Supply-Siders Still Push What Doesn't Work

August 1, 2017
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The case for supply-side economics is by now so familiar that it’s almost a catechism. First, the supply-siders will point out that economic growth is slow. They’ll remind us how much better things were in the 1980s (and, occasionally, the 1990s). Then they’ll recommend growth be increased through a mix of tax cuts, deregulation and fiscal austerity. Usually, the policies they suggest will happen to coincide with whatever Republicans in Congress or the presidency are currently proposing.

A recent essay by John Cogan, Glenn Hubbard, John Taylor and Kevin Warsh sticks very closely to this standard script. The authors, who are all affiliated with the Hoover Institution, a conservative think tank, assert that:

Economic theory and historical experience indicate economic policies are the primary cause of both the productivity slowdown and the poorly performing labor market. [These include] high marginal tax rates … costly new labor market and other regulations, [and] high debt-financed government spending.

They go on to claim that “the policy changes of the kind proposed by the Congress and the [Trump] Administration, if enacted, would significantly improve the economy’s growth prospects,” predicting that these policies would raise real growth to 3 percent a year, from about 2 percent now.

A number of economists and writers have already highlighted the flaws in Cogan et al.’s essay. Berkeley’s Brad DeLong points out that although Cogan et al. claim that productivity growth “rose markedly through the 1980s and 1990s,” it was actually fairly slow during much of that time period:

Misplaced Nostalgia for the '80s and '90s

Real output per hour, percentage change from prior year's quarter

Source: Federal Reserve Bank of St. Louis

Meanwhile, Bloomberg View’s Justin Fox notes that the recent decade of slow growth came in the wake of a major financial crisis. The aftermath of a crisis usually brings an extended “hangover,” probably due to a weakened financial system, decreased business confidence and an accumulation of private debt. Simon Johnson, a professor at Massachusetts Institute of Technology's Sloan School of Management, agrees, and adds that the aging population has also been a headwind for the economy. Because there have been all these other factors at work, it isn’t accurate to casually blame recent slow growth on high taxes or regulation.

But relatively few critics have focused on what I see as the weakest part of Cogan et al.’s essay — the claim that lower taxes, deregulation and reduced government spending can boost growth significantly.

Tax cuts have generally proven to be a big bust during the past few decades. Former President George W. Bush pushed through a series of substantial tax cuts in 2001 and 2003, but growth failed to return to 1990s levels. More recently, experiments with lowering taxes at the state level have showed very disappointing results. The most glaring example is Kansas Governor Sam Brownback’s tax-cutting program, begun in 2012. In the years since Brownback slashed taxes, the state’s finances have been drowning in red ink. But economic growth didn’t pick up, and Kansas has lagged behind its neighbor Nebraska in both labor supply and income per person:

Job Differential

Employment-to-population ratio

Source: Federal Reserve Bank of St. Louis

Advantage Nebraska

Real median household income*

Source: Federal Reserve Bank of St. Louis

Fed up with the failure of supply-side magic to materialize, the Kansas legislature voted this year to roll back the tax cuts. Meanwhile, to the north, lower taxes haven’t helped Wisconsin’s economy outperform Minnesota’s. With tax-cutting experiments achieving nothing at the state level and not seeming to have any big effect nationally, one would hope supply-siders like Cogan et al. would reconsider.

On deregulation, I’m much more sympathetic to the supply-sider concerns. Some regulations are probably hurting economic dynamism by protecting incumbent industries, while others would fail a cost-benefit test. But other regulations probably help the economy, by assuring customers that their products are safe, keeping the workforce and populace healthy, or protecting long-term availability of natural resources. It’s no easy job to tell the good regulations from the bad. The Trump administration has promised to tackle this thorny problem, but given its record of general ineffectiveness, there’s no reason to assume, as Cogan et al. do, that it will make wise choices. Also, many of the country’s important and potentially harmful regulations are at the state level, not the federal.

As for fiscal austerity, there is no reason to think that any further gains can be made there. Most of the deficit that the U.S. ran during the Great Recession has now been eliminated:

The Worst Is Over

Federal deficit as a percent of GDP

Source: Federal Reserve Bank of St. Louis

The deficit is now about 3 percent of gross domestic product, which is less than the rate of nominal GDP growth. That means the deficit is now sustainable, and further austerity won’t have much effect.

Additionally, basic economic theory says that low deficits boost growth by lowering long-term interest rates — but with rates already near record lows, there isn't much scope for improvement in this regard. Finally, Cogan et al.’s goal of deficit reduction is strongly at odds with their recommendation of big tax cuts, as Brownback’s experiment in Kansas shows.

So policy makers shouldn’t listen to the supply-side orthodoxy. Deregulation could have some positive effects if done right, but tax cuts and austerity — even if they could both be accomplished at the same time — are policies with very little promise. To boost growth, the U.S. should look to other policies, like better infrastructure, stronger antitrust enforcement and more investment in research and technology.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Noah Smith at nsmith150@bloomberg.net

To contact the editor responsible for this story:
James Greiff at jgreiff@bloomberg.net

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