Effective Supply: The Real Key

It’s no wonder that voodoo is no longer being used as a smokescreen. In 2017, when the tax reform package was being hashed out, the Democrats were disparaging the legislation, calling it, “tax cuts for the rich” or “trickled down economics” and of course, “voodoo economics.”

Those talking points have vanished faster than the media hype over Beto O'Rockstar and his skateboard.

Perhaps these characterizations are no longer in most Democrat’s lexicons because it would remind voters just how wrong they were.

With the economy booming, the last thing the left wants is for Republicans to point out that supply side economics work. The question is, why isn’t the GOP making this point over and over even without antagonists?

If conservatives were more apt to teach the public by connecting dots, then perhaps light bulbs would go off. Instead, they just hope that people will get it. It’s time for more strategic thinking about communications that would actually expand the base.

The Tax Cuts and Jobs Act of 2017, which went into effect on January 1, 2018, is a bill in line with supply side economics. Supply side is much more than tax cuts, though. The singular purpose of supply side economics is to create a climate that’s business friendly.

Conservatives claim a friendly climate will result in economic growth and a vibrant job market because with less barriers, businesses will pursue revenue to earn profit. In this pursuit, jobs are created. The benefits for workers are upward mobility, higher wages and more opportunities for everyone.

Such policies are quite a different approach than that of liberal economics. In fact, they’re the opposite.

Ineffective Demand

Liberals today base their macroeconomic ideas upon the work of John Maynard Keynes, who wrote, The General Theory of Employment, Interest and Money (1936). People who adhere to this philosophy are called Keynesians.

In his book, Keynes introduced the principle that he dubbed, effective demand. This occurs when aggregate demand meets aggregate supply. At this theoretical place, demand’s buying power has reached its limit. Therefore, businesses won’t supply anything further because it couldn’t be sold and, as such, hiring will cease. The problem is, this point of effective demand may not be full employment, so how does an economy create more jobs?

The remedy, according to Keynes, is to cut taxes or to increase government spending to create more demand. The supply would then respond and begin hiring once again. The Democrats seem to always want government spending over tax cuts to increase demand. Maybe they’re not really Keynesians after all, but that’s a digression.

Based on this theory, the liberal approach to grow the economy is to stimulate the demand side with government spending. Conservatives, on the other hand, know that supply side economics is what leads to economic growth.

In my upcoming book, I advance the notion that in free market capitalism the emphasis is on the demand side. In other words, it’s up to the supply side to satisfy the demand side or there will not be a transaction. Accordingly, policies that free up businesses will then allow them to pursue profit, which can only occur by meeting market demand.

Economists should doubt Keynes’ underlying assumptions that demand could ever be satisfied. In reality, demand is never fully satisfied at any point in time. Even if buying power could ever be at its maximum, consumption could be diverted somewhere else. This is because companies are continually competing for market share and disposable income. The fact is, if a company meets demand, they will earn an income – even at this mystical dead place of effective demand.

The crux is that our national income or buying power will never prevent growth. This is because demand is never fully satisfied.

To prove this, in my book I use the hypothetical of someone starting a lawn cutting business in his neighborhood, even within this idea of effective demand. Let’s say a homeowner pays $40 for a grass trimming, which he otherwise would have spent at Target. The guy cutting the grass effectively replaces that diverted consumption by spending the $40 at Target himself. So Target didn’t lose anything.

Our national income, though, increased by $40 because the grass cutter earned $40 by meeting demand, not because the homeowner had more buying power. The guy is so successful that he begins hiring people to meet more demand, which further increases employment and our national income.

As the above small business reveals, growing the economy is about meeting demand, not the need for more buying power.

Individuals and companies meet demand all the time, in big ways and in small ways like our mowing entrepreneur. If demand is met, they’ll earn income and our national income likewise increases.

If Keynes underlying assumptions about demand’s buying power are wrong, then the principle called effective demand is a misnomer. If your goal is to create robust economic growth, stimulating demand is not effective; simply because demand’s buying power isn’t the problem.

In times of unemployment and economic slowdown, stimulating the demand doesn’t create a buying frenzy so that businesses begin expanding again. Why? Because businesses won’t borrow or invest saved capital to expand further without having confidence that the economy is improving, which a government stimulus package doesn’t achieve.

These policies do affect the demand so there is more economic activity, but that doesn’t improve the business climate. In the majority of cases, an employer’s current staffing can absorb an uptick in demand.

A Better Climate

In order for economic growth to be robust and not anemic, the climate in which businesses operate in has to improve. Fundamentally, this means more freedom to create things that meet demand.

Supply side policies accomplish this by unshackling businesses by removing government regulations, lowering corporate taxes, and opening up new foreign markets with trade agreements.

By removing constraints, business confidence improves. Companies move beyond survival and seek to grow the top line of revenue. They’ll then expand their operations in the pursuit of revenue and with that, create jobs.

Just think, the Democrats running for President want to go backward and add constraints to business. They’re promising more corporate taxes and regulations. This is a formula to slow growth.

When businesses are constrained, the only way to survive is to cut expenses to improve the bottom line. This results in job losses. High corporate taxes, for instance, make it more difficult to compete with foreign companies. This is why manufacturing was in steady decline and offshoring was on the rise before Trump’s tax reform.

Demand stimulus also doesn’t change consumer confidence in the economy. This is because business confidence needs improving first. If you can improve business confidence, consumer confidence will follow. Whether we like it or not, that’s the order of things. The dog wags the tail, not the other way around.

Boosting consumers’ outlook doesn’t take place with government spending. It only occurs if these workers are confident about their future earnings potential. If the job market is abysmal and they’re worried about losing their job, then no demand stimulus can alleviate that. People only increase consumption when the job market improves and they believe their earning potential is not in jeopardy.

Supply side economic policies are effective and the key to free market capitalism's success. They are not voodoo and you don’t need a magic wand to create job growth. It would be beneficial to the whole capitalism vs. socialism debate if we had people to point that out.

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