Analysis by Keith Rankin.
In the last three months, Elizabeth (Liz) Truss and Kwasi Kwarteng performed an amazing political boom and bust routine. They captured the British Conservative Party at a time that such a capture meant a direct route to power in the United Kingdom. (More commonly, at least in New Zealand, political party leaders change when their parties are not leading the government.) A few weeks later, their fall – first Kwarteng, the Truss – was even quicker, as their mantra was politically discredited. But what about the economic rationale for their tone-deaf programme; a self-serving agenda which captured the hearts of a few privileged Englishmen, while appearing foolish to everyone else.
There was a clear-cut economic rationale, which was not properly explained in the media; the British and other media were generally looking for political angles to their stories.
Truss and Kwarteng, in reality, were supplying a dose of 1980s-style ‘supply-side economics’; commonly called ‘trickle-down’, though the concept of ‘trickle-down’ has been politicised to the point of becoming academically meaningless and politically vacuous.
Supply-side economics formed the ideological basis for ‘Reaganomics’ in the early 1980s, and was linked in particular to the economic analysis of Arthur Laffer and the advocacy of economist Robert Mundell. So, formal ‘supply-side economics’ may be called the ‘Laffer/Mundell theory of economic growth’.
The policy is one of ‘unfunded tax cuts’ which reduce the tax liability mainly of those in the top income decile. Technically, ‘unfunded’ means that they are financed by borrowed money. However, the critical component of the supply-side theory is that tax reductions would in themselves cause the economy – real gross domestic product (GDP), ‘the taxable pie’ – to grow sufficiently more than it otherwise would; so that the tax cuts would be funded, albeit with a lag, not by borrowing but instead by increased revenue arising from that presumed increase in the size of the GDP pie.
The Truss/Kwarteng project was particularly tone-deaf because of its advocacy of accelerated economic growth in a time that traditional growth is destroying the planet as we know it. And it was tone-deaf because it was advocating more inequality in a nation, indeed in the world, in which there was clearly too much inequality.
But what were the assumptions which led Truss and Kwarteng to believe that Laffer/Mundell supply-side economics was good economic or good political policy? First, I’ll note the political assumptions. To get into power, Truss and Kwarteng had to play to a privileged minority who liked the sound of policies; a political audience with ‘low political intelligence’ who liked the sound of policies that would augment their own entrenched privilege.
That political marketing then became a liability, as Truss and Kwarteng then had to perform for very different and much larger audiences; audiences with more political nous, though not necessarily with the intellectual tools to debunk supply-side economics.
‘Unfunded’ fiscal policy
Unfunded fiscal policy – whether increased government spending or subsidies unmatched by tax increases, or decreased revenue unmatched by spending cuts – is appropriate in many situations. This is despite the widespread belief, pushed in New Zealand by both big political parties, that economic health for a country depends on ‘balanced budgets’ for its government sector.
The most obvious of these contexts is that, as formally described by Keynes in the 1930s, increased government or consumer spending becomes necessary to spark a recovery from economic depression. This was an argument for a temporary deviation from balanced budget fiscal policy; and, as with supply-side economics, it looked to higher future GDP as the means to restore fiscal balance. But this was ‘demand-side economics’, with the emphasis on a mix of government projects and belated consumer spending as drivers of growth.
Keynesian economics almost always succeeded in this aim when pursued in this context, although there were international constraints; balance of payments difficulties would emerge in those countries which pursued the ‘get-out-of-depression’ policy most vigorously. And, in today’s world of floating exchange rates, currency depreciation would likely lead to higher inflation in such countries. (Though, today, Japan has lower inflation with a falling currency, and the United States has higher inflation with a rising currency!)
The world economy since the 1990s has faced additional structural issues, which may make sluggish economies more resistant to Keynesian-style demand stimulus. The most important of these issues relate to the physical environment, with carbon-dioxide-led global warming being pre-eminent among these issues. In today’s world, growth is increasingly seen as the problem, not the solution.
Nevertheless, the Japan model, which arose after its crisis in the early 1990s, has shown that unfunded government spending need not be the mistake that most bureaucrats and commentators assume such policy to be. This successful approach by Japan became known as Abenomics; although, when under the auspices of Shinzo Abe, it should probably have been called Japanomics 2.0. Abenomics actually preceded Abe.
Now, this month, we have seen the effective commencement of Japanomics 2.1. (Refer ‘Counting the Cost’ – Al Jazeera, 5 Nov 2022 – for the relaunch of Japan’s successful heterodox approach; a stimulus rather than a depressant.) Abenomics is about running structural fiscal deficits as a way of offsetting both a domestic resistance to higher taxes and a domestic predilection for investment in public infrastructure. It shows. Japan has arguably the highest living standard in the world, low inequality, and easily the world’s highest public debt as a percent of GDP. High Japanese public debt is not perceived as a constraint on government investment.
Today, Japan has the world’s lowest interest rates and just about the world’s lowest inflation. Further, it is not pushing for economic growth as such, as the way forward. Rather, Japan seeks to counter the negative growth that both its demographics and its consumer conservatism would otherwise bring about. An important and exportable variation of Japannomics would be to stimulate ‘sustainability’ rather than overt ‘growth’.
In 2022, Japan is to macroeconomics what Sweden is to covid. Successful, so ignored lest the word gets out that there are alternative policies to deal with the West’s apparently intractable public health, labour, and cost of living problems.
The supply-side version of unfunded fiscal policy is quite different to either Keynesonomics or Abenomics, in that Laffer and Mundell emphasised tax cuts over increased government outlays, and that they looked to business and entrepreneurs – rather than consumers or bureaucrats – to lead the growth charge.
An appraisal of the Laffer/Mundell theory
First, we note the present questioning of the belief that perpetual economic growth is not only good but also necessary. Concern about the ‘economic growth is always good’ assumption was already starting to be questioned in the early 1970s. (The questioning in the late-1960s of the sustainability of rapid population growth came from a different but overlapping political constituency. In the 1960s the concern emerged that population growth, as was occurring then, would erode the otherwise beneficial increases in material living standards.) In the 1980s, however, economic growth – understood as the imperative to ‘make money’, the more the better – was back in vogue.
Second, an underlying assumption of supply-side economics is that people – especially people who already have high incomes – are somewhat lazy, unmotivated to ‘produce more’ in the absence of ‘sweeteners’. The particular sweeteners emphasised here are the ‘marginal tax rate’ and the company tax rate. (A key part of the ideology here is the liberal idea that ‘tax is theft’; and, per se, a discouragement to produce [especially a discouragement to capitalists]. Also is the mercantilist idea of growth as the accumulation of capital/money; where value to society lies in the money made, not necessarily in the mass-consumption of consumables.) The flipside to the view that capitalists need sweeteners is the view that labourers need discipline. If after-tax wages become too high, then labourers would respond by working less, not more. (Hence, increased national incomes should only trickle down to workers, giving them time to raise their material aspirations.)
In essence, the Laffer/Mundell assumptions are that growth is the essence of goodness. And that national economies have substantial spare capacity; we may call this the postulate of ‘latent surge capacity’. Laffer and Mundell emphasised entrepreneurial surge as the central benefit of supply-side economics.
We are now just coming to appreciate that the capacities of our economies are indeed critically important; contrast that with our former (pre-covid) general assumption that it was money – rather than labour and the environment – which constrained our capacity to progress.
A particular ‘technical’ feature of the supply-side theory was called the ‘Laffer Curve’. This was an inverted u-shape graph which pointed out that tax revenue is zero if the tax rate is 0%, and also zero if the tax rate is 100%. (If the tax rate was 100%, in a free economy nobody would work at all; no money made would mean no tax could be collected.) Therefore, Laffer argued, some tax rate between 0% and 100% maximises tax revenue. While finding what that ‘optimal’ tax rate is might be difficult, Laffer’s emphasis suggested that a ‘marginal rate’ of around 30% might be the magic number. Supply-siders favoured a flat rate – or flattish-rate – tax structure, so that moving onto a higher marginal tax rate would not be available as a disincentive to the undertaking of additional production. Keynesian economists rubbished the idea that switching from a top marginal rate of 45% to one of say 33% could ever actually increase the tax take.
The central concept, little discussed in economics’ education, is called ‘supply elasticity’. It’s essentially ‘surge capacity’. Jacinda Ardern had a good understanding of the concept, when discussing the difficulties faced by the New Zealand economy in meeting the challenges of the Covid19 pandemic.
The principal economic lesson we should have been learning from the pandemic is that economies with surge capacity are healthier than economies which are ‘maxed out’. Supply-elastic economies do not necessarily grow more slowly than maxed-out economies, though at any point in time a supply-elastic economy has a lower GDP than an economy with the same resources that is maxed out. While supply-elastic economies have ‘work-life balance’ in normal times, they have the capacity to surge during emergencies (ie to strike a different balance); such surges represent temporary changes to normal work-life balance. Even if, post-emergency, a new normal is established, any normal (by definition) should have work-life balance with ample spare capacity. It is work-life balance in normal times that gives an economy that reserve capacity to respond to the special needs associated with special circumstances.
Supply-side economics represents a particular – and peculiar – take on the reasons why humans might not produce as much as they could be producing; that is, on why human productivity is less than it could be. From their perspective, having disabled capacity is the central problem; and their ‘growth’ solution is really to ‘max out’ the economy, to use the spare capacity of economies in normal times, and therefore to create a ‘normal’ with no spare capacity to respond in the event of an emergency.
Supply-side economists argue – possibly correctly – that in total more money is made over a century under their policy prescription than under other policy settings, essentially because they believe that a well-functioning economy is permanently maxed-out. (That doesn’t mean they favour an unemployment target of zero percent. Supply-siders believe that an unemployment rate of at least four percent is necessary to have a disciplined workforce, and that a disciplined workforce always produces more than a workforce with workers who have options to work less.)
We should also note that the huge ‘success’ of supply-side economics in the late twentieth century – ie success in the terms of its advocates – was fulfilled through the much greater exploitation of female labour in 2000 compared to 1975. In World Wars One and Two, much of the surge capacities of our economies was made possible through the ‘manpowering’ (as it was called) of women. Economies grew through the utilisation of more labour; this contrasts with the 1950s, the 1920s, and with the later nineteenth century, when economies grew despite a substantial and disproportionate expansion of the non-workforce.
The situation in Aotearoa New Zealand
The Labour Party in New Zealand is very actively trying to connect the Luxon/Willis National Party with the British Conservatives under Truss and Kwarteng. It doesn’t really work. National in New Zealand – while probably stuck in 1990s’ orthodoxy – is essentially pragmatic in intent. Luxon does not seek ‘growth’ in the way that Liz Truss did.
In wanting to price-index income tax thresholds, National are actually seeking to maintain the status quo. This contrasts with Labour (Ardern/Robertson) who are using the retention of nominal income tax thresholds as a means to increase tax revenue relative to GDP, and as a means to suppress working-class demand for goods and services.
We should also note that Truss and Kwarteng wanted to remove a long-standing top income-tax rate set at 45%. That would have left 40% as the top marginal rate (although Truss and Kwarteng also wanted to lower the ‘basic’ tax rate – equivalent to New Zealand’s 17½% rate – from 20% to 19%.) In New Zealand in 2017, the top income tax rate was 33%. The following year an additional tax step was introduced, recreating (from the 2000 to 2009) a 39% tax rate which few people pay (in part because many high-income-recipients are able to avoid it). The 39% rate has minimal economic significance in New Zealand, but was set in 2017 by Grant Robertson as a political trip-wire. Thus, in 2023, National will be forever accused of pursuing ‘Trussonomics’, meaning to grant tax cuts to the wealthy.
Beware the ‘forward to the 1980s’ political designs of those who seek to flatten their country’s income tax scale without also introducing a benefit in the form of a genuinely universal income. While such a project was the intent of the ‘come and gone’ leaders of the United Kingdom Conservative Party government, it is not the intent of His Majesty’s New Zealand Opposition (aka the National Party).
‘Supply-side economics’ is a trope whose time has passed. However, we do need a ‘new supply-side economics’ which emphasises both work-life balance in normal times – a balance which incentivises more sustainable ways of living – and stresses the need for economies to have space capacity to meet the special needs of unusual times. Spare capacity should not be taken to mean spare money! It means having workers and employers who are capable of becoming more productive – and differently productive – over short periods of time. (People who can ‘pivot’! Temporarily.)
Keith Rankin (keith at rankin dot nz), trained as an economic historian, is a retired lecturer in Economics and Statistics. He lives in Auckland, New Zealand.