Thursday, July 23, 2015

Left vs. Right on How to Create Prosperity

by Neil H. Buchanan

A Dorf on Law reader contacted me recently, asking me to clarify the major parties' competing theories on how to create economic prosperity.  This reader, a non-economist (horrors!), asked if I could lay out the differences between the Republicans' and Democrats' approaches to economic policy, and explain what the evidence says about which approach is right (or, one supposes, possibly that both are wrong).

In some ways, I could argue that this is a very timely question, because -- with only 474 days to go before Election Day!! -- the Republican presidential candidates are already talking about taxes.  A lot.  OK, so I will argue that this is a very timely question, but for a very specific reason: Almost surely, no one (and certainly none of the Republicans) will actually explain why their economic plans will lead to greater prosperity.  There will instead be an unstated presumption that it is self-evident where the key to prosperity is stored, yet somehow only Candidate X is the one who knows how to unlock the door.

On the Republican side, everything is about cutting taxes.  Well, not quite everything, because cutting spending (in particular, social spending) is also a big deal for them, although given the choice, they will always prioritize lower taxes over lower spending (even when offered a $10-for-$1 deal).  It is also worth noting again that Republicans have revealed quite clearly that reducing deficits and the national debt is not a priority at all.  They talk about it a lot, but they do not act on it, and most of what they do while in power increases deficits.  (Not that deficits are inherently bad, but for reasons that should be obvious by the end of this post, the way that Republicans increase deficits actually is usually bad.)  They also talk a fair bit about cutting supposedly burdensome regulations, but again, that is nothing compared to their commitment to tax cuts.

Democrats are not as monolithic or single-minded.  In part, this is because they are only now emerging from a four-decade-long defensive crouch on economic policy.  I specifically include the Carter Administration in this time period, by the way, because notwithstanding his other virtues, Jimmy Carter's economic policy began the period of full-on neoliberalism from the Democrats.  Having spent so much time saying "Me too!" about the whole Reaganite economic agenda, Democrats are finally showing stirrings that they might rally around labor rights (although President Obama's strong-arming of the recent Trans-Pacific Partnership fast-track vote shows that there is still a long way to go there) and stake out other issues on which they truly differ from Republicans.

With economic inequality having recently become such a major concern for most Americans, Democrats are increasingly willing to come out in favor of dreaded "tax increases," because they are evidently now confident that they can sell progressive tax changes (higher tax rates on higher incomes) without losing votes.  That will not stop Republicans from screaming about tax increases, of course, but the terrain has thankfully changed.  Democrats are also willing to talk about spending money on income supports (food stamps, unemployment benefits, and so on), infrastructure, education, social programs (universal pre-K, nutrition programs, and so on).

In a basic sense, then, the current political reality looks like this: Republicans are in favor of tax cuts and spending cuts, usually combined in a way that increases borrowing, and Democrats are in favor of some tax increases and spending increases, with varying effects on deficits.

What my email correspondent wanted to know, specifically, was why it was not obvious that tax cuts for the non-rich and spending increases on programs for the non-rich are the clear path to prosperity.  When the economy is weak, that is clearly and obviously correct.  It is, in fact, classic Keynesianism.  And the evidence of the past eight years, in the U.S. and especially in Europe, strongly supports the classic Keynesian story.  A weak economy needs spending, and a government that either spends directly or that gives money to people (through food stamps, other benefits, or tax cuts) who will immediately spend that money is going to see its economy get stronger.  The too-small (and too regressive) 2009-10 U.S. fiscal stimulus had exactly this effect, and when it went away, the economy weakened predictably.  In Europe, austerity policies harmed the economy, and pauses in austerity policies (especially in the U.K., prior to their most recent election) temporarily eased the pain.

Readers who are old enough to remember Ronald Reagan's embrace of "supply-side economics" might correctly intuit that the Reagan Revolution was in part a reaction to demand-side economics.  Classic Keynesianism is, in fact, generally concerned with demand (that is, spending), because it is focused on dealing with an economy that has unemployed resources -- that is, an economy that can supply much more than is currently being demanded.

But Keynesian economics was never exclusively about demand-side economics.  Once the economy reaches its potential, there is no reason to continue to push up demand, because there are no unused resources to put back to work.  Even this, however, is somewhat overstated, because it turns out that a very strong economy can make it profitable to put seemingly unusable resources to work.  For the wonks out there, this is the theory of "hysteresis," which simply says that backing off on demand-side policies too soon squanders the opportunity to take people who are too easily viewed as "unemployable" and turn them into productive workers.

In the 1980's, the big argument among conventional economists of the non-Keynesian persuasion was that the "full employment" rate of unemployment was 6%, or 6.5%, or something like that.  Any rate lower than that would unleash ruinous inflation, these economists predicted.  By the time Bill Clinton left office, however, we had had more than six years of sub-6% unemployment rates, the last three-plus years of which were below 5%.  In fact, unemployment was at 3.9% for September through October of 2000 (yet Al Gore managed to make that election close enough to be stolen, rather than winning in a romp).

Today, the Democrats are sensibly talking about various types of spending and taxing policies that would put more people to work.  Just as important, the Democrats are also noticing that the unemployment rate's decline to 5.3% under Obama has not had the usual positive effect on wages, which is part of the inequality story, and which is why the economy of 2015 does not feel as prosperous as in 1995-97, when unemployment was at current levels.

Again, however, it is not at all accurate to say "Republicans care only about the supply side, and Democrats care only about the demand side."  Instead, it would be more accurate to say, "Republicans care only about the supply side (and think that demand-side policies are per se ruinous), and Democrats think about both, depending on the context."

What is the supply side?  Rather than getting people to buy everything that firms and workers can currently produce, the goal of supply-side policies is to make it possible for firms and workers to produce ever more output, even when they are all fully employed.  That is, supply-side policies are designed to increase economic productivity.  The big difference between the parties is in how to accomplish that.

Republicans are, again, all about tax cuts.  (Their anti-regulatory fervor rears its head here, too, but I will put that aside.)  And to the extent that they feel the need to justify those tax cuts, the do so with standard supply-side rhetoric.  Tax cuts, they say, will unleash economic activity that is being discouraged by low rates of return.  Although their rhetoric generally obscures the top-down nature of their underlying economic theory, this really is nothing but trickle-down economics.  The more the tax cuts are aimed at the "job creators," they say, the better the economic outcome.

One of the standard claims made by Republican politicians and their economic advisors is that "if you tax something, you'll get less of it."  Therefore, if you tax income, you'll get less income, and if you tax the returns on business investment (capital gains, for example), you'll get less of that.  Too many non-conservative economists and politicians buy that line as a starting point, but that is a story for a different day.

The problem, in any case, is that the evidence for the supply-side effects of tax cuts is incredibly weak, bordering on nonexistent.  In a Verdict column during the 2012 primaries, I quoted Christina Romer (Berkeley economics professor and former chief economist for the Obama Administration) as follows: "[T]he strong conclusion from available evidence is that [the] effects [of income tax rates on people’s earnings] are small. This means policy makers should spend a lot less time worrying about the incentive effects of marginal rates and a lot more worrying about other tax issues."  I also noted the lack of evidence supporting capital gains tax cuts as a way to increase economic productivity.

I should also note that the Paul Ryan-led attempt to revive dependency theory -- the idea that "the dole" causes people to settle for lives of indolence and sloth -- is a subset of supply-side analysis.  The claim is that offering, for example, unemployment benefits simply encourages people to choose not to work, which reduces the economy's potential output.  This was the deranged excuse for cutting off unemployment benefits for long-term unemployed people during the aftermath of the Great Recession, even though their continued inability to find jobs was clearly a demand-side phenomenon, not a matter of government-induced laziness.

Democrats, meanwhile, are much more eclectic in their efforts to look for ways to increase economic productivity.  In part, this is because they are not crazy enough to imagine, as Jeb Bush bizarrely does, that the economy's growth rate could permanently be increased to 4%.  The evidence of modern capitalism, especially in the United States, is that supply-side effects are never that large.  Still, Democrats (including President Obama) have endorsed various types of spending designed to improve the current and long-range productivity of the economy: paying for infrastructure improvements, subsidizing basic research and development, improving schools at all levels, and so on.

Obviously, I do not view the Republicans-versus-Democrats question on economic prosperity as being a close call, or even a fair fight.  That is why I am a liberal and (though frequently disappointed) a Democrat.  The evidence and theory are so clear, and the contrary evidence and theories (such as "expansionary austerity") so weak, that listening to every Republican talk about the magic of further tax cuts takes on a surreal air.

But, even for people who reject my assessment of the weight of the evidence, the basic story is this: Republicans focus only on supply-side policies, believing that tax cuts in particular will increase economic prosperity, while Democrats favor expansionary demand-side policies when needed, and they favor various supply-side spending policies as well.  If any Republican presidential candidate says anything that deviates from that script, I will be shocked.  If any Democratic candidate fails to push for progressive policies that also have clearly positive supply-side effects, I will be appalled.