Sunday, October 21, 2007

Spending Cuts What's Important

Jurgen Reinhoudt from the American Enterprise Institute has an article about the Irish economic miracle which illustrates the shortcomings of supply-side economists.

While he rejects the false claim that money from EU structural funds was responsible for it by pointing out that other mayor receivers, particularly Portugal, failed to grow at anywhere near Irish levels, his attempt to refute those who deny the role of free market economic policies is unsatisfactory to say the least. Here is what he wrote:

"Some allege that Irish economic growth “came first,” which then enabled tax cuts to be passed, rather than the other way around. It is difficult to disprove this theory, but it is not difficult to see that Ireland’s growth would almost certainly have stalled had no tax relief been enacted from the early 1990s onwards. Regardless of which came first, tax relief—particularly corporate tax relief—has played an indispensable role in Ireland’s economic success."

That is about as unconvincing argument as it gets. He provided no evidence that growth would have stalled without the tax cuts, but merely asserted it.

The truth is that while growth took of before the tax cuts, it didn't take of before spending cuts. In the mid-1980s Ireland had an enormous budget deficit, at over 10%
of GDP and government spending at over 50% of GDP. Ireland then reduced the deficit by deep spending cuts, which allowed interest rates to fall sharply and confidence return in Ireland's economic stability.

Reinhoudts focus on only tax cuts, illustrate the problem with supply-side economics. They view government spending and deficits as irrelevant, or even positive, and only focus on tax cuts. This leads them to misleading analysis, such as their prediction that the Bush tax cuts would significantly increase growth even through they were combined with higher spending and deficits and even though the economy has been damaged by Greenspan's monetary policy. Or in this case, when they fail to explain why growth in Ireland preceded the tax cuts.


Anonymous Anonymous said...

Interesting. Can I summarize the matter by saying that supply-siders confuse the credit-driven boom that tax-cut-led deficit monetization creates with genuine sustainable growth created by the reallocation of resources from the state to the market which occurs by cutting government outlays?


12:33 PM  
Blogger stefankarlsson said...

Well, yeah. They don't recognice that government spending is a problem at all as long as it is financed through borrowing.

9:25 PM  

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