The sea upon which the economic ship of state navigates is never calm unless you happen to look at a stagnant economy operating in an ossified culture. But given that the age of globalization is upon us, no culture can remain ossified for long, therefore no economy can remain stagnant and everyone must advance or be forced to regress. So how should the captain of a modern ship of a state navigate the new sea?
To navigate the economic sea of any kind you must have a mental picture of the economy, and the question to ask right off the bat is this: What does it take to have an economy? On the surface, the answer looks simple enough and it goes like this: To have an economy you need someone to supply the goods and services, and someone to consume them.
The first group is made of entrepreneurs and they start the businesses, run them or do both. And the second group is made of consumers who usually work for the entrepreneurs and they form the middle class which happens to be the largest of the consumer groups.
The government is one big institution that is both a consumer of goods and services, and a producer of many services. It has an important role to play in the economy which stems from the fact that many individuals work for it and many more receive money from it under various programs in what is referred to as the redistribution of wealth. The government also has various responsibilities for which it needs to procure goods, the most important being the military hardware which is used to defend the nation.
But while the coming together of the production side and the consumption side of the equation make an economy, they hardly signal the end of the story because things tend to get complicated when the rights and privileges of the various parties come into conflict. This is when the stakes are raised to a high level and all those who are involved start to pull in different directions.
The important thing to remember here is that both the suppliers and the consumers need money to do what they do which is why money is in high demand and why it is at the center of this discussion. The notion to always keep in mind is that to avoid getting the economy into trouble, the amount of money in circulation must match the availability of the goods and services. This is because too much money will create inflation but too little of it can lead to a recession, neither of which is a desirable outcome.
The amount of money in circulation is determined by the central bank which prints it and oversees the financial institutions that handle it. Because this is an important role, the bank provokes a few discussions whenever it changes the interest rate or fails to do so.
The government too plays an important role in the economy. To pay its employees, procure the goods it needs and redistribute the wealth, it collects vast amounts of money in the form of taxes. And all these activities are reflected in a massive document issued every year called the Budget. It is easy to imagine that the discussions generated by this document dwarf anything generated by the central bank.
The bank does not make policy; it only reacts to the marketplace and uses a number of tools at its disposal to try and maintain price stability. It is the job of the captain of the ship of state to set the policy and to influence the actions of both the central bank and the government. To do this, he formulates in his mind a vision of what the economic equation should look like and then tries to balance it equitably by prodding the bank and the legislative side of the government.
But while the captain tries to influence the bank and the government, there are those that try to influence the captain. These are individuals and organizations which divide into two broad groups. One group speaks for the interests of the suppliers and the other speaks for the interests of the consumers. Thus, what we have here is again a split between the supply side of the economy and the consumption side.
Those in the first group have been called proponents of supply side economics. They basically say that businesses should be taxed lightly to encourage new businesses to set up and encourage the existing ones to expand. When this happens businesses hire more workers who also happen to be the consumers of the nation. When hired, these people buy more of the products and services that they and their colleagues produce because they have the money to pay for such things and have a steady paycheque to give them the confidence that their future is secure.
Thus, when the policies of the government help to strengthen the supply side of the equation they also strengthen the consumption side. This happens because the strength that builds up at the supply side inevitably trickles down to the consumption side and renders it equally strong. They call this effect “trickle down economics.” And those economists go on to explain that when both sides of the equation are strong the result will be an economy that hums at maximum potential which is what everybody wants.
And there is no doubt these are compelling arguments.
However, the proponents of the other side respond with equally compelling arguments. They say that if you have a good idea, plenty of people and institutions will come knocking at your door to finance it as this is the never ending story of the perfect mousetrap. Thus, to find financing for your ideas is not a difficult thing if all you want to do is to produce the mousetrap. But what is difficult to do after you have produced the mousetrap is sell it. This becomes a nearly impossible task when the potential buyers have little money to spend and plenty of other priorities to spend it on.
Thus, if the government leaves more money in the hands of the consumers by taxing them less, the latter will have the purchasing power to become the locomotive that pulls the economy. This will make it possible for the businesses that have good ideas to borrow the money, make all the mousetraps they want and sell them. And they will be selling in a seller’s market that is filled with deep pocketed buyers. And the proponents of this argument conclude that this is a better way to strengthen the two sides of the economic equation.
And there is no doubt that these too are compelling arguments.
To sum up, the supply side economists want the businesses to get the tax breaks from where, they say, the benefits will flow to the workers and to the consumers. But the labor and consumption side economists say businesses do not need those breaks because they can secure financing for their ideas when a market is created for their products which is what happens when you give the breaks to the workers and the consumers. And they go on to explain that this should be a better incentive for businesses than handing them the money.
When all is said and done, the captain of the ship of state must wrestle with these ideas and choose between them. Clearly he needs to decide how much tax the government should take from either side of the equation and how the government should allocate that take between all the parties that come knocking at his door.
And the discussion will continue in part 2 of this series.