Study: U.S. Supply Side vs. Keynesian Economics

Analyzing the Historical Record 

A 1995 study by A. Reza Hoshmand’s of the International Business University of Hawaii West Oahu provides a comparative analysis of two divergent economic policies between 1960 and 1988. His retrospective look at the economic policy results of the Keynesian era (1960-1980) and the Supply-side era (1980-1988) economic policies may shed light on the choice of future policies.

Hoshmand breaks the period after 1960 into two subperiods:

• The “Keynesian era” covers policies from 1961 to 1980.
• The “Supply-side era” covers policies from 1981 to 1988. 

The Birth of Supply Side Economics

While the Keynesian period was characterized by a high degree of fiscal and social activism in economic policies, the Supply Side era was born when President Reagan came into office in 1981.

The Supply Side view of economic management was that individual initiative and unfettered markets would produce the best possible economic outcome. The Reagan budgetary philosophy was that a strong military, and cutback of civilian programs (other than middle class income support programs such as social security) would significantly enhance economic growth prospects for the nation.

The Verdict: Reaganomics’ Failure

Policy and Economic Indicators	Economic Performance Keynesian period (1960-1980)	Supply-side period (1981-1988)
Top tax rate (%, end of period)	50.0%	28.0%
Spending to GNP (%) Defense Interest Non-interest Non-defense	– 20.2 7.0 1.5 11.7	– 24.0 6.2 2.5 15.3
Deficit to GNP (%)	1.1%	4.1%
Government debt to GNP(%, end of period)	21.0%	37.1%
Unemployment rate (%)	5.6%	7.5%
Growth in real average hourly earnings(% per year)	0.7%	0.0%
Personal savings rate (% of income)	7.3%	5.2%
Percentage of families in poverty	9.4%	11.3%

The results of “Reaganomics” were that, while defense spending grew rapidly over the eight years of the Reagan period, other goals were very much blunted. Other than the inflation rate, virtually all major economic indicators showed a marked deterioration during the 1980s:

• Government spending as a share of GNP grew from 20% in the Carter administration to 24 percent in the Reagan years.
• Government debt increased dramatically.
• Despite the gospel of balanced budgets, the 1980s say the highest peacetime budget deficits in half a century.
• The national and personal savings rates declined sharply.
•  and the budget moved into deficit. 
• Real average hourly earnings was completely stagnant during the 1980s.

• There was a sharp increase in the proportion of families

  in poverty.

Conclusions and Observations

Income Inequality: The assumption that free-market policies will generate economic growth and in turn improve the distribution of income for the nation as a whole proved incorrect. The 1980s’ economic policies had severe impacts on the distribution of income. According to Hoshmand, “o

ne clear verdict of the 1980s is that free-market policies tend to make the distribution of economic welfare more unequal.

Declining Savings: While the decline in the savings rate during the Reagan era is a complex phenomena, research by Bayoumi in 1993 indicates that deregulation of industries lowered the equilibrium level of saving over the 1980s  by 2.25% per year,  making saving significantly more dependent on changes in wealth, income and real interest rates. A study by Winston in 1993 is also cited by Hoshmand:

 In 1977, 17% of U. S. GNP was produced by fully regulated industries. By 1988, following ten years of partial and complete economic deregulation of larger parts of the transportation, communication, energy, and financial industries, that total had been cut significantly to 6.6% of GNP

Implications for Today

While Hoshmand’s paper was written in the 1990s, his findings were prophetic, seemingly anticipating the historically unproductive 112th Congress’s inability to implement fiscal stimulus policies, and the monetary measures that Federal Reserve Chairman Benanke has been forced to undertake in response:

Past experience shows that the response to cyclical conditions will fall primarily on monetary policy with little help from fiscal policy. Fiscal policy will be ineffective not because it is impotent, but because the need to reduce the deficit will steer fiscal policy. Furthermore, the straightjacket imposed by Gramm-Rudman targets will dominate the setting of fiscal policy for the foreseeable future. Luckily, monetary policy, contrary to the views of skeptics of an earlier age, has proven to be a powerful stabilization policy. The lesson of the last decade is surely that the short-run stabilization of the U.S. economy is firmly in the hands of the Federal Reserve.

Keynesian economics (or demand side) encourages fiscal responsibility by running a budget surplus during boom times so that it can then run a deficit to help spur the economy during economic declines.  Stimulus spending in years prior to the Reagan administration succeeded in bringing an end to the Depression and building a strong middle class. Since “the Reagan revolution,” the general trend has been income inequality and deteriorating economic conditions.

Today, the Congress has returned to supply side economics with the simple goal of lowering taxes on the wealthy. A new set of buzz words have been introduced to promote the same supply side principles surreptitiously. They include “lowering taxes on the job creators,” “fixing the deficit,” and “fiscal responsibility,” but, as the record shows, such policies are not in fact fiscally responsible.

Fortunately, should the media decide to highlight the economic results of supply side, a clear picture of the economic choices ahead may emerge. While today’s supply siders look back with nostalgia on Presidents Reagan, Bush and Bush, it is important to note that none of them ever submitted a balanced budget, and the Ryan budget, which was supposedly fiscally conservative, would add $6 trillion to the debt over the next decade, and doesn’t predict a balanced budget until about 2040. If we heed the lessons of history, the U.S. economy can return to a path of growth and prosperity through policies that promote investment, consumer demand and meaningful regulation to restore some of the economic balance that promoted the growth of a burgeoning consumer class in the past.