Multiple-bounce Economics How trickle-down and trickle-up both miss the mark

[evought 0]

Trickle Whither Thou Wilt...

 

Trickle-down economics, also called "supply-side" economics is the idea that making the prosperous more prosperous will cause some of that prosperity to "trickle-down" to the less prosperous. In short, the wealthy will have to buy things and hire people in order to spend their money and the things they buy and people they hire will improve the economy overall and, in particular, aid the poor and unemployed by creating new jobs. "Trickle-down" economics was a major component of Reagan's economic policies and Bush (Junior's) corporate tax cuts but has a long history in the US. The thinking behind the banking bailouts is similar as well: giving banks money will cause them to lend more. On the other side of the political spectrum is "trickle-up" or "demand-side" economics, the idea that giving money to the poor will cause them to buy more products which in turn will cause businesses to expand and so stimulate the economy. This is a major component of Keynesian economics and the stated purpose of the "Economic Stimulus Package," tax credits for the poor, as well as many public welfare programs.

 

Both ways of thinking have serious flaws. Trickle-down economics was always more of a political mantra than an accepted economic theory. Economists have long known that the type of spending engaged in by the rich: yachts and corporate jets, expensive dinners, tailored suits, etc., does not generate much useful long-term economic activity. In addition, the rich tend to save a larger portion of their income than the poor, meaning that less of the money being put into the system stays in the system. The rich are more capable of spending or investing windfall money abroad so extra spending may not stimulate the domestic economy. Large businesses will not expand manufacturing or hire new workers just because they get a lump of money: if consumption is not increasing, they will just pay out the money in dividends or perhaps use it to pay off debts. Large payouts to the rich and big business can be used by them to consolidate power and squash smaller competitors.

 

Trickle-up economics has always enjoyed more academic support, but it really works no better in practice. The poor may save the money or use it to pay down debts which may not "stimulate" the economy. They may go to your local chain store and buy foreign products which fails to stimulate the domestic economy just as much as when the rich do it. Companies they buy products from will not expand manufacturing or hire new workers because they know the money is a one-time influx. It is also the case that many attempts to use trickle-up policies simply consist of wasteful government spending on nothing in particular: the 2009 stimulus contained the text of pork spending bills which had failed to be passed repeatedly for decades all lumped into one ugly package. Most of this spending does nothing to actually improve the economy, manufacturing, or fix the problems which lead to the downturn. By choosing winners and losers: a new tire company gets a boost because they funded a congressional campaign but a bicycle manufacturing company did not and does not, many healthy businesses can be destroyed as collateral damage. Lastly, one must wonder how the rich benefits from the fact that a small portion of the money taxed from them in the first place may or may not eventually trickle back up the economy.

 

... Problems Still Be Bilt

 

What both theories share is an idea that capital ("money") which enters the economy at one level does not stay there; it circulates through the economy in a cycle or web. The idea is that, by putting new capital in the right place it will stimulate the rest of the economy. What both theories lack is a sound grasp of what portion of the economy is responsible for the generation of wealth. Wealth is distinctive from money or capital. $100 in the bank or spent on a candy bar represents money. $100 invested in a new tool or gaining a skill represents wealth: the actual productive capacity of the economy has increased and everyone benefits from the expansion. $100 in "new capital" generated by banks actual results in a tax on everyone. There is suddenly more money in the economy but the same selection of products to buy. This results in inflation: the cost of everything goes up a small amount.

 

Proponents of the trickle-up effect often say that "any spending will do", that, for instance, paying people to sweep their streets in their neighborhood or to dig holes in the morning and fill them in the afternoon will stimulate the economy merely because money is being spent and activity is occurring. This was the underlying idea of many of the "New Deal" programs under FDR: get people back to work, it does not matter what they do. But people are not learning new skills, no new (lasting) business or enterprise has been generated, and nothing has been changed. In fact, since the money was stolen from the economy in the first place, very little actually occurs at all. But what does occur can be dangerous: a bubble may form.

 

Double Bubble Trouble

 

We said above that companies will not expand their business just because of a one-time stimulus. They know that the money coming in now will not repeat, so if they sell out their inventory and order more than usual to replace it, they will be stuck with unused and unsold inventory. In the end, this will hurt them far more than the one-time influx of cash helps. Smart businesses will pay down debt or work to reduce future costs, but many will simply pass the money through to owners and share-holders. As the consequences of inflation set in, this new money will simply evaporate. But what if businesses are tricked into expanding by a stimulus activity?

 

Then businesses will begin investing in production that the economy does not actually need. Certain business, resources, or materials which are not normally the target of excess investment will suddenly get more expensive, such as plastic for new toys or real estate for new malls. Existing owners of these resources will suddenly see more money on their balance sheets and feel 'rich'. They may borrow more against their new equity and cause expansion in still other places. Prices go up sharply, but mostly in odd, out-of-the-way parts of the economy. This is how the housing bubble formed: the government changed the rules to force more mortgage loans to "high-risk" borrowers to "stimulate" home buying among the poor. More people bought real estate, especially new housing. The prices of these houses went up. Developers got new contracts to build more houses. People started speculating in residential real estate. They buy a house at $100,000, wait a month, and sell it for $110,000. This causes even more housing demand. But all through this, the actual number of people needing housing has not changed. Investment pulled into housing comes at the cost of things the economy actually needs. Why get a new degree or start a new business when you can make money flipping houses or as a realtor? Why follow a job to a new city when you cannot afford to get housing there? Why get a decent $100,000 house you can pay off quickly when you can get an interest-only loan approved for a spectacular $200,000 house? How does a retiree in a quiet neighborhood afford property taxes when property prices double over night?

 

Eventually the bubble has to burst and people get hurt. But it was "new money" that caused the problem in the first place. It is not much different from the dot-com bubble, the telecom bubble, or the commercial real-estate bubble which is yet to burst.

 

Bounces By the Ounces

 

The $100 spent on a tool, however, not only increases the productive capacity of the economy directly, the manufacturer of the tool also has the opportunity to use their new profit to invest in their manufacturing capacity, possibly by increasing their employees' hours or buying new equipment. A real change has happened and the bottom-layer business has a chance to realize new profits or compete in new areas. Money saved at one layer or another, say deposited in a bank account, makes money available for new loans, but the rules for loaning that money to ventures likely to be profitable have not changed, so it is more likely to be invested wisely. Inflation may be offset by real growth. So, in this sense, "trickle-up" theory works, but only if 1) the new expenditure increases productive capacity (or decreases its cost), 2) the money has a chance to "bounce" through the various layers of the economy a few times. and 3) the investment occurs where a more or less real need exists in the economy.

 

Think about, for instance, spending money at a local (grower's only) farm stand versus going to a chain grocery store and buying foreign produce. The foreign produce purchase increases the marginal profit of the chain grocery a minuscule amount and then exits the domestic economy. The local purchase goes to a small farmer who must buy seed for the next year, fertilizer, tools, labor, machinery, transportation, etc., as well as pay the costs of their own household. Farming is what is referred to as "capital intensive" industry: most of the money coming in gets invested right back into the business in the form of new resources, improvements in the land or its productive capacity. Very little comes back out as cash profits for mad-money-shopping-sprees. The money invested in the farm may bounce around several times (seed producer or nursery, hardware store, feed store, migratory farm workers, etc.) before it ends up in a Wal-Mart and heads to China. At each point that money touches, it has an opportunity to expand the economy and be invested in productive industry or improving skills. The local investment may or may not actually happen but the opportunity is there to create real wealth rather than merely move money. Expansion of local farm production might end up invested in local processing and canning industry for instance, natural textile production, bio-fuels processing, seed banks, tool manufacturers, etc., much of which has disappeared from the US altogether.

 

This is what I call "multiple-bounce" economics. How do you make sure that money spent in your community stays in that community as long as possible before ricocheting abroad? Well, one might think that simply targeting a stimulus package at small farms and capital-intensive cottage industry might work. Local industry always starts as cottage-industry/small industry before capital investment increases its economy of scale. A local machinist who hits a market niche with a new tool gets capital to mass produce it. A local woolen producer working out of a barn with steady business gradually gets newer, higher production tools, and is able to hire staff. Every Hewlett-Packard and Dell starts somewhere in a garage on weekends. So, targeting these businesses with government money taxed from the wealthy should turn everything around, right? Ur... maybe not.

 

Why Do I Keep Hitting Myself In the Head? ...

 

The truth is that government expenditures rarely target this class. The small farm/small business/cottage industry folks do not have the numbers of the poor nor the political connections of big business. Government grants designed to stimulate small business is disproportionately scooped up by big business or people connected to it or to big politics: they are better at writing grant proposals, have more time to find out what grants are available, and the connections to make sure their proposals are seen by the right people. They also tend to have the chutzpah to simply cheat: Congress decides to spend money on "carbon sequestration" and a big business scoops up the funds for "planting new trees". The only catch is that the trees were planted two years before the program started. Tracking and identifying these abuses, overseeing the grants, overseeing the people overseeing the grants, finding out whether the overseers have in-laws with the very businesses applying for these grants, etc., and trying to identify the right businesses to fund--- you want to fund the business with an idea that will revolutionize transportation, not the idiot who has reinvented the square wheel--- costs much more than these programs have any potential to generate.

 

So how do you achieve multiple-bounce investment? The easiest way to do it is to make it easier to start new local businesses. There are already people out there who have ideas and want to make something new. They will work in their garage and eat Ramen noodles at 5 cents a package for years to see their dream become reality. But they cannot compete with government or keep track of the dizzying variety of new regulations passed every day to make new businesses more complex and the consequences of not filing form 4539A-DUH more severe: local, county, and state sales taxes, state and federal income taxes, CIP taxes, business licenses, mandatory safety testing, child labor laws and working papers, reporting requirements, zoning requirements, farm registration, animal identification, workers' compensation laws and taxes, track-back requirements for produce, business inspections, "intellectual property" laws, "business method" patents, workers compensation taxes, unemployment taxes, insurance requirements, unemployment taxes, restrictions on household chemicals "used by terrorists" or "drug manufacturers" often used in small and farmstead manufacturing, disposal requirements, complex medical insurance regulations, special taxes on phone lines for "business use", grants or government favors given to competitors, regulations on online money processing, regulations on weights and measures, health department requirements on "commercial" kitchens, egg licenses, etc., etc., etc.

 

Most would-be entrepreneurs are hard pressed to even find out what half of the regulations they are required to follow are, let alone comply with them. A new farmer has little chance of being able to afford a $200+ inspected food scale and no chance of affording $30,000+ of licensed, commercial dairy equipment or a $15,000 commercial kitchen with a separate entrance and all stainless-steel fixtures which would take roughly 8,000 years of farmers' market cookie sales to pay off. A local hobbyist making wood toys cannot afford $300 worth of CPSIA and ASTM-compliant lead and safety testing to sell their unique $40 wooden toy train. 99.9% of the issues which caused the regulations to be passed are not caused by cottage-industry business. Recent problems with lead-contaminated toys were entirely from large importers with overseas mass-production but CPSIA's rigid (and expensive) requirements on third-party lead and pthalate testing are easily born by these manufacturers making 10,000 identical copies of each toy. Small manufacturers cannot comply nor are powerful enough to negotiate political favors like Mattel's granting them the privilege of testing their toys, responsible for six of the 2008 product recalls, in house. A cattle ranch with 18,000 head can afford the overhead of premises registration and animal tagging where one with 8 head cannot, but one cannot start a new home business with 18,000 head of cattle and a Senator on the payroll.

 

... 'Cause It Feels So Good When I Stop!

 

So, the first way to stimulate "local business" is simply to stop killing it off.

 

Make it easy to license and register a new business.

Make exemptions to many of the stringent "safety" laws for smaller businesses producing and selling locally--- a local dairy with eight goats simply does not require a commercial milking machine capable of milking 800 gallons a day. A gallon of teat-dip and a clean bucket will do the job just fine. The practices of a local business are visible within their community: word gets around and people spend their money elsewhere. Have the buyer decide whether they want to buy a CPSIA and ASTM-compliant toy from a foreign manufacturer with a history of problems or an un-certified toy from the local woodworker who has been selling them locally for 35-years with no problems.

Have state governments push back against the Federal by protecting local businesses from laws on "interstate commerce". Regulations appropriate for Missouri are very different from what is appropriate for Connecticut or Los Angeles. Small businesses have much better representation in state government to get stupid laws corrected or repealed--- and so do consumers.

Stop picking "winners and losers" in the marketplace by certifying a specific product or technology as the "right" solution. A regulation forcing people to buy today's "efficient light bulb" not only hurts manufacturers of today's inefficient light bulb but of tomorrow's even-more-efficient mercury-free light bulb.

Get rid of 50-year-old taxes passed for "emergency funding," like the WWII telephone tax, which are still around today and being patched by legislation to apply to new technologies (like Internet telephony) it was never meant to tax. Make tax codes simpler. Instead of spending money on a CPA to try to save money on taxes--- find the latest loophole or tax credit--- businesses can spend money on... oh, I don't know... their business.

Make tax penalties on local trade currencies less harsh. Trade coupons encourage people to start new businesses to take advantage of local businesses with coupons to spend. When trade coupons or barter transactions are taxed (sales/income tax) at full face value and must be paid in cash, trade coupons bleed cash from the communities rather than bringing cash into them.

Get rid of three-quarters or more of the grant and loan programs. If an entrepreneur has to spend half of their time looking for new grants in order to keep their competitor from getting an unfair advantage, then they are not thinking about their business. The people who are good at finding and writing grants and the people that have the mettle to push through a fledgling business with private investment and personal sacrifice, build a local market, and respond to customers are not often the same people.

Make it clear that people have the unassailable right to make whatever direct, private purchases they want, even cookies baked by their Aunt Tildy in a non-commercial kitchen, a gallon of "unlicensed" milk or eggs from their neighbor with three goats and a couple of laying hens, or a spaghetti dinner for charity at the local church. Period.

Rethink "free trade agreements" which put a local producer required to meet 18 bajillion

Once people can start new businesses again, encourage local money to stay local. There are a lot of ways to do this which require little or no government intervention. Growers' Farmer's Markets (produce sold must be grown within a certain distance of the market), Producers' Cooperatives, and Local Product Directories make it easy for people to identify local products and spend their money on them. Anyone can find a local organization and go there to buy things. If you cannot find one, starting one is easy; just get together with other like-minded people and do it.

 

Use trade coupons and local currencies to encourage money spent in the community to bounce once or twice before leaving. Make a local hardware store think twice about whether they can get equipment from a local machinist. Make a local consumer think twice about paying a local handyman to fix old equipment versus buying imported new equipment. Where tax consequences make this hard, use indirect methods, like using junk silver coins as a local currency. In the end, the goal is not to eliminate non-local purchases or imported goods, but to make sure that the money can bounce more than once before leaving, and that the local economy has the productive capacity to meet its own critical needs without depending on the vagaries of global markets.

 

A Penny Saved Is A Student Larned

 

Encourage savings. That's right, the boogieman of both trickle-down and trickle-up economics: money which is saved rather than immediately spent, helps local economies. How? By allowing people to save capital for future investment in themselves. One $250 stimulus check will not make a family suddenly decide to send their kid to college. Fifteen years of steady saving will. A $250 stimulus check will not let a family pay off their house so that more money is freed up for starting a new business. Fifteen years of steady saving will. A $250 stimulus check will not convince Bart, his brother Dan, and his other brother Dan to open a new feed store. Fifteen years of steady saving from a 'day job' will. While that savings grows, it is available to banks to be loaned out for new mortgages or new business ventures, but only if people have money for down payments, if the economy is strong enough to support those new ventures, and the regulatory environment is stable enough to make the risk worthwhile. What kind of idiot is going to buy a new farm when they have no money for a down payment, the economy is bad enough that they cannot guarantee they will sell anything, and a new "food safety" bill is sitting in the Senate which may require them to make $30,000 in new improvements to their farm and $8,000 a year in ongoing expenses before they can sell a carrot to their neighbor? What kind of idiot starts a new business without the savings to get by if the sales don't start pouring in on Day One? In my contracting days, the rule of thumb was to save up 6 months of coasting time in case business was particularly stale. A farm has to count on a bad harvest now and then, meaning they need to get through a full year to the next big harvest. No savings, no new business.

 

Savings does not happen in "bubble economies". There is no point to putting money in the bank at 0.000000000025% per year interest when you can make 84,556,673% per month flipping houses (until the music stops) or buying bad paper on the run-away derivatives market. There is no point to sitting on money in any form when inflation due to tax-and-spend or borrow-and-spend budgets causes the dollar to lose its value just sitting in your pocket overnight. A silver dollar from 1930 is worth fourteen times the value for its metal content than for the number stamped on the front. That is a direct measure of how much that dollar has lost in actual buying power. Until we learn "Multiple-Bounce Economics," there will be nothing in our local economies to save and no money available to pay our way out of crushing debt. Our "trade imbalance" will not improve, no matter how low the exchange rate falls, until there is something produced in the US worth buying with foreign money and that will not happen until we revive local industry.

 

...And We Close With Some Pithy Sayings

 

In some ways, Keynesians are right in that it does not matter what local industry produces--- it might be a great new recipe for liver and onions or a new electric motor, a great dance hit or a biography of Alan Keyes, hand-woven wool rugs or a tool for pounding fence staples without hitting your finger with the hammer--- as long as it produces, but it also has to invest in itself along the way and that tends to weed out the truly wretched ideas over time. Only a rolling stone gathers no moss, and only a bouncing buck keeps from getting stuck.

 

In many ways, this is why our family farm-based business spends a lot of time encouraging other local cottage industry and patronizing other local businesses. Rather than being a source for new competition (which keeps us on our toes anyway), it means more places to spend our income locally and more local businesses with money to spend on our products: "a rising tide lifts all ships" as the saying goes. The more businesses start thinking this way, the faster our economy will really recover.

[dangerdan 0]

Apparently the UK is out of recession based on a growth figure for last quarter of 0.1%, which will probably be revised, which could mean that we never entered recession at all, or that we 'bounced' back by as much 1.0% (adjustments of up to 0.8% are not uncommon) so if the UK has already left the recession, there is a danger that it will 'fall' back into recession the very next quarter, especially as the Bank of England's policy of 'quantitative easing' (printing money) has stopped. If the economy left recession last quarter then its likely we will have a double dip recession, if it turns out we never left recession, then we'll just have a standard 'U' or 'V' shaped recession as opposed to the 'W' shaped recession many are predicting.

[evought 0]

If the economy left recession last quarter then its likely we will have a double dip recession, if it turns out we never left recession, then we'll just have a standard 'U' or 'V' shaped recession as opposed to the 'W' shaped recession many are predicting.

I believe history will show that we never had a "recovery" at all. Gold and silver are still bouncing around north of $1500/oz and $40/oz. respectively, and pressure on (US) bond interest rates has not eased.

 

In all likelihood, UK's economy is healthier right now than ours in real terms, but I think you folks will find that your economy and much of the world's are too tightly chained to our sinking ship. The disaster in Japan really did not help things either.

 

But I think the real disaster that is setting things on a downward spiral is the recent and continuing travesty over the US budget. We fought back and forth, tooth and nail, for several weeks over a 2011 continuing resolution which cut at most $32 billion out of a $1.3 trillion deficit (and at worst estimated as having cut only a couple of hundred million USD). We are heading down the same road with 2012: not arguing over how to actually reduce our debt or even reduce the deficit in real terms but merely about whether to reduce the growth in the deficit by a miniscule fraction while exempting most of the budget from any cuts at all. This just tells our creditors that we are not capable of taking any action to protect their money and their investment which is what S&P's murmurings are about. US bonds were a good (or at least 'safe') investment as long as there was some hope we would get around to providing a return on that investment someday. I think the world markets are a good bit less clear on that right now, and the only thing keeping us afloat are the Federal Reserve's price support on bonds and the fact that investors are reluctant to drive commodities providing an alternative to US bonds (e.g. silver, gold, wheat, oil, sugar) any higher.

[imjjss 0]

Fixed income markets have been behaving as if the UK is a relative safe haven. There are several reasons whyinvestors tend to attribute something of a ‘safe haven' status to the UK.

 

The most obvious reason is "The UK Can ‘Print or Inflate its Way Out of Trouble".

 

On the surface, high inflation looks potentially helpful. It should boost nominal GDP and, by boosting tax revenues, it can also help to lower the primary deficit.

 

The oposite thoughts--

 

The UK has a high proportion of inflation-linked government debt.

 

Many items of government expenditure are explicitly linked to inflation.

 

If wages fail to keep pace with consumer price inflation, that can worsen deficit projections further.

 

A sharp deterioration in credibility could lead to a fast rise in bond yields and sterling weakness - a loss of ‘safe haven status' irrespective of any positive benefit on deficit as a % of GDP from a period of high nominal GDP growth.

[fermin25 3]

Interesting topic. In my country the goverment doesn´t have money to give to a part of the economy like US or Uk but in my country all the economic politics are designed by the interntional monetary fund and we have to take them. In my country there are 5% of the people who are rich 60% who are poor but we can say that maybe have a life like a middle class and 35% who are extremely poor so here there is no a lot of parts of the economy there are only three and the rich people have companies who sell products directly to the state in the most of the cases. There is a little good companies who work in the mass production model like the americans so we are behind in that sense. I think I am more inclinated with the trickled-up theory because the poor people in almost all the cases don´t have the habit to save money in the bank or in their houses and try to spend all the money and don´t pay debts too. The poor are who keep the economy because they are who spend all the money they earn and they put the working power in the factories. Well giving money to the poor maybe is the better way. Because if you give money to the rich they have a lot of ways to put this money to work and they have the habit to save money. So giving to the poor is better and that theory which say the poor go to buy foreign products is totally wrong because they only buy what they need and in the most of cases they have to buy the cheaper products who in the most of cases are made in the same country. So maybe the economy is something complex but we have to understand that we need to create a better economic system because in the actual there is a big hole because maybe we have the perception of there is not enough money to all of us because a lot of people is without a job and can´t bring money to their houses. Good topic.

[evought 0]

So giving to the poor is better and that theory which say the poor go to buy foreign products is totally wrong because they only buy what they need and in the most of cases they have to buy the cheaper products who in the most of cases are made in the same country.

That depends on the country. Here, the least expensive products are from abroad because local producers pay high taxes, have to comply with expensive regulations, and have a high cost of living. Many of the countries which export products to us can get away with paying their workers a fraction of what is paid here. That is even starting to be true of food, even though we have some of the best farmland in the world. So, it is not that we can't produce local goods but that the system has been set up in such a way that the local economy has been destroyed.

But it is very interesting to hear the perspective from another country. Thank you.