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Demand-side vs. Supply-side

Here’s a post from Robert Reich, who was Bill Clinton’s Labor Secretary, and is a union sympathizer and all-around nice guy.

Reich’s thesis is very simple. He says that the economy is now in a depression, with the “fully loaded” unemployment rate (including people who have stopped looking for work and people working part-time) at 15.6%. The top unemployment rate in the Great Depression was 25%.

Reich’s prescription is equally simple. The government has to spend far, far more than it has been. Like Paul Krugman, he faults Obama not for being a radical, but for not being radical enough. Obama, in other words, needs to spend more.

Spend on what? All the same stuff you’ve been hearing about. Solar panels and windmills. Universal health care. Public transportation systems. Reich, refreshingly, goes the full Keynesian mile and speaks what others have merely fantasized about: he also wants to put Americans to work weatherizing other people’s homes and building more (unneeded) buses and trains with Detroit’s unused car-making capacity. In short, it’s the old “pay someone to dig a hole and then fill it up again” idea, refuted by Bastiat and embraced by Keynes.

You couldn’t get a more pure expression of demand-side dogma.

And unless the political winds take a 180-degree turn, some version of this is precisely what is going to happen in America. No one who has the attention of the administration is making the case that there might be something wrong with this picture.

Let’s go back to Economics 101 (and please forgive me for repeating things you already know). The government can effectively substitute public demand for private demand at a time (like now) when private demand has become severely diminished. But it doesn’t necessarily follow that demand creates supply.

Macroeconomic policy is measured these days in terms of the unemployment rate. Fair enough, that’s the most politically meaningful barometer of economic health, and macroeconomic management in a democracy is at root a political exercise.

But over time, it’s just as important to increase the aggregate production of goods and services in the economy. You really can’t have a sustainable government-driven economy unless it’s a highly productive one. Socialism is a luxury affordable only by rich societies, a lesson learned before our eyes by the USSR.

And that’s where the supply-side comes back into play. As I said, supply doesn’t necessarily increase just because demand does. Supply only increases when the risk-adjusted returns to capital are high enough to justify the additional investments in productive capacity. And that goes double in a time like now, when a big part of the cost of capital consists of retiring obsolescent capacity.

That’s where Obama is making his biggest mistake. He has chosen to make business, and business leaders, the bad guys in his crusade to remake American life in his own image. CEOs are today’s serpents in the garden of Eden.

How wrong he is. His vision of an American economy operating of the government, by the government, and for the government simply can’t work unless business leaders are able to make the needed investments.

How? Easy. Eliminate all taxes on business income and capital gains, eliminate export tariffs, and reduce regulation. Now that would be a radical.

Is that going to happen? Well, Mr. Obama? Just how much of a radical are you, really?


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