December 10, 2009

Supply Side 2.0

Attention Reagan Republicans: If you believe in the virtues of supply side economics prepare for a bit of a re-think. Don't worry, it won't kill you.

Supply side economics is generally understood to mean that in order to promote economic development and activity, the role of the government is to provide incentives for producers to produce. This is done through tax incentives including things like decreasing corporate tax rates and capital gains taxes. It is also understood to mean a regulatory environment that is as unobtrusive for business as is reasonable (meaning you still don't use lead paint in children's toys). The benefit to consumers is that by having all of this product available because of a producer friendly environment, consumers will have more choice, and because of the increased competition, cheaper prices. Other fallout would include the fact that increased competition means an implicit incentive to innovate - better quality or cheaper production. Again the consumer benefits in the end.

So far, so good. How could anybody be against supply side economics? Well there is a singular drawback that causes two distinct observable issues. The problem is in the application of innovation. Innovation in the above calculus is meant to focus on technical innovation (thereby decreasing production costs or increasing product quality). But there are other ways to accomplish the same outcome. Remember though, that for a business the goal is not to innovate, the goal (reasonably) is to maximize profit. If you can reduce production costs without innovation why spend the time and treasure to do so? Why not reap the savings more cheaply if you can? Again, an entirely reasonable thought.

One of the single biggest costs of doing business is labor. Therein lies a welcoming target for producers. And that leads to the problems. If it's beneficial to suppress wages then there some alternatives available to producers. They can pay existing employees less, or they can find cheaper employees. When you throw in Free Trade deals (or even without them), the choice becomes pretty clear for a manufacturer - cheaper labor, FAR cheaper labor, exists in an awful lot of other countries. So as a result, production goes off shore.

In the short term, consumers see a real boon in cost savings; shoes that used to cost $50 you can find for $8. But there's a problem that arises out of the new dynamic. If labor goes offshore, then so do wages, and so does buying power of the domestic consumers. Unless every person in America becomes a producer, domestic consumption will necessarily stagnate and then decline. In order to offset this problem, the only way domestic consumption can continue, and not indefinitely, is to increase consumer debt. That consumer can be in the form of the general public, or the government, but the debt is real regardless of how it is split - the government is of the people after all.

So now you have a situation where production has been offshored, manufacturing has declined, and debt has risen dramatically. In fact at this rate the next thing to see being offshored is the innovations themselves. And this is just the transition phase. What happens when there is no manufacturing base left in America? I contend that you can not have an economy that is entirely service based. People can add value (wealth) with service to each other within a country, but ultimately if there is a continued net outflow of capital (goods flow in and services flow out of the nation in smaller amounts), that wealth transfer can only go on for so long. Think of it as a Monopoly game where you have mortgaged all of your properties and have no income and you keep landing on the other players' properties and having to pay. What happens? You lose the game.

So is supply side economics doomed in a free trade world? Are the only ones safe the high flying uber-rich who can offshore their entire fortunes and move to the next economic paradise if needed? No. The situation is not the fault of supply side economics. It's not even the fault of Free Trade. It's the fault of supply side economics not being applied enough and equally importantly, not being applied intelligently enough.

The core concepts of supply side economics are sound. What needs to be tweaked is the application of said concepts. Clearly, the federal government has NOT made the country one where tax incentives favor investment. It has not made the country one where development and production are highly prized. It's easy enough to be protectionist without being protectionist IF you do it on the supply side. What I mean by that is the idea of having a two-tiered capital gains tax - one for domestically realized capital gains and a higher one for foreign capital gains, unless the gains are realized by ownership investment overseas. What I mean is having a two tiered corporate tax rate - one for companies selling domestically produced goods and services and one that sells foreign produced goods and services. There are no direct tariffs, no disincentives for consumers who want to buy Danish cheese or French wine, or Saudi oil. But there is a distinct, demonstrable and significant value to producers to produce domestically. It means a reduced regulatory footprint so that companies can compete on a level playing field with India and China (again, with things like public safety not forsaken). It means saying no to the burden of Cap and Trade, and the labyrinth of Sarbanes Oxley. The solution is in fact a supply side solution to a supply side problem.

What does Supply Side 2.0 look like? It's as hard to define as what does Supply Side economics look like in general. It certainly doesn't look Keynesian. In fact it's pretty much the same as the original Supply Side economics, with an additional layer of thought applied to stimulating production. Production needs to be stimulated domestically not stimulated regardless of national origin. Free Trade thinks of the world in an economic vacuum. Would anyone in America be happy if all the world's manufacturing production came from Russia, Venezuela and Iran? The world, clearly, is not a vacuum. If there is such a thing as national interest, then it must include domestic wealth production. That requires more than just a post-manufacturing economy. And that means that it behooves the United States to act in it's own economic interest just as if it were an individual or a corporation. And it's national interest means maintaining it's economic status, not becoming an economic also-ran, or just another nation, as President Obama seems to see it.

In order to recapture American economic and manufacturing might, all that is needed is a re-visiting of the environment in which businesses in America have been forced to operate. Granted, it would take some hard decisions and difficult changes to bring about the optimal environment for economic success. Granted also, that the changes would not come overnight. But the issue is bigger than an election cycle and some difficult changes, the issue is the economic future, indeed the very future of the United States.

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