Demand Side Versus Supply Side Economics

19 03 2011

One of the continuing mantras of the neo-conservative approach to economic theory is embodied in their emphasis on supply side economics, touted by Reagan and Thatcher supporters to the present day. The theory is that with economic deregulation and tax incentives to corporations and business owners, the business sector is better able to effectively grow and efficiently manage their companies, without unnecessary government intervention.

At the same time, the investment community, in its current paradigm, argues that the strength of the consumer sector, or demand side, is essential to driving economic growth expectations. Yet few groups within the investment and business community emphasize the importance of demand side fiscal policies. The argument is that by catering to the stimulus of the supply side through various tax and regulatory incentives, business growth fosters sufficient wealth to bolster the demand side by hiring workers and by making improvements in market efficiencies through deregulation.  This general approach is commonly known as the “trickle down” effect.

Historically, the truth is that whenever the classical supply side approach is taken in fiscal policy, it results in exaggeration of boom-bust business cycles, and consistently puts further stress on the viability of the middle and lower income sectors. This is borne out by the experience of recessions during the Reagan and Bush Sr. administrations, including the double dip recession of the early 1990s, and the more recent and nearly catastrophic results of the Bush Jr. administration. These recessions are caused, in large measure, by unbalanced tax policies and a regulatory structure that fails to ensure sound corporate investment and spending behaviours.

Another argument from supply-side economists is founded on the somewhat blinkered belief that tax incentives for corporations result in higher corporate investment and spending, thus increasing the tax base and ultimately tax revenues. The unfortunate effect, however, is that these very tax incentives result in higher government deficits and debts that cause higher inflation. Given these new parameters, monetary policy usually emphasizes inflation rate management through higher interest rates. This effect is well established in the history of economic behaviours in response to these policies. In other words, the increased “effective tax rate” resulting from high inflation and high interest rates on both business and the consumer caused by the tax cuts becomes greater in magnitude than the gross tax rate cut, and results in an economic squeeze on the consumer sector of the economy.

Perhaps by moderation of the tendency of neo-conservative governments to deregulate the business sector and by adoption of regulatory policies to ensure responsible investment and spending by business leaders, some of the more extreme downturns in market economies may be better mitigated and managed. A progressive and productive economic policy envisions corporate tax reductions tied to corporate hiring policies and, possibly, re-investment practices. In addition, any tax reductions should first take into consideration reductions to the middle and lower income sectors with the objective of a fair and balanced distribution of the overall taxation burden.

The time has arrived when government, business, and labour leaders need to refocus and rebalance demand side versus supply side sectors of the economy.

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