The Audacity of Economics

What I have always loved about chemistry is that, at its base, it is so simple, reliable, and efficient it is almost mathematic. Writing a chain of chemical equations is itself like writing out a series of arithmetic problems; under the right circumstances, when all variable are appropriately controlled for, compound X will always react with element Y to produce exactly the same amount of molecule Z. Despite this apparent simplicity, it is chemistry, this illustrated mathematics, that shapes and animates life. It is beautiful, in a way, how such complex things can be reduced down to such a clean and basic level.

And then there's economics. The social sciences are many levels removed from the cause and effect of the hard sciences. Despite attempts and protests to the contrary economic and political studies have never been able to provide us with truths resembling anything like a mathematical proof or scientific law. And despite this, or perhaps because of this, everyone seems to be an expert in these very fields. The lack of hard set, verifiable data which should produce caution in interpretation instead seems to provoke people to fits of interpretive grandiosity. A few ideas and perhaps a few examples are all that are needed for people to make sweeping, dogmatic generalizations on how our economy, and indeed all economies, should be run. This has never been more true, or so it seems, than now in our current crisis with our current president. Stimulus or no stimulus? Bailout or no bailout? Nationalization, socialism, and communism or private enterprise, free markets, and minimal governance? It is with all this ballyhoo that I feel led to share the only three things about economics that I know: the Keynesian multiplier, the Laffer curve, and Adam Smith.

The Keynesian Multiplier -
Sometimes a little money goes a long way. Or so the idea itself at least goes. In certain circumstances $5 will go a lot further than $5. For example, suppose I were to give five bucks to my dear old friend Eddie Spaghetti to build me an interstate highway. Being the managerial type, Eddie keeps a small portion of this as his income and then highers the appropriate laborers, engineers, and undocumented migrant workers to get the job done. Each of those individuals of course takes their share in turn (and spends it on food, clothing, and assorted dry goods further stimulating the merchants of those respective items as well.) The $5 is not done, however. Beyond labor, the few dollars spent in capital and supplies required to build this highway can all themselves come from other proprietors and entrepreneurs, and the resulting freeway will create economic opportunity for further economic investments spreading the wealth even further. Five dollars can thus be spent many times over stimulating the economy in a way a simple tax cut may not necessarily do. The spending is effectively multiplied. And even though all projects conceivably multiply to some extent, it is often state directed projects, such as the construction of bridges, airports, and port facilities, which are the biggest multipliers. Theoretically, if spent wisely and judiciously enough the projects would pay for themselves and would be less empty "spending" and more investive "stimulus." Thus we have, in simplified form, government driven, stimulus supported recovery.

The Laffer Curve -
But suppose we could do it another way. What if we could, instead of deficit spend, deficit save? Lower tax rates and still, at the end of the day, have more in the way of total tax income? That's where the supply sided recoverists sally forth with the all-triumphant Laffer curve. Like the Keynesian multiplier, it breaks down a whole lot of complex economics, digests it, and spits out nothing but lean, pure economic truth. Unlike the multiplication trick of before, however, we must now work with a parabola. This parabola, basically described, suggests that if we were to look at tax rates vs total tax revenue we would find that on opposing extremes of taxation rates we will receive no actual money in taxes. On the near end of the graph if taxed nothing then no matter how much business we have there will be no revenue for the state, and, conversely, on the far end of the graph if we tax too much profit will be impossible, no one will do business, and we will still end the day with zero net income. Conceivably then there should be a sweet spot somewhere in the middle of this curve where tax rates are primed just right to maximize tax revenues. More importantly, if we have taxed to excess and are thus descending down the curve from this maximum we should be able to actually increase total tax inflows by lowering tax rates -- something that at least on superficial analysis would seem counterintuitive. Thus by taxing Eddie Spaghetti less he and his highway building cohorts will reinvest their added profits and business will boom to such an extent that when we send out our tax gatherers at the end of the year we actually have more money. In short, privately driven, tax cut supported recovery.

Adam Smith -
So what should we do? Deficit spend or deficit save? Supply or demand?!

I sure the hell don't know.

But maybe... Adam Smith does? What does the patron saint of economics have to say? Is he a Reaganite or a FDR at heart?

"It is not from the benevolence of the butcher the brewer, or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity, but to their self-love, and never talk to them of our own necessities, but of their advantages."

Uhmm....

"It is not very unreasonable that the rich should contribute to the public expense, not only in proportion to their revenue, but something more than in that proportion."

But....

"The man of system, on the contrary, is apt to be very wise in his own conceit; and is often so enamoured with the supposed beauty of his own ideal plan of government, that he cannot suffer the smallest deviation from any part of it. He goes on to establish it completely and in all its parts, without any regard either to the great interests, or to the strong prejudices which may oppose it. He seems to imagine that he can arrange the different members of a great society with as much ease as the hand arranges the different pieces upon a chess-board. He does not consider that the pieces upon the chess-board have no other principle of motion besides that which the hand impresses upon them; but that, in the great chess-board of human society, every single piece has a principle of motion of its own, altogether different from that which the legislature might choose to impress upon it. If those two principles coincide and act in the same direction, the game of human society will go on easily and harmoniously, and is very likely to be happy and successful. If they are opposite or different, the game will go on miserably, and the society must be at all times in the highest degree of disorder."

Okay. It is settled then. I have no idea what I am talking about, and will not pretend otherwise.

Hopefully much of the rest of America can agree to do the same.