...Or Why the Keynesian Economists, President, and Congress Are Wrong

I don’t know if you have noticed, but there is an interesting debate playing out in the economic realm. The debate will determine the fate of the country, and the future of our children. The debate is one of supply-side or Keynesian consumer driven economics.

Consumer driven economics, also known as Keynesian economics, believes that consumers and their demand for goods and services are key economic drivers. If demand falters, a decreasing consumer demand drags the economy into recession as production contracts. In response, the role of government is intervention - often with fiscal and monetary stimulus policies in an effort to entice the consumer to resume demand of goods and services. A recent example is the Cash for Clunkers program as well as the first time home buyer credit. But these programs are only temporary in nature and produce a contraction when removed. In a time of debt, any money the government has outlaid for stimulus has to be paid back – by the consumer. The consumer also has to pay back loans taken for large purchase items. By now you should begin wondering how that is going to work in an economy where jobs have not recovered and revenues generated by taxes vaporize?

“Any dollar spent by the government must eventually be paid by the consumer.”

There are three options: borrow more money to pay government obligations, print/inject more money in an effort to stimulate the consumer demand, or do nothing. The first two create inflation, burgeoning government debt, and a decline in the value of the dollar, and investments moving offshore, while the third leads to prolonged recession and economic contraction; both lead to a lack of consumer confidence. If you have been keeping an eye on the European financial crisis, you have seen these results articulated. Therefore, each option demonstrates that the government cannot spend its way to economic prosperity. So what should we do? Enter a fourth option: 

Supply-side Economics.

Supply-side economics believes that producers and their willingness to create goods and services set the pace of economic growth. As goods are produced, it increases demand for labor and services, also solving the issue of job losses under the consumer model.

“The natural state of business is to seek growth, expand production and services in order to maximize return on investment.”

And I know, you may be asking how can consumers buy more if they are out of job in order to stimulate demand that increases supply? Believe it or not, supply-side economics claims that demand is largely irrelevant. Let me explain why. Supply-siders argue for lower marginal tax (personal income) and lower capital-gains tax rates. First, lower personal income rates allow workers to keep a larger portion of their income, making it expendable, allowing additional purchasing of goods and services. Workers are also incented to prefer work over leisure as larger ticket items (homes, cars) deemed once out of reach are more accessible thanks to increased retained income. Secondly, lower capital-gains tax rates induce investors to deploy capital where it has the best chance for profit and producing income, thereby providing capital for business expansion, driving by a desire for market expansion and profitability. Business expansion not only produces a direct hire of workers, but also stimulates the economic pipeline producing further demand and growth. And, as an added benefit, tax revenues to the government increase as the tax base expands due to greater employment and productivity, allowing the government to service, eliminates deficits, and balances the budget without borrowing from foreign countries.

In addition, supply-side economics keeps excessive swings of inflation and deflation in check as over-production and under-production are not sustainable. Why? When companies temporarily over-produce and excess inventory is created, prices fall and production slows. Consumers will increase their purchases thanks to expendable income, removing the excess supply. The later is also true that when inventories are constrained, the free flow of available private sector capital allows for expansion to meet demand. Overall this give and take drives predictable and sustainable growth.

Supply-siders tend to be political conservatives - those who prefer small government, a stable dollar, and less intervention in the free market. The Keynesian-Consumer camp tends to favor big government intervention and spending your way to prosperity. But as the attempt at stimulus has shown, it has not caused sustained demand or permanent growth. The later can only be accomplished by the free market and supply-side economics. The only question is how much will the President and Congress spend and raise taxes to find this out – and will it be too late?

The author, Lee Anderson, is on the Board of Directors of the American Conservative Party and formation committee for the state of Florida.

For more information on the historic track record of Supply-side economics, the author of this article suggests Econoclasts by Brian Domitrovic, published by ISI Books (www.isibooks.com).