There can always be a different way of looking at things. What looks like sugar being added to milk to some may look like milk being added to sugar to others. In economics, too, we come across many interesting differences of opinion.?For example, there is no one answer to how the economic output can best be increased. By increasing aggregate demand? Or by increasing aggregate supply? The “supply-siders” would bet on aggregate supply, much to the discomfort of “Keynesians” who believe in aggregate demand. Interestingly, “supply-side economics” is also called “Reaganomics” by some, “trickle-down economics” by others, and “voodoo economics” by some critics. If the greatness of a theory were to be decided by how many different names it has, then supply-side economics has already secured its place.
Johnny: Well, I am neither a critic nor a supporter of supply-side economics. But could you explain what exactly it is?
Jinny: Supply-side economics is a school of economic thought that became popular during the 1970s and 1980s through the work of Robert Mundell, Art Laffer and Jude Wanniski, among others.
Ronald Reagan, former US president, is credited with putting this theory into actual practice during his tenure in the 1980s.
Illustration: Jayachandran / Mint
The basic idea of supply-side economics rests on the classical principles of a French economist, Jean Baptiste Say (1767-1832), who proposed what became popular as Say’s Law: “Supply creates its own demand”.
So, supply-siders believe that we can attain high economic growth by increasing the aggregate supply of goods and services. “Aggregate demand” in itself is not of much use. The simple formula is to create a flood of supply and the pull of demand automatically follows.
Johnny: But is it actually so? Could you explain how supply creates its own demand?
Jinny: Let’s try to understand how supply-siders interpret the workings of demand and supply.
As you may be aware, the output and price of goods and services in any economy are determined by both demand and supply. The Keynesian school of economics (followers of John Maynard Keynes) believes that increasing “aggregate demand” leads to an increase in aggregate supply, which in turn implies the production of more goods and services. A long line of buyers outside a factory would definitely encourage more production. In case private demand falters, the Keynesian theory prescribes the intervention of the government through fiscal and monetary stimulus.
The argument sounds convincing but supply-siders approach the whole problem from a different angle. First, the best way of stimulating private demand is by improving the purchasing power of people. But how can we do that? Here, we must keep in mind that one person can buy the goods of another only when he has himself produced something which he can sell. Why? Just think about it. A baker can buy milk only if he has money, and for that he needs to sell the bread he produces. Nobody can get the money or the purchasing power to buy anything unless he himself has produced something. In others words, the buying power or “aggregate demand” comes out of your purchasing power, which in turn comes out of your ability to produce more.
Supply-siders believe that more production of goods would automatically generate more purchasing power. Say, for instance, a factory is running overtime to produce more, then it would be paying more wages to its workers, which can be used by them for buying more goods and services. If every chain in an economy, right from the baker and milkman to factories, starts producing more, then there would be no reason for “aggregate demand” to slow.
Supply-siders believe that producers of goods and services and their willingness to produce more sets the pace of economic growth.
Johnny: Well, some may disagree with that. But tell me, what measures do supply-siders suggest for increasing production?
Jinny: First and foremost, supply-siders prescribe lower taxes, both for businesses and individuals. This works as an incentive. Businesses produce more goods and services when higher profits are not subject to higher taxation. Likewise, individuals have more purchasing power at their disposal when they have to pay lower income tax.
The second prescription of supply-siders is to remove all kinds of regulatory hurdles in production. Less regulation means less compliance cost for businesses, which gets translated into more profit on production of goods and services.
The third, and most important, prescription of supply-siders is stable monetary policy. According to supply-siders, the aim of monetary policy should be to ensure that the currency acts as a reliable store of value. For this reason, many supply-siders are also in favour of the gold standard, which ensures that the money supply is strictly tied with the level of gold reserves with the central bank. The supply-siders wish for the increase in money supply to be commensurate with rise in production. Why? That’s because a disproportionate change in money supply distorts the purchasing power of people, which in turn disturbs the entire chain of production.
Johnny: The entire chain is so tangled that I just want to say all the best to my friends standing on the supply side.
What:‘Supply-side economics’ believes that higher economic growth can be achieved by increasing aggregate supply in an economy.
How: Aggregate supply can be stimulated by lower taxes, less regulation and by ensuring the increase in money supply is commensurate with the rise in production.
Who: This school of economic thought became popular through the work of Robert Mundell, Art Laffer and Jude Wanniski, among others.
Shailaja and Manoj K. Singh have important day jobs with an important bank. But Jinny and Johnny have plenty of time for your suggestions and ideas for their weekly chat. You can write to both of them at email@example.com