Demand-side? You're on the wrong side

With current economic woes finally starting to influence regular people over the past few months, it has created this feeling over time that "main street", that is, you and me, are losing out. That is, of course, because we are. While it may be little comfort to know that things aren't getting worse on purpose, we've got to understand that things are getting worse, in part, due to the economic systems that we have in place.

In order to understand this, we've got to look at the "demand side" economic model, as it's definitely the most popular way that politicians look at things at the moment. The basic premise is this:

Demand creates Jobs (to produce the supply) which creates disposable Income (from wages) which creates demand (because people have money, and want to buy things with it).

Assuming you're paying attention, you're getting bombarded by demand-side messages all the time. For example, people are concerned about consumer confidence, because if consumers aren't confident, they won't generate demand, even if they have the income. Likewise there is a concern about unemployment, not just because people suffer when they're out of work, but because job cuts decrease income. As well, there is this constant talk about the "credit crisis" which is a problem because people can no longer raise the income they need (through loans) to have enough demand (for things like cars and homes, which few have 100% down-payments for).

The thing is, though, that while this particular philosophy is very cohesive and internally consistent, it also has serious problems once it starts interfacing with the real world. Problems, which make average people like you and me lose out in the end.

The first of these problems comes from technology. Efficiency creates redundency. Likewise, we have seen thousands, if not millions of jobs simply disappear over the past decade or two because jobs that human beings were doing got replaced by machines. In any case, improvement in technology always leads to job loss, which can sometimes be substantial. Consider, for example, the fact that a single human with only hand tools can farm a few acres of land by themselves, whereas a person who has a few pieces of large farm technology, like a tractor and a combine, can farm hundreds of acres just by themselves. As such, if you introduced technology to a non-modern farm society, you'd instantly get a 99% unemployment rate as the one farmer with the machines can do the work of the 99 others. See THIS for example.

In any case, improvements in technology and labor methods (like improving efficiency) cause unemployment, and unemployment drives down incomes which drives down demand, and the whole system enters a death spiral. While it is possible to use technology to create new jobs, these efforts are usually forced, and not only do they not replace all the jobs lost, but those new jobs will also continue to be lost as the technology used to create the jobs in the first place improves.

A second major problem that demand-side economic thought creates relates to incomes. In the ideal world, the most income would be distributed to the people who would generate the most demand (that is, they would go out and spend it). In the end, the best, most organized, most dedicated organizations to the purpose of spending money are governments. Thus, it's not surprising that when times are tough, demand-side thinkers will take money away from average people (who aren't spending "enough") and give it to the government, which has the will to blow around cash and always too many ideas with regards to how to blow it. FDR created the New Deal, for example, and Obama is currently touting rhetoric of government-backed infrastructure projects, and whatever. The point is that if the government has the income for us it can have the demand on our behalf, which will create the jobs that we'll all fill, which will give us money to buy things on our own.

This idea, though very internally consistent, carries a bathtub full of problems. The first is that just because the government has the willpower to spend money doesn't mean that it has the ability to spend the money well. Large organizations with lots of money invariably have lots of corruption. Corruption means that there will be money sitting in bank accounts rather than money being paid to new employees. Secondly, the whole point is to spend money for the sake of spending money. Thus, it doesn't matter what kind of jobs are created so long as jobs are being created. This can mean that jobs are quickly lost once the government subsidies fade if what the jobs were creating wasn't something that anyone would ever buy. For example, if the government paid a million people to make buggy whips, they would be providing a false demand that couldn't possibly be filled in by the private sector once the government backing left. As such, this type of spending ultimately only prolongs problems, rather than fixing them.

Most importantly, however, the government is taking money away from people who aren't spending it in order for the government to spend it on their behalf. This is one way in which you definitely lose, as normal people are now losing money. As well, with less money in the hands of people, they are now less likely to spend what remains, which works to offset the increase in demand caused by the government.

As well, this decreases saving rates. While saving is an anathema to demand side thought, wiping it out is actually very hazardous. When savings goes down, it makes it so that small economic units, like you or your family, are more likely to go bust. Not only does this further decrease demand, but it also causes problems with people you're indebted to (I'll get to that in a minute), and it causes organizations like the government to come in and bail you out. When this happens, a lot of money is spent (and lost in overhead) without necessarily all that many more jobs created at the local unemployment office.

Also, the people who save the most also tend to be the wealthier, who are also the people who get taxed more (in part precisely because they're saving, rather than contributing to demand). When wealthy people save, they tend to do it in the form of investments (like stocks) or in large sums in banks. Without this, companies, like families, have less capital to fall back on when things go bad. In the case of corporations, it results in the government bailing them out, as we've seen recently. This, yet again, is an expensive way to add little demand or income to the system. More critically, however, if there isn't savings in banks it creates very brittle banks. Let's all remember what happens when there is a systematic collapse of the banking system...

This brings us to a final problem, that of debt. Remember that all three parts of the tripod of income, jobs and demand need to be going up in order for the economy to grow. When technology guts jobs, and inflation guts income (and globalization guts both), there is invariably going to be a crash in demand. As we've seen over the past decade, the only way to prop up the whole system is to create fake income in the form of consumer debt. If you don't have any money, but you have the ability to buy things with your credit card, you will continue to buy things (create demand) because you have the ability to buy things.

This, of course, has the potential to be absolutely disastrous, as we're seeing right now. Remember, credit is FAKE income. While you have more money now, you have to actually give it back at some point because it was never yours. In fact, once you put your interest rate into the mix, credit actually decreases income, even if it very temporarily props it up. In the end, however, debt must be repaid. If you and I have been good economic citizens and have been spending rather than saving, it means we will be unable to pay the debts back, especially if there is a shock.

The only result is a proverbial day of reckoning where homeowners default on their mortgages, families file for chapter 11, and all the fake income comes crashing down, revealing a lack of demand, freezing the ability to create more fake wealth to keep the system going (cf. the credit crisis), while jobs, created by fake wealth disappear (cf. current unemployment numbers), which creates a loss of income which causes you and me, on the wrong side of this whole equation to shudder in fear and darkness as we scrounge to find food in a world with no jobs, inflating food prices, while trying to find shelter when our homes foreclose and we desperately try to use jobs we don't have to pay back debts we can't afford.

And here's the real kicker: we're going to the government for help. The government, meanwhile, is horribly strapped for cash (see THIS, for example) because the tax revenues they're bringing in have plummeted as Americans have lost, on average, 40% of their wealth last year. So, if the government has LESS money, and they're called on to spend MORE money, the end result is a massive increase to the government's debt (projected to increase by 1 to 2 TRILLION in 2009). Remember how I was just talking about what happens when you and I go into debt to artificially keep the economy going? Yeah, now imagine that the debts you're defaulting on were to the tune of $14 trillion dollars. The world, as we know it, will end.

So, what does demand-side economic thought mean to us all? It means we have a system in place that is corroded by technology, quick to implement protectionist policies, makes you, me, and the whole system more vulnerable by stripping away savings while forcing you, me, and the government into debt that will ultimately destroy you, me, and all of civilization as we know it.

Remember, the demand-side philosophy is a neat little internally consistent package, but when it comes into the real world, the natural results of its ideas (policy) hurt you and me. While I'm not about to ring out the virtues of supply-side thought (they'll get a bloggal tongue-lashing later), we've all go to realize that we are most definitely on the wrong side.