How 'Supply' Became a Dirty Word in Economics
“Supply” is a dirty word in economic policy discussions. That needs to change.
Over the past few decades, the word “supply” has come to be associated with pro-market, anti-government policy. That has earned it the scorn of many among the growing number of intellectuals, activists and policymakers who worry about rising inequality and other economic ills that laissez-faire thinkers overlook. How did this happen?
Part of it might have to do with basic economic theory. In the Econ 101 of competitive markets, supply just means the amount of stuff -- cars, back massages, consulting services -- that businesses are willing to sell at a given price. The concept isn’t always a useful one: For example, when companies have market power, and can set prices instead of simply reacting to them, it often doesn’t make sense to think in terms of supply curves. So when people talk about supply, it can carry the connotation that markets are more competitive than they are -- implicitly turning people’s attention away from the growing worries over industrial concentration and monopoly power.
But I doubt this is the reason “supply” sounds suspicious. A more important factor is the history of the 1970s and 1980s.
Before the 1970s, Keynesian stabilization policy was all the rage among politicians and their advisers. The idea was to use fiscal and monetary policy to manage aggregate demand -- the willingness of consumers to spend their money instead of hoarding it. In the ’70s, though, this approach seemed to hit a dead end. Monetary easing seemed to be producing inflation without lifting the economy out of the doldrums.
In fact, the turn against Keynesian policy was almost certainly overdone, and the idea eventually made a comeback. But in the ’70s and ’80s, people were looking for alternatives, and conservative intellectuals gave them one: “supply-side economics.”
In economic modeling terms, “supply-side” is a nerdy reference to the idea that the total amount of goods and services produced in the economy -- called aggregate supply -- is constant, and doesn’t depend on inflation. If that were true, it would mean that efforts to boost aggregate demand -- fiscal stimulus, or interest rate cuts -- can never do anything except raise inflation. That’s not actually the case, but during the stagflation of the 1970s, it was a popular viewpoint.
Instead of trying to manage demand, supply-siders suggested that policy makers focus on boosting the total amount that the economy can produce. But then they made another huge leap. Supply-siders assumed that government intervention in the economy -- taxes, spending, and regulation -- can only get in the way of economic efficiency. Their main recommendations for boosting productive capacity were, therefore, tax cuts and deregulation.
Thus, the supply-siders associated the concept of “supply” with market fundamentalism, totally divorcing it from its original meaning. Even simple economic theory offers a number of reasons why government intervention in the economy can raise aggregate supply rather than lowering it. Public goods like infrastructure and research, externalities like pollution or information problems like adverse selection are all well-known areas where government spending and regulation can help markets instead of hurting them. Supply-siders ignored these, and pressed ahead with the fiction that government can only be a problem.
When presented with the likelihood that their tax cuts would increase deficits, extreme supply-siders even resorted to arguing that tax cuts boost government revenue. Though this must be true at some level -- for example, a 100 percent tax would drive all economic activity underground, and send revenue to zero -- most economists agree that at the currently prevailing rates, tax cuts can’t pay for themselves:
It’s a shame that the word “supply” has become associated with this sort of overblown claim. Cutting taxes can sometimes help the economy, but in recent decades, all they’ve done is raise deficits without giving growth a measurable boost.
Meanwhile, there are plenty of things government can be doing that actually would increase supply. Reversing the decline in research spending is one. Repairing dilapidated infrastructure is another: The McKinsey Global Institute, for example, estimates that the world needs to invest $3.7 trillion in infrastructure annually over the next 18 years to meet growth projections.
There is also a strong possibility that measures to fight recessions can increase demand and supply at the same time. Workers who are laid off during downturns will see their job skills, networks, and work ethic erode, making the economy less productive in the long run. Also, recessions make companies less willing to invest in new technologies, which also reduces supply. So fiscal and monetary measures that cushion the blow of recessions are also supply-side policy.
Real supply-side policy -- rather than the misguided tax-cut version -- is often both a good idea and something liberals should embrace. Even when it comes to deregulation, the biggest opportunity for growth comes from increasing density to make cities more affordable -- also something liberals should want.
Thus, it’s time to remove the stigma associated with the word “supply.” Growing the economic pie doesn’t necessarily require giveaways to the rich. Far more often, it means more investment in the 99 percent.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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Mark Whitehouse at firstname.lastname@example.org