This is part two of my article series on supply side nuttery.

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In article one, I (hopefully) made my position very clear.

It doesn’t work.

No matter what measure you use…no matter what standard you apply to it…it DOES NOT WORK.

Having said that, I’m now going to explain when it DOES work, not to give supply siders hope, but rather, to understand, from the perspective of real world examples, more about where their misguided notions may have come from.

I’m not going to spend much time re-hashing the debunkery from article one, but in case you didn’t read article one, I’ll give a brief treatment here.

Supply side economics is centered around something called Says Law. We have adopted a shorthand code for describing Say’s Law, not in terms of what Say’s Law actually says, but rather, in the context of how modern Supply Siders (apparently) perceive what Say said. That shorthand is “supply creates its own demand.”

On the surface of it, this is a silly notion, undone by a number of historical examples (ie, “The Potato Famine”), but also by simple logic.

Imagine if we could, for instance, build one billion cars in the US, tomorrow. Supply side economics says that by doing so, and by presenting the cars for sale, people will flock to buy them.

But one billion cars would be ~3 cars for every man, woman, and child in the country. A family of four would have TWELVE vehicles. Why would they do this? Why would they want to? Could they afford to insure them? Where would they keep them? Where would they get the money to afford to buy them in the first place?

Supply side doesn’t concern itself with the answers to such questions. It just accepts on faith the premise that “if you build it, they will come.” I know…I know…it doesn’t make logical sense, but it doesn’t have to. The people who buy into this line of thinking don’t do it because of facts and data (which they often disdain, unless they can find some numbers that happen to support whatever premise they’re pursuing)…they BELIEVE, and you CANNOT fight a belief with facts and figures. It just can’t be done.

But where did such a silly belief come from?

As a macroeconomic policy, supply side is sheer fantasy, but in certain cases at the micro level, there is some truth to it….here’s what I mean:

My first example will be computer chips. The little processors that reside in everything from alarm clocks to toasters, to home computers and television sets. These devices were once expensive and highly specialized, but have become ubiquitous, and appear in almost every gadget and gizmo you can imagine. Economies of scale play a major role here. If you can build a factory to crank out ten thousand of these a year, then you can build a factory to crank out a billion of them a year, and you can do the billion cheaper (on a per unit basis) than you can 10k, because the cost of the physical plant (the factory), is fixed, and X/10,000 gives you a bigger number than X/1,000,000,000 (where “X” is the price of the factory), so from a chip making perspective, more is better.

And because these chips are damned useful, if you build them, and build them cheap, and make them available, people WILL find ways to use them (ie – if a chip costs fifty bucks, you will NEVER see one in an alarm clock, but if it costs ten cents, you’ll get alarm clocks that will display the time on the ceiling, read it off to you in six different languages, and automatically adjust itself for daylight savings, and this is, in fact, what we have today).

So supply siders will point to examples like this and say, “see! I told you! Supply side works!”

But there are some major problems with using an example like this and extrapolating to the economy as a whole.

First, we here in America, don’t make chips. They’re almost all made in giant factories in Asia, so doubling chip production doesn’t create a single new job here.

Second, while the chips are finding their way into an ever increasing pool of products for sale (alarm clocks, toasters, etc), this doesn’t mean many net new products coming to market. What it means is REPLACMENT products coming to market (ie, as the demand grows for the spiffy French-speaking alarm clock that auto-adjusts for daylight savings time, the demand for wind up alarm clocks sees a corresponding drop). The end result is that the net job creation from this kind of thing is negligible, with most of it showing up on the factory floor of the chip factory in Asia, as a new shift is added to build more chips. Good for them, a push for everybody else.

Third, and most compellingly, the properties of computer chips (build more and people will find uses for them) don’t readily transfer to other goods. In other words, if we mine more steel, we’ll have these big globs (sheets?) of steel lying about, but that doesn’t mean that people will magically start constructing skyscrapers with them…you know….just cos there’s steel laying about. The logic that applies to semi-conductors doesn’t work in those (and many–most–other cases).

But let’s take a look at another example and see if we can start identifying a trend: What about the iPhone? When it came out, there really wasn’t anything quite like it on the American market, surely this is an example of the success of supply side, isn’t it?

Yes it is!

Because it was the “first of its kind” supply side logic DOES, in fact, hold here. Marketing plays a role too, as does the product’s “cool factor” and practical application (ie, the “pocket fisherman” by Ronco, was ALSO the first product of its kind, but it did not make nearly the splash that the iPhone did, and there are a number of (fairly obvious, I would think) reasons for this which we will not devote space to just now). So, with the understanding that marketing, practical application, and the “cool factor” all have a role to play, certain brand new products can be brought to market via supply side magic.

Bear in mind though that this is a) a HUGE risk to the company bringing the product to market, and b) only possible at the micro level, when dealing with specific products…it would be impossible to construct, or even conceive of an entire economy the size of the US economy, built around a series of individual product launches, built in turn around the notion of supply side economics. Such an economy, if it DID exist, would be enormously unstable, and prone to gigantic shifts in unemployment and dislocations (when the inevitable “product flop” happened, or when tastes changed, etc). It’s just not possible to imagine a sustained (or sustainable) economic entity operating at the macro level under these principles.

But with the iPhone example, we’re really getting somewhere, because unlike the computer chip example, iPhone gives us some features we can recognize.

See…the iPhone isn’t “really” a new product, but rather, an amalgamation. It borrows features from OTHER, existing products, and reconfigures them in new and exciting ways. It’s part iPod (the precedent technology). It’s part cell phone. It’s part digital camera, and it’s part computer.

You roll all these ingredients together, give it a sleek packaging, a marketing blitz, and yes…if you are lucky, and if the market is ready to receive it, “if you build it, they will come.”

In that specific instance.

For that specific release.

One of the trends you should be picking up on at this point is that supply side magic tends to work better with “new stuff” (sexy new products), or commodities stuff (a category which computer chips fall into, undeniably, these days).

But here’s the thing. At the end of the day, most of this “new stuff” (and certainly the iPhone) is a toy. Yes, it has practical, day to day uses, but it very definitely falls into the “nice to have” category, not the “gotta have,” category (this may well change as time goes by…if there’s a market for killer apps for this platform, then it may one day become indispensable).

Why is this important?

Well, because, in a recession, “nice to haves” aren’t the thing that will drive the recovery. It’s your “gotta haves” that are going to drive the recovery, because during a recession, people scale back. People eat out less, cut corners, clip coupons, and do all sorts of stuff that in flush times, they might not do. And if you’re looking for a corner to cut, you’re going to seriously consider anything in the “nice to have” category before you turn off, or get rid of anything in the “gotta have” category.

Yes. It is entirely possible to find specific individual examples where sales of a given “nice to have” go up during a recession. That happens for a couple of reasons….price drops, special deals, overproduction leading to close-outs and clearances, using the product as a loss leader for something else, increasing population…any (or several, or all) of those things can lead to an uptick in sales for an individual product. What you won’t find though, is a broad based trend among “nice to haves” in a recessional environment.

So why is THAT important?

Again, if you’re looking for ways out of a recession, reliance on sexy new toys hitting the market isn’t going to get the job done as reliably as a focus on the fundamentals (which have nothing to do with supply side witchery).

Further, these individual product releases that do have supply side traits are only possible in a robust economic environment, and they only occur at the margins (ie, you could take every “sexy new product release” for the past ten years, total the sales data, and wind up with less than 10%–and prolly less than 5%) of the total GDP of the nation. It’s good at the margins, yes, and its innovation value is without question, but as a driving piece of the economy? No.

These types of products also tend to build on one another, and tend to find their genesis in new combinations of every day/commonplace items.

The text file has been around as long as the computer. The PDF for nearly so. miniaturization, a scaled down operating system, and a sexy new look gave rise to the first eBook readers, which eventually gave rise to the stylish Kindle.

The iPod fathered the iPhone, which fathered the iPad. These technologies grew from one another in an iterative fashion, and when seen through that lens, they’re not nearly as groundbreakingly innovative as they first appear. Important? Certainly. And they do illustrate supply side principles, but to mistakenly believe that one can somehow structure an entire national economy around such product launches is…well, frankly nuts.

In any case, I did not want conservatives who come here to think that I’ve just rejected their theories of economics out of hand.

I think about this stuff. I evaluate it alongside my current best understanding, and if I find something that’s compelling, it changes my view.

I am always open to having my mind changed, because at the end of the day, I’m looking for the policy that WORKS, not the policy that fits some preconceived ideology, so I studied supply side and found it hokum.

What I don’t enjoy is reinventing the wheel, and rehashing the same old discussions, so if you don’t have anything new to add or offer, don’t bother me with your latest supply side rant. I’m always interested in looking at new data, but I’ve laid out here and in other areas of this site why supply side is bunk. You may not like it, but unless you’ve got something new, we don’t really have much to talk about.

-=Vel=