Trickle-down fashion
In economics the trickle-down effect is central to recent versions of conservative economic theory. It is promulgated in hard-right organs such as The Wall Street Journal editorial page, and by billionaire-financed think tanks such as The American Enterprise Institute and the Cato Institute. This theory does not propose that benefits given to the upper classes will "trickle down" to those below them on the social hierarchy due to the benevolence or generosity of the rich; rather, its proponents maintain this will occur as a result of the normal workings of unfettered markets.
It is hard to define, while the validity of the concept depends on the definition. For example, one online magazine defines trickle-down theory as an "economic theory which advocates letting businesses flourish, since their profits will ultimately trickle down to lower-income individuals and the rest of the economy" [1]. Another defines it as being the same "as Supply Side Economics. ... An economic theory that the support of businesses that allows them to flourish will eventually benefit middle- and lower-income people, in the form of increased economic activity and reduced unemployment" [2]. One economist defines it as "A theory of economic development that claims higher standards of living for the poor will develop gradually [with economic growth] and not at the overt expense of the more affluent." [3] Other economists define it as simply the economics of President Ronald Reagan, known as "Reaganomics." However, following the two definitions above, it seems to be a more general theory applied by President George W. Bush in economic policy-making, and perhaps by most of recent U.S Republican Party policy proposals, hearkening back to those of Calvin Coolidge and Warren G. Harding, if not William McKinley. There are at least three different ways of looking at the trickle-down effect.
Upper income and corporate tax cuts
In this view, it is a central tenet that government policies which benefit upper-income taxpayers and corporations (through tax cuts, subsidies, etc.), will indirectly benefit the middle classes and even the poor. These benefits will trickle down. This tenet is central to Supply-Side economics, a version of laissez-faire economics, and it was a highly charged issue during the Reagan Administration. In fact, at some times, pro-Reagan economists (such as Arthur Laffer) were arguing that the benefits of supply-side tax cuts were so large that total tax revenues would actually rise, helping to pay for the Reagan administration's increased spending on the military and the like, so that the government deficit would not rise.
Note that it is also part of Keynesian economics to see the possibility that cuts in the tax rate will stimulate increases in tax revenue (though usually not enough that the tax cut "pays for itself"). But that effect is due to increases in aggregate demand until it reaches potential output, while Supply-Side economics sees their policies as increasing potential output. Further, Supply-Side economists often see the positive effects on potential as happening very quickly, almost immediately. On the other hand, Keynesian policies that affect the supply side, such as government investment in infrastructure, are seen as taking years to pay off.
Trickle-down theory is a major rhetorical variant of "what's good for business and the rich is good for the country." While many believe this is generally true, others argue that trickle-down economics simply helps the special interests of business and its owners. David Stockman said Supply-Side rhetoric was used during the Reagan Administration as a "trojan horse" for lowering taxes on the wealthiest individuals. One economist critical of this theory, John Kenneth Galbraith, has summarized trickle-down theory as "horse and sparrow" economics: "if you feed enough oats to the horse, some will pass through to feed the sparrows." Before he became Vice-President under Reagan, George H.W. Bush had referred to this theory as "voodoo econonomics."
In Robert J. Gordon's Macroeconomics (9th ed, 2003, p. 393) he points to three elements behind the idea of supply-side tax cuts:
- 1. Taxes on income reduce the after-tax rewards for working and saving.
- 2. An increase in this reward would cause a big and significant increase in both working and saving. These are seen as raising potential output.
- 3. In the Laffer variant, the increase in work and saving would allow the government to collect more extra revenues than was lost due to the tax cut.
While Gordon sees the first as valid, the second and third do not pass the test of empirical data (in his survey). One problem is that a rise in after-tax income does not always mean a rise in work or saving (step #2). If I receive a ten-percent raise (due to tax cuts), I could easily decide to work ten percent fewer hours, receiving roughly the same amount of income as before, but having more time to enjoy it. I could also attain my saving goals (saving for retirement) more easily after the tax cut, so that I need to save less. (In economics jargon, the supply-side argument encorporates the incentive or substitution effect but ignores the income or wealth effect.)
In its defense, the economy did improve in the later Reagan years, after supply-side economics was implemented. But almost all economists would reject this history as a justification of supply-side economics; instead, they apply an eclectic version of Keynesian economics. Paul Volcker, the then Fed chief (appointed by Jimmy Carter), had already begun implementing contractionary monetary policies to solve the problem of severe inflation by raising unemployment {see Phillips Curve). Once inflation has been beaten (by the back-to-back recessions of 1980 and 1982), the Reagan policy of deficit spending (due to tax cuts and military spending increases) can be seen as sparking the prosperity of the late 1980s, following the Keynesian logic of what normally happens due to deficit spending. This expansionary effect was helped by the rapid fall in oil prices, especially around 1986. Contrary to Supply-Side promises, the government deficit rose from 1.6 percent to 2.8 percent of GDP from 1979 to 1989. The government debt rose from 25.6 percent of GDP in 1979 to 40.6 percent in 1989.
Laissez Faire
Second, there is the related view that unfettered markets benefit all in society. This is linked to the first version of trickle-down economics because free-market rhetoric was often used to justify tax cuts for the rich and corporations. Further, much of the laissez faire theory turned out in practice to be nothing but pro-business policy.
David Stockman, one of Ronald Reagan's economic advisors, placed Supply-Side economics in a long tradition in economics, and maintained that laissez-faire will benefit not just those well-placed in the market (the rich) but also the poorest. The general principle is argued in Bernard de Mandeville, The Grumbling Hive (1733): "private vices are public virtues". Because the wealthy spend lavishly and employ others, benefitting the rich, they help the poor. In the context of trickle-down theory the rich are called the "creative sector" of the economy, and their demand for capital goods is seen as being the driving force of the economy.
Some interpret the following quote from Adam Smith in this light.
- "It is the great multiplication of the productions of all the different arts, in consequence of the division of labour, which occasions, in a well-governed society, that universal opulence which extends itself to the lowest ranks of the people." (An Inquiry into the Nature and Causes of the Wealth of Nations, ch. 1. Emphasis added.)
In this interpretation, the "well-governed society" is one in which free markets dominated by tax-favored and legally protected corporate entities who have close relationships with the government, which is how conservatives interpret the phrase "natural liberty", replace the state's guidance as the method of resource allocation. This interpretation, while widely repeated, is questionable, there was no such thing as a planned state economy in Smith's day; instead the King and other officials were economic actors who used their power to advance their own economic interests. (See Mercentilism). The argument rests on equating the liberal state with the mercentile state, and with not equating the heads of large corporations with the nobility of that mercentile state. For these reasons many doubt that Adam Smith can be invoked in favor of trickle-down theory. The Wealth of Nations is a comprehensive criticism of special interests, and Supply-Side economics bears a striking resemblance to the sort of special-interest arrangements that Smith was critical of.
However, it is equally easy to argue that state interference in the economy is a "slippery slope" and that once begun, its inevitable endpoint is the complex of large, inefficent state-run enterprises which encumbered European growth in the late 1970s. Since the genisis of the current version of trickle-down theory has its genesis in that period, it is from the perspective of a depressed equities market, raging inflation and stagnant growth that trickle-down must be seen. In this view, government regulation is a form of fiscal policy which inefficiently redistributes income from the top of society to the purchase of commodities for which there is insufficient demand. This argument runs that if people were willing to pay for whatever government regulation purchases, they would. Therefore, the result is, in effect, "purchasing" goods at a cost above demand.
The Growth of the GDP Benefits All
A third variant centers on Kuznets' "Law", which says that increases in income inequality that occur in the early stages of industrialization are followed by increases in income equality. A more general version argues that increases in real gross domestic product are almost always good for the poor. This is linked to the previous version of trickle-down because GDP is best seen as a measure of market activity, the buying of goods and services produced for sale. As many critics have noted, it does not measure well-being very successfully. (One effort to replace GDP as a measure of well-being is the Genuine Progress Indicator.)
Though Kuznets' "law" seems to describe the process of industrialization in the U.S., at this point it is past its application, with steady increases in inequality in wealth and income. Rises in gross domestic product in recent decades have usually coincided with increases in inequality.
The opposite of this version of the trickle-down effect can be seen in Karl Marx's "absolute general law of capitalist accumulation," in which he posits the normal tendency of economic growth under capitalism as being that wages fall behind the growth of labor productivity. This "immiseration" tendency implies that the workers' share ot the total product will fall in percentage terms. In recent decades, when this theory fits better with the empirical data in the United Sates than it did during the 1950s or 1960s, more people have begun to think in these terms (though probably without citing Marx). For example, people posit a "race to the bottom," in which wages around the world are being dragged down to the standards of manufacturing in poor countries (adjusted for differences in labor productivity). (See Globalization.)
See Also
Wikipedia
- supply-side economics
- neoliberalism
- Regressive Taxes
- an alternative interpretation of the Trickle-down effect