Does trickle-down economics apply to a down market?

At the outset of the Great Depression, many people blamed the fiscal policies under President Hoover that favored the wealthy. See more ­recession pictures.

When the Great Depression hit the United States in the 1930s, the country was battling the worst economic situation it had ever seen. Understandably, the sentiment at the time was that something needed to be done. The question was: What? The public turned to elected officials in Congress for some glimmer of hope. Suddenly, everyone revolted against the policies of the Roaring '20s that provided sweeping tax breaks for the top earners. It didn't feel right to let the rich off easy when people were starving in the streets. The idea that wealth would eventually trickle down to the needy was thought to be too slow a process -- if not completely bunk.

Some people still argue that giving tax breaks to the wealthy is sound economic policy. The idea didn't quite die with the Great Depression; rather, trickle-down economics resurfaced a few times since then. It enjoyed a strong resurgence in the 1980s under the Ronald Reagan administration in particular. Now, most people primarily associate trickle-down theory with Reagan's economic policies, known as Reaganomics.

Supporters of trickle-down theory claim that it is a sorely misunderstood philosophy. It certainly gets a bad reputation -- due in no small part to its name. Instead, proponents prefer to call it supply-side economics. By this or any other name, though, it's hard to convince the lower and middle class that tax breaks for the rich are a good idea. So what's the logic behind the theory that George H.W. Bush vilified as "voodoo economics?" [source: Kotlikoff].

­Supply-siders believe that when the wealthy don't have to face high, debilitating taxes, their business endeavors will fuel the economy naturally in a way that benefits everyone. Thomas Sowell, one advocate of the theory, goes so far as to claim that although the tax cuts apply primarily to the wealthy, th­ey benefit the working class first and foremost. He reasons that when the wealthy believe they can keep more of their profits, they will invest more in business (rather than save or consume). This investment goes to creating jobs for the working class, often long before the investor sees a return [source: Sowell].

This logic remains highly controversial. But were a nation to accept it as general policy, what do supply-siders propose we do during difficult economic times?

 

Recession Response: Quick Fix vs. Trickle-down

Under the influence of John Maynard Keynes, the United States turned away from Say's Law and trickle-down economics in the 1930s.
Under the influence of John Maynard Keynes, the United States turned away from Say's Law and trickle-down economics in the 1930s.
Tim Gidal/Picture Post/Getty Images

­All capitalist economies go through natural ups and downs. When a down hits for an extende­d period of time, it's known as a recession. Economists argue about the best way to handle a recession when it happens and what government can do to reinvigorate the economy. One may assume that when a recession hits, even supply-siders would jump ship and (at least temporarily) abandon the policy of giving tax breaks to the wealthy. But many don't. In fact, one foundational pillar of trickle-down theory was concocted as a cure for recession.

French economist Jean-Baptiste Say proposed a radical idea in the early 19th century. He said that when economies suffer downturns, the solution is to encourage the market to produce more output. Although people thought at the time that overproduction and lack of demand were the cause of a downturn, Say argued that wherever there are workers, there's demand not being met. The challenge is to make more of whatever is demanded, which will drive down costs. When these products become more affordable, more people will buy them, business will become profitable, and more workers can buy more things. This "build it and they will come" philosophy is known as Say's Law.

According to Say, when the economy goes south, the government should encourage more investment and production. Trickle-down theory evolved from this law, hypothesizing that tax breaks to the wealthy will encourage production that propels the economy out of a recession. So rather than recessions being the exception to the trickle-down rule, recessions are the very problem that trickle-down economists seek to ease.

For a long time, most economists and politicians in the United States accepted Say's Law as gospel -- that is, until the Great Depression. By then, a new theory emerged that sought to debunk Say's Law. British economist John Maynard Keynes insisted that a suffering economy results from overproduction and lack of demand, not the other way around. He said that in a recession, government should give the economy a shot of steroids in the demand side of the equation, not on the supply side.

Keynesian economics advocates governmental policy that's more popular among the working class, such as pumping money into the market to encourage spending, lowering taxes on the poor (who consume) and raising taxes on the wealthy (who produce). Keynes looked for short-term fixes, like adjusting the interest rates and increasing government spending, in order to restore stability to a volatile market.

It's because Keynes rejected Say's Law that he promoted these stabilizing quick-fixes. Grassroots supply-siders who haven't rejected Say's Law generally stick to their guns during a recession -- precisely because the law is specifically meant to ease recessions.

If you're still thirsty for more on trickle-down theory and the economy in general, explore the links on next page.

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Sources

  • Formaini, Robert L. "Economic Insights: Jean-Baptiste Say." Federal Reserve Bank of Dallas. Vol. 11, Num. 1. [Nov. 20, 2008] http://www.dallasfed.org/research/ei/ei0601.pdf
  • Kotlikoff, Laurence J. "The Coming Generational Storm." MIT Press, 2005. [Nov. 21, 2008] http://books.google.com/books?id=GRSpr8TOWegC
  • Sowell, Thomas. "The 'Trickle Down' Economics Straw Man." Capitalism Magazine. Sept. 27, 2001. [Nov. 20, 2008] http://www.capmag.com/article.asp?ID=1115