Some good news is that the Chinese are interested in further diversification into equity and away from government securities.

Maybe supply-side economics isn’t as wrong as its reputation indicates. Maybe the earlier supply siders just spent too much time focusing on one supply obstacle – high taxes – when other barriers were bigger problems. 

Conard recognizes that there are many factors behind slow innovation, but for my taste he plays up tax cuts too much, believing that the wealthy are sufficiently willing to bear risk and dynamically invest. Consistent with this view, Conard argues that the American middle class has in recent times experienced bigger real income gains than the numbers indicate, once job benefits are counted properly.

I have argued extensively that real U.S. wage stagnation is a significant problem, and thus investment is in some ways subpar. In addition to the institutional obstacles, might too many of our elites be risk-averse, much like Conard’s East Asian savers who seek safe assets? Or could it be that innovation takes decades, and therefore the middle-class payoff from income inequality still lies in the future?

While we shouldn’t rely on tax cuts, they may still play a role in this debate. Cuts in marginal tax rates became overrated after the Reagan recovery years of the 1980s, but maybe after the failed Bush experience they are now somewhat underrated.

Perhaps no economic policy is going to work especially well in a time when median incomes are falling. If we can clear away other impediments to supply, tax cuts may prove potent once again. Don’t forget that there are decades of research in economics showing that tax incentives matter.

"The Upside of Inequality" won’t convince everyone, but it’s one of this year’s economics books that is actually asking questions about the right side of the market.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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