Supply-side Economics Never Made Sense

As we see the collapse of Wall Street, AIG, Bear Stearns, Merrill Lynch, Washington Mutual, and Lehman Brothers, we all must wonder what happened. We have been told that our economy was strong. Yet within the last seven to eight months we’ve seen 19 banks collapse and the kind of volatility in the stock market that makes us all queasy and seasick.

Within 20 years, we went from being the most prosperous nation on the earth to the nation carrying the most debt. Personally, I think we have to look back to the 1980s for the answers. This was the so-called Me Generation. It was all about nicer clothes, nicer cars, and the biggest house in the gated community. It didn’t matter if you obtained all of this through credit cards, six mortgages and a loan from Guido down the street. The bottom line was it was all about Me.

Some of this thinking came from supply-side economics. The theory behind supply-side economics: tax cuts for the wealthy and for businesses will free up capital; the wealthy would spend more money; business and the wealthy would hire more people. This prosperity would trickle down to everyone. On the surface, this makes a lot of sense but upon further reflection we see it is a magician’s trick. Before we get the hard data, let’s just think about this. If you’re a wealthy businessman who makes $10 million a year, for argument’s sake, you pay 40% of what you make in income tax. This comes to $4 million. With tax cuts, your tax rate is changed from 40% to 35%. You take home an extra $500,000. What are you going to do to spur the economy? You already have a new car, maybe two or three. You have a house, possibly two. You already have a maid and someone to cut your grass. Most likely, you will do what most multimillionaires would do, which is to invest that $500,000. The logic for business is about the same. Businesses don’t hire people just because there’s extra money lying around. Extra money from tax cuts can be paid out as bonuses (remember upper management is very fond of bonuses and stock options) or distributed as increased dividends to stockholders. Therefore, in this example, it appears that supply-side economics lines the pockets of the rich.

With President Bush, President Clinton, and President Reagan, we are able to look at two eras of supply-side economics sandwiching a more traditional economic approach. Real investment growth was greater in the period of 1993-2001 at the rate of 10.2 percent. President Reagan had a growth of 2.8 percent. President Bush has had a growth of 2.7 percent. Gross Domestic Product, a measurement of economic growth, increased at an average annual rate of 3.9 percent during the Clinton era while Reagan and Bush had rates of growth of 3.9 percent and 2.5 percent respectively. For me, the most important indicator of how we are doing is real average annual median income. With the tax increases during Clinton’s presidency, real average annual median income grew at a rate of 2 percent. Reagan’s presidency spurred an increase 1.4 percent and under the Bush administration, the increase was only 0.3 percent. (Data from Center For American Progress.)

There are multiple excuses that true supply-side believers will give us as to why supply-side economics did not work. They will claim that any change in the economy takes years to make an effect. This plainly contradicts the father of supply-side economics, Art Laffer, who stated that we would see changes in our economy “before the ink is dry” on the legislation for tax cuts. They will argue that there weren’t enough government spending cuts. There’s further data to support a more traditional economic approach. This approach includes higher wages, higher employment growth and results in decreased federal deficits. This was the case during Clinton’s years in office, as compared with either supply-side era. In spite of all this data, though, some still advocate tax cuts for the rich. Why?

Supply-side economics simply does not work for America. Maybe this “Me First, Everything Else Second” mentality helped cause the craziness that we’re seeing on Wall Street. I’m just askin’.

  • Chris

    Doc:

    You’re oversimplifying the current crisis.

    I’ll start by stating for the record, AGAIN, that I’ve proved elsewhere on this blog that this current crisis was born of the Clinton initiative regarding the “right” of everyone to own a home (which, as we both probably agree, isn’t a right at all, but a privilege of success), compounded by the Greenspan/Bernake gaffe of keeping interest rates too low for too long. Finally, when approached with a pre-emptive solution to this mess 5 years ago, Chris Dodd and Barney Frank, ranking Democrats in Congress, rebuffed all relief efforts of the White House, based on the fear that regulating Fannie/Freddie would dry up housing funding for people who presumably would vote Democrat.

    This crisis has less to do with the “Me Generation” and “Supply Side Economics” than it does with Democrat pandering.

    I’ll correct your misconceptions of Supply Side economics later, when I have more time.

  • Chris –

    2 points. First, I really wasn’t addressing the root cause of the crisis today. I was trying to explain the failure of supply-side econ in general. Secondly, I think that you are ignoring a couple of major facts. Sub-prime mortgages exploded in 2002 – 2005 during the Bush administration. If Bush and the gang thought that they were a problem, they could have enacted legislation to fix it but they didn’t. As a matter of fact, Bush went around the country and encouraged home ownership. Remember the ownership society? CRA – community reinvestment act, which was strengthen under Clinton, was signed into law in 1977. Since most of the problem that we are seeing today came from mortgage lenders and not banks or thrifts the argument completely falls apart since CRA governs banks and thrifts.

    Thanks for your comments.

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  • Chris

    Woah there, Doc:

    If Bush and the gang thought that they were a problem, they could have enacted legislation to fix it but they didn’t

    Again, in my earlier posts, according to the NY Times, the White House attempted legislation in 2003, 5 full years before this “crisis” began. Chris Dodd and the Democrat caucus blocked their passage because funding might dry up amongst the poorer applicants for mortgages, which is silly, because if they couldn’t afford the house on their own, they shouldn’t buy one in the first place!

    Again, the Bush Administration attempted to fix the problem, and were stopped by Democrats looking for votes.

    Since most of the problem that we are seeing today came from mortgage lenders and not banks or thrifts the argument completely falls apart since CRA governs banks and thrifts.

    Again, you’re mistaken. Fannie/Freddie, the quasi-governmental behemoths whose implosion precipitated this mess were involved in packaging mortgage backed securities, which were sold to various banking/lending/investment firms who saw the packages as investments that would appreciate in value. The gamble was on the idea that 1) homes always appreciate, and 2) foreclosures would be minimal.

    Since the housing market began to correct itself, and people were allowed, at the discretion of President Clinton, to purchase houses at exorbitant prices with no money down, they had no or negative equity on the real value of the house. So, when people found out they couldn’t afford the houses they bought, they simply walked away, and foreclosures skyrocketed.

    If the Clinton administration hadn’t pushed Fannie/Freddie into offering loans to people who couldn’t afford them, or the Democrats in Congress in 2003 had looked at the situation facing them, instead of ignoring the warning signs and pandering for votes, this crap all could have been averted.

    The problem isn’t transparency or regulation, it’s the failed ideas of a liberal system. The “right” of home ownership is a fallacy, but it was intrinsic in the Democrat agenda under Clinton and immediately thereafter.

    Doc, did you read the articles I posted?

  • Chris

    Ralphie, you’re a silly/scary man.

    Doc: Please read this.

    http://www.washingtonpost.com/wp-dyn/content/article/2008/09/12/AR2008091202415.html

    From the Washington Post:

    Quit Doling Out That Bad-Economy Line

    By Donald Luskin
    Sunday, September 14, 2008; Page B01

    “It was the worst of times, and it was the worst of times.”

    I imagine that’s what Charles Dickens would conclude about the current condition of the U.S. economy, based on the relentless drumbeat of pessimism in the media and on the campaign trail. In the past two months, this newspaper alone has written no fewer than nine times, in news stories, columns and op-eds, that key elements of the economy are the worst they’ve been “since the Great Depression.” That diagnosis has been applied twice to the housing “slump” and once to the housing “crisis,” to the “severe” decline in home prices, to the “spike” in mortgage foreclosures, to the “change” in the mortgage market and the “turmoil” in debt markets, and to the “crisis” or “meltdown” in financial markets.

    It’s a virus — and it’s spreading. Do a Google News search for “since the Great Depression,” and you come up with more than 4,500 examples of the phrase’s use in just the past month.

    But that doesn’t make any of it true. Things today just aren’t that bad. Sure, there are trouble spots in the economy, as the government takeover of mortgage giants Fannie Mae and Freddie Mac, and jitters about Wall Street firm Lehman Brothers, amply demonstrate. And unemployment figures are up a bit, too. None of this, however, is cause for depression — or exaggerated Depression comparisons.

    Overall, the pessimists are up against an insurmountable reality: In the last reported quarter, the U.S. economy grew at an annual rate of 3.3 percent, adjusted for inflation. That’s virtually the same as the 3.4 percent average growth rate since — yes — the Great Depression.

    Why, then, does the public appear to agree with the media? A recent Zogby poll shows that 66 percent of likely voters believe that “the entire world is either now locked in a global economic recession or soon will be.” Actually, that’s a major clue to what started this thought-contagion about everything being the worst it has been “since the Great Depression”: Politics.

    Patient zero in this epidemic is the Democratic candidate for president. As it would be for any challenger, it’s in his interest to portray the incumbent party’s economic performance in the grimmest possible terms. Barack Obama has frequently used the Depression exaggeration, including during a campaign speech in June, when he said that the “percentage of homes in foreclosure and late mortgage payments is the highest since the Great Depression.” At best, this statement is a good guess. To be really true, it would have to be heavily qualified with words such as “maybe” or “probably.” According to economist David C. Wheelock of the Federal Reserve Bank of St. Louis, who has studied the history of mortgage markets for the Fed, “there are no consistent data on foreclosure or delinquency going all the way back to the Depression.”

    The Mortgage Bankers Association (MBA) database, which allows rigorous apples-to-apples comparisons, only goes back to 1979. It shows that today’s delinquency rate is only a little higher than the level seen in 1985. As to the foreclosure rate, it was setting records for the day — the highest since the Great Depression, one supposes — in 1999, at the peak of the Clinton-era prosperity that Obama celebrated in his acceptance speech at the Democratic National Convention late last month. I don’t recall hearing any Democratic politicians complaining back then.

    Even if Obama is right that the foreclosure rate is the worst since the Great Depression, it’s spurious to evoke memories of that great national calamity when talking about today — it’s akin to equating a sore throat with stomach cancer. According to the MBA, 6.4 percent of mortgages are delinquent to some extent, and 2.75 percent are in foreclosure. During the Great Depression, according to Wheelock’s research, more than 50 percent of home loans were in default.

    Moreover, MBA data show that today’s foreclosures are concentrated in that small fraction of U.S. homes financed by subprime mortgages. Such homes make up only 12 percent of all mortgages, yet account for 52 percent of foreclosures. This suggests that today’s mortgage difficulties are probably a side effect of the otherwise happy fact that, over the past several years, millions of Americans of modest means have come to own their own homes for the first time.

    Here’s another one not to be too alarmed about: Obama is flat-out wrong when he frets on his campaign Web site that “the personal savings rate is now the lowest it’s been since the Great Depression.” The latest rate, for the second quarter of 2008, is 2.6 percent — higher than the 1.9 percent rate that prevailed in the last quarter of Bill Clinton’s presidency.

    Full disclosure: I’m an adviser to John McCain’s campaign, though as far as I know, the senator has never taken one word of my advice. He’s been sounding a little pessimistic on the economy of late, too. And to be fair, he isn’t immune to the Depression-exaggeration virus, either. At a campaign news conference in July, my fellow adviser Steve Forbes warned that Obama was seeking “the biggest tax increase since Herbert Hoover and the Great Depression.” Factual? Almost certainly not.

    But at least Forbes wasn’t dissing the economy — he was dissing Obama. And Obama’s infection by the Depression-exaggeration bug goes way back. His first outbreak came on Oct. 2, 2002, in his famous speech opposing the invasion of Iraq, delivered when he was an Illinois state senator. He said that the invasion was “the attempt by political hacks like Karl Rove to distract us from” a litany of economic troubles including “a stock market that has just gone through the worst month since the Great Depression.”

    Quite an exaggeration. When state senator Obama made that remark, the Standard & Poor’s 500 had just dropped 11 percent for the month of September 2002. But stocks dropped twice that much in October 1987. Since the Great Depression, the stock market has had bigger one-month drops on four occasions. Obama’s pessimism on stocks then happened to be as ineptly timed as it was factually incorrect. Exactly one week later, stocks hit bottom, and over the next five years the S&P 500 more than doubled, surging to new all-time highs.

    So much for Obama’s hyperbole about our terrible economy. But what about the media’s?

    A housing “slump,” a housing “crisis”? A “severe” price decline? According to the latest report from the National Association of Realtors, the median price of an existing home is up 8.5 percent from the low of last February. And according to the U.S. Census Bureau, the median price of a new home is up 1.3 percent from the low of last December. Home prices may not be at all-time highs — and there are pockets of continuing decline in some urban areas — but overall they’ve clearly stopped going down and have started to recover. So why keep proclaiming a “crisis” after it’s over?

    “Turmoil” in the debt markets? Sure, but we’ve seen plenty worse. According to the FDIC, there have been a total of 13 bank failures in 2007 and so far into 2008. There were 15 in 1999-2000, the climax of the Obama-celebrated era of Clintonian prosperity. And in recession-free 1988-89, there were 1,004 failures — almost an order of magnitude more than today. Since the Great Depression, the average number of bank failures each year has been 94.

    Despite highly publicized losses in subprime mortgage lending, bank equity capital — the best measure of core financial strength — is now $1.35 trillion, more than the $1.28 trillion level of mid-2007, before the “turmoil” even began.

    Financial market “crisis” and “meltdown”? Yes, from all-time highs last October, the S&P 500 has fallen 20 percent. But that’s nothing by historical standards. Stocks have often fallen more than that over comparable spans of time. They fell more than twice that much in 1974 — which was truly the worst drop since the Great Depression. Even the present 20-percent loss isn’t what it seems. The damage has been heavily concentrated in the financial sector — banks, investment firms and mortgage companies. If you exclude that sector, stocks are off 14.8 percent.

    Some economic indicators — export growth and non-defense capital goods orders such as industrial machinery, for example — are running at levels associated with brisk expansion. Others are running at middling levels, such as the closely followed Institute for Supply Management manufacturing index. But it’s actually difficult to find many that are running at truly recessionary levels.

    There have been 11 recessions since the Great Depression. And we’re nowhere close to being in the 12th one now. This isn’t just a matter of opinion. Words — even words as seemingly subjective as “recession” — have meaning.

    In a new working paper, economist Edward Leamer of UCLA’s Anderson School of Management shows that changes in the unemployment rate, payroll jobs and industrial production almost precisely explain every recession as officially determined by the National Bureau of Economic Research. At present, only the unemployment rate exceeds the recession threshold. The other two factors are far from it. According to Leamer’s paper, we’ll only fall into recession “if things get much worse.”

    This would suggest that anyone who says we’re in a recession, or heading into one — especially the worst one since the Great Depression — is making up his own private definition of “recession.” And probably for his own political purposes.

    McCain campaign adviser and former U.S. senator Phil Gramm was right in July when he said that our current state “is a mental recession.” Maybe he was out of line when he added that the United States has become “a nation of whiners.” But when it comes to the economy, we have surely become a nation of exaggerators.

    Yet Gramm was pilloried for his remarks, and McCain had to distance himself from his adviser by joking that in a McCain administration, Gramm would be ambassador to Belarus. What does it say about our nation that it has become political suicide to state the good news that our economy is not in recession?

    Whatever the political outcome this year, hopefully this will prove to be yet another instance of that iron law of economics and markets: The sentiment of the majority is always wrong at key turning points. And the majority is plenty pessimistic right now. That suggests that we’re on the brink not of recession, but of accelerating prosperity.

    Maybe this will turn out to be the best of times — at least since the Great Depression.

    Donald L. Luskin is chief investment officer of Trend Macrolytics LLC, an economics consulting firm based in Menlo Park, Calif.

  • TCB

    ET: Since most of the problem that we are seeing today came from mortgage lenders and not banks or thrifts the argument completely falls apart since CRA governs banks and thrifts

    Rep. Michele Bachmann (R-Minn) wrote
    “The recklessness of government is a primary culprit here. For years, Congress has been pushing banks to make risky, subprime loans. Using the authority of the Community Reinvestment Act, the big push for subprime mortgages began in earnest during the Clinton years. Banks that didn’t play ball were subject to serious fines and lawsuits, and regulatory obstacles were placed in their way.

    And.. from the other side:
    Bill Clinton on Thursday told ABC’s Chris Cuomo that Democrats for years have been “resisting any efforts by Republicans in the Congress or by me when I was President to put some standards and tighten up a little on Fannie Mae and Freddie Mac”

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  • TCB –

    Michele Bachmann is batsh#t crazy. There are literally a thousand really stupid things that she has said in front of the camera/reporter.

    * Our candidate was chosen by the media. (about McCain)
    * The big thing we are working on now is the global warming hoax. It’s all voodoo, nonsense, hokum, a hoax.
    * What our service men and women have accomplished over there has been nothing short of astounding. Though you never hear about it in the media. God has not abandoned us.
    * “[Pelosi] is committed to her global warming fanaticism to the point where she has said that she’s just trying to save the planet,” Bachmann told the right-wing news site OneNewsNow. “We all know that someone did that over 2,000 years ago, they saved the planet — we didn’t need Nancy Pelosi to do that.”
    * “Some suggestions are that perhaps we would see an enhancement of wildlife expansion because of the warmth of the pipeline,” she said. […] The pipeline has now become a meeting ground and “coffee klatch” for the caribou, she said.

    Think Progress
    Talking Points Memo
    Crooks and Liars

  • Chris –

    I’m sorry. Maybe I’m dense. But I’m not buying the Clinton is the root of all evil theory. Republicans have been floating this ever since Bush took office. Remember Dems destroyed the computers by removing all of the W’s. Bush did NOT push for increased regulation. If Bush wanted to change the regulation, he would have changed the regulation. He had no legislative defeats in 2003/2004. You are talking about a trial balloon when the Republicans were at their peak of power. How many major speeches did Bush give on this subject? None? He wasn’t pushing to change the legislation. Sorry.

    Why you are wrong and I’m right.

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