Sunday, December 20, 2009

The Irony of Keynes

If I were to ask you to name the single biggest ideological struggle of our time what would you say? Capitalism vs. Communism? Liberalism vs. Conservatism? Democrat vs. Republican? Sure, those are all big ones, but to me the struggle at the root of all those is an economic one; Supply Side Economics (SSE) vs. Demand Side Economics (DSE). As John Maynard Keynes (1883 – 1946), the man most associated with DSE said about economics: “In reality, the world is ruled by little else. Practical men (and women), who believe themselves quite untouched by any such intellectual influence, are usually slaves of some dead economist." Wow, talk about irony!

For most of the last 100 years we have oscillated between these two economic theories. In the 30’s it was pure DSE. In the 60’s and 80’s it was mostly SSE. Often it’s been a blend of the two. But now we are back to pure DSE and not since the 30’s have we put so many eggs in that basket. In fact, the experiment we are conducting right now is a historic case study in economics and the result will determine our economic future. One possibility is that everything will work out just fine  Then again, it could be an epic and profound human disaster! Have I got your attention?

Now, if you’re like me, you’ve heard these terms over the years and have a basic understanding of them. But, speaking for myself, I sometimes get confused by the language of economics. A further source of confusion enters in when economists let their unrevealed political bias color their explanations. Not being an economist, but as someone who has studied this stuff on my own gives me a perspective that might help others get to the essence behind SSE and DSE. In that spirit, the following is a summary of the big poli/economic debate of our time using simple language which absolutely reflects my bias.

Here are my boiled-down definitions of SSE and DSE:
  • Supply Side Economics is the theory that people will enthusiastically SUPPLY their efforts and capital if they are free to realize the rewards. 
  • Demand Side Economics is the theory that people will enthusiastically DEMAND goods and services if they are subsidized to do so.

Supply Side Economics is all about freeing people to create and produce.

Demand Side Economics is all about re-distributing wealth to get people to consume and spend.

Politicians use terms like “targeted spending”, “deficit spending”, and “investment”, instead of "wealth redistribution".  But those terms violate double-entry accounting rules; they only show one side of the ledger. Where does the spending or investment come from?   It has to come from someone, right? Are we really gaining anything by taking a dollar from one person and giving it to someone else? Well, yes in a sense we are: as the old saying goes, “If you rob Peter to pay Paul, you’re guaranteed to gain Paul’s vote!” And the vote tally goes up exponentially when Peter has yet to be born! In fact, this is the politician’s favorite funding source. Politicians get elected time and again by re-distributing wealth from the unborn to active voters. It’s a classic heads I win, tails you lose scenario where the winners never have to face the losers in an election. This has become the essence of DSE today.

DSE or “Keynesian Theory” when associated with John Maynard Keynes usually refers to targeted re-distribution exemplified by short-term “stimulus” designed to minimize a dip in the “business cycle”. Cash for Clunkers, the 787 Billion Dollar Stimulus Bill, and TARP are recent examples of the original intent of DSE re-distribution. But that is a small part of total DSE. Most wealth re-distribution is done to achieve political or social goals and not for specific economic benefit. Social Security, Medicare, Medicaid, and Obamacare are all re-distributive programs and are social and political programs first and foremost. But regardless of the intent, the economic effects are the same. Thus all re-distribution behaves as Demand Side Economics.

So, what is the difference between wealth re-distribution and “normal” government spending? I maintain that any fiscal expenditure for a reason other than the essential roles of government is a form of wealth re-distribution. Neither SSE nor DSE questions the need for essential government services, or the idea that taxes must be collected in order to fund them. But of course, the devil is in the details.  In this case the detail is how a society defines the “essential roles of government”.  In our case we can start with the US Constitution and call anything in that document essential. Anything we have added above and beyond our constitution is, I would contend, wealth re-distribution.

This definition helps answer one of the big questions surrounding Supply Side Theory: What is the optimum level of taxation which will promote prosperity? The answer: Just enough to fund the essential roles of government.  Anytime we spend government money on things not explicitly enumerated in the Constitution, we are choosing DSE re-distribution over optimum prosperity.

Again, there are often compelling socio/political reasons for a society to engage in wealth re-distribution. But what often is obscured is the economic damage and deceit involved in this choice. Unfortunately, the underlying premise of DSE is flawed as is the generational theft which accompanies it.

So, what is the big flawed premise of DSE? In short; Supply can satisfy Demand, but Demand can never satisfy Supply. Put another way, all the Demand in the world can never Supply food for the hungry unless there is a reason for producers to Supply food. Demand alone does no good. Remember the old Soviet Union? Was the Demand for groceries any less in the Soviet Union than in the US - yet who could forget those pictures of the Soviet food stores with empty shelves? Naked Demand is like the person wandering through a desert dying of thirst; they have infinite Demand for a drink but it does them no good without a Supply of water.

The theory is that Demand alone will stimulate producers to Supply more. But the flaw in that thinking is that the re-distribution of wealth works exactly in the opposite direction in two ways: first, by taking money from producers it reduces the reward for them to create Supply, and second, it disincentivizes Demanders to contribute their labor. It’s a classic lose-lose scenario.

Socio/political reasons aside, engaging in DSE in the name of helping the Economy is nonsense. And this is not just a critique of Obamanomics. George W Bush is often mistakenly called a “Supply-Sider” for lowering taxes, and yes he did lower taxes which aided prosperity. But his record is much more complicated than that, for while lowering tax rates, he also engaged in plenty of DSE, especially in his last two years with the Pelosi/Reid Congress. Ultimately, he was both a Supply-Sider and a Demand-Sider and thus he was neither.

The current course we are on is as close to a pure Demand Side Economic model as we are likely to ever see. That makes this a watershed moment in the debate over economic theory. Too bad for us we may end up, as the father of DSE John Maynard Keynes famously said, “slaves of some dead economist”. If that isn’t ironic enough for you, consider this; we are being led into this servitude by our First Black President.


  1. Your analysis, in my estimation as a non-economist with a strong interest in the subject, is spot-on.

    I commend you for a plain-speaking explanation of why we are in dire straits as a nation today.

    I plan on referencing (via extract and link) your excellent post in my own blog.

  2. Bottom line both in the long run and the short run DSE doesn't work. Actually it can't work. DSE ultimately encourages corruption because of the lack of supply. This was proven so aptly by the Soviet Communist experiment. I believe that Keynes did (what as most economists are wont to do) was assume away the variables till his theory worked.

    You have done an excellent job of explaining the very complex issue.

    From a practical point the problem comes from deciding just how much government is desirable. Just how much the constitution actually mandates.