In praise of trickle-up economics

 

Have you heard about it? Trickle-down economics has failed. Barack Obama says so. Paul Krugman says so. The Wall Street Journal says so. The Guardian says so. You’ll hear it in sociology campuses across the Western world, albeit phrased in a more complicated way. And if that isn’t enough, type ‘trickle-down economics’ into Google and Google will automatically suggest the additions ‘doesn’t work’, ‘myth’, ‘debunked’ and ‘failure’. So it must be right, mustn’t it?

But what exactly is trickle-down economics? According to its critics, it is the idea that making the rich richer is good economic policy. Why? Because as the rich buy goods and services, save, invest, and perhaps make philanthropic donations, their wealth will radiate off to the rest of society.

Over the last ten years, I have met all sorts of economists believing all sorts of weird things, but I have yet to meet a trickle-down economist. Where are these people, about whom so much is written, and whom so many are busy debunking? Could it be that they are a fantasy product, made up by people who combine an intuitive disgust for free-market ideas with an unwillingness to understand them?

Whatever trickle-down economics is, it has nothing whatsoever to do with free-market economics. According to the way his critics describe him, the hypothetical trickle-down economist seems completely indifferent to how the rich have made their riches. If an actual trickle-down economist could be conjured up, he would presumably defend the fortunes of Sicily’s mafia, Colombia’s drug barons, and Putin’s oligarchs. Their wealth trickles down, he might argue, as they hire people to polish their Ferraris and fish the leaves out of their swimming pools.

Let’s contrast this to three people who have amassed great fortunes by means of market exchanges: Ingvar Kamprad (IKEA), Karl Albrecht (Aldi), and Michael O’Leary (Ryanair). What these three have in common is that they found ways of stripping a product to its bare bones, and then cut the cost of providing it to a fraction of what it previously was. And while it was not their intention, they have also spurred competitors to cut their costs to comparable levels. As a result, low-income earners in contemporary Europe find groceries, functional furniture and the occasional flight more affordable than middle-income earners a generation ago.

It would be absurd to argue that nobody has benefited from these three gentlemen’s economic activities except themselves. But it would be even more absurd to claim that their wealth had somehow trickled down to the poor, because it was exactly the other way round: our three entrepreneurs have found ways of making life easier for the least-well-off, which is why millions chose to buy from them. Only then, and then only gradually, did wealth ‘trickle up’ to them.  

Free-market economists defend the right to get obscenely rich by making the poor better off. They couldn’t care less about how rich the rich are, but they care a lot about how they got rich in the first place. Our problem is not that we have too many innovative, cost-slashing entrepreneurs. Our problem is that we have too many people who get rich not by means of market exchange, but through the zero-sum game of the political process: the landlord who can get away with excessive rents, because the planning system keeps competitors out; the renewable energy producer from whom no sane electricity supplier would buy anything, if the government did not force them to do so; the farmer, who gets most of his income through subsidies; the sock puppet CEO, who, unable to find voluntary donors, has his generous salary effectively paid by the EU and the Department of Health.

These are the undeserving rich - no matter how much of their wealth may trickle down.   

Excellent piece, Kristian.
"obscenely rich"? I'm not sure that Free-market economists would acknowledge the validity of the phrase "obscenely rich". I like this quote by George Reisman: Of course, in a further display of their ignorance and blindness, members of the Left will undoubtedly characterize the line of argument I've presented in this article as the "trickle-down theory." There is nothing trickle-down about it. There is only the fact that capital accumulation and economic progress depend on saving and innovation and that these in turn depend on the freedom to make high profits and accumulate great wealth. The only alternative to improvement for all, through economic progress achieved in this way, is the futile attempt of some men to gain at the expense of others by means of looting and plundering. This, the loot-and-plunder theory, is the alternative advocated by the redistributionist critics…. It is time to supplant it with ... sound economic theory….
Please, the fallacy of "growth" and "prosperity" hinges on ever increasing debt and relies on both human beings dying (and so opting "out" of the system) and the continual influx of new human beings at the bottom. It's inherently psychotic.
I don't get your point, Trent. Who's dying? And of what?
I found this a really confused article which deviated considerably from its headline - if I was your supervisor, I'd ask you to go back and rewrite the whole thing. A few points... You state "Free-market economists defend the right to get obscenely rich by making the poor better off", but you should also realise that "Free-market economists defend the right to get obscenely rich by making the poor WORSE off" - that is the nature of the free market. Belief in the trickle-down or the trickle-up effect does not depend on whether one is an advocate of the free market or not. Belief in the trickle-down effect is reflected in support of a policy of, for example, cutting the top marginal rate of income tax (the rich have more disposable income and they will spend that on goods and services in the wider economy). Belief in the trickle-up effect would be reflected in support of a policy of, for example, giving those on the dole an extra GBP100 to spend at Christmas (the poor will have more disposable income and they will spend that on goods and services in the wider economy). The actual impact of either policy on the economy will depend on the propensity of the rich and the poor to spend the resultant marginal increase in their income - most would agree that the poor are more likely to spend a higher proportion of that marginal increase in their income. If you, as a policy maker, have an objective of boosting the economy and only have a limited level of resources, surely you should direct those resources towards the area where they will have the greatest impact - give all those on the dole an extra GBP100 to spend rather than reducing the top marginal rate of tax from 50 to 45%.
David: " "Free-market economists defend the right to get obscenely rich by making the poor WORSE off" - that is the nature of the free market.". May I ask for your evidence for this assertion? Have not wages in China, for example, increased several-fold since the government there adopted more free market policies? Perhaps you would like to provide a counter-example whereby people have got worse off as a result of free market policies.
"...if I was your supervisor, I'd ask you to go back and rewrite the whole thing." And since you're not, I'd ask you to go back and reread the whole thing, and come back once you've actually understood it.
i've been looking from some pro free-market reading material and i'm glad i found this blog. i've made a note of the china question and look forward to investigating it, but in terms of people who are worse off by free market policies i would say - a huge proportion of the people in spain, greece, italy portugal who are suffering from the crisis. all communties who are being destroyed by huge hydro damns which get the go ahead due to private (pro-market) influence over gov decisions. many communities who have lost out to the resource grab, or land grab of multi-national companies, and about a billion more. the poor who are being made WORSE off may not be next door (and the deaths trent is refering to i assume are those people in poverty who are dying of hunger as lack of regulation of bank speculation causes volatile food prices). isn't there a huge and growing body of evidence that inequality is a fundamental problem within an economic system? and that free-market economics, even while pulling actual salries up in some places, has INCREASED inequality. a fundamental of whatever economic system we have on this planet is that we have enough to provide for everyone and at the meoment we don't. it's an embarassment that as a human race we haven't managed to stop people dying of hunger and easily treated disease. the "obscenely rich" are getting rich off the backs of others, yes people can buy ryan air flights so some of the poor are getting access to a service, but follow the path further to think about the impacts around the globe of tax dodging CEOs, lobbying to influence laws that protect emplyees and civil society, not to mention climate change. i'm just throwing things out there as i think of them - and i look forward to some sensile answers from the perspective i don't normally see. thanks anna
Anna, three things. Firstly, the euro crisis has NOTHING WHATSOEVER to do with free market economics. It is a consequence of tying economies that are not suited for a currency union into a currency union anyway. There are a number of requirements that have to be in place for a monetary union to work, and the current euro zone does not meet these requirements. Economists have warned about this from the start, but politicians chose to ignore them. The euro crisis is the result of the megalomania of politicians like Helmut Kohl, and free-market economics is precisely about REDUCING the influence of politicians over the economy. It's about getting the Helmut Kohls of this world out of our lives. Secondly, there's a world of difference between being 'pro-business' and being 'pro-market'. I'm spelling this out in Chapter 1 here: http://www.iea.org.uk/sites/default/files/publications/files/IEA%20Redef... Thirdly, speculation REDUCES the volatility of food prices, if it has an impact at all. A speculator is somebody who buys when a product is cheap, in anticipation of future price increases, and sells when the product is expensive. Thus, he adds to demand when the product is cheap (thereby raising prices a bit), and adds to supply when the product is expensive (thereby reducing prices a bit). In the longer run, his impact is zero. The speculator does not keep anything, he sells as much as he buys. If he didn't, he would be a speculator.
Kris - thanks for the reply, i've read the first section of the book. i like your writing style its easy to read and balanced. and i agree very much with your suggestion that part-time and full time work should be differentiated in the stats. i've annotated it with comments, if you're interested in carrying on the conversation please email me thegurney at hotmail dot com and i will send you the pdf. in response to your comment : you are right, i bunch the general economic crisis with the euro crisis and see them as basically the same thing. i probably won't get around to learning enough about currency and policy to be able debate on that one. of course speculators dont keep anything. they have absolutely no interest in buying wheat. they just make money out of the transactions. and it is now widely accepted that food speculation does cause volatility in food prices (http://www.wdm.org.uk/stop-bankers-betting-food/depth-research) - and even if it's not 100% proven (what is?) then is there no way a free market approach could accept the idea that if there's even a chance they are messing with the prices then maybe they should stop? its not like a housing sup-prime mortgage crash where people lose their houses (which is bad enough) this is actually people dying of hunger because they cant eat. if there was a chance that food speculation was causing people to die, is that a good enough argument for the market to analyse the situation and say hey well, since it would be easy to stop why dont we stop for five years, see if that helps? i guess the answer is no, because markets dont look at problems in that way- and i've yet to read more of your book, but i think maybe that is the problem. hope to hear from you on email (i know we are all busy - but this is better than the guardian comments section so i hope you have time to answer more questions) anna
Anna - no time for e-mails at the moment, but Ill respond here. It is not "widely accepted" that speculation raises food prices. It is widely REPEATED, no doubt about that. But even if you follow your own link, you will see that the actual economic models they refer to say nothing more than that specific types of financial instruments may raise volatility in specific food markets under specific circumstances. And even that is a careful selection. I could respond by copying links to models which find the opposite, but I won't, because that would make it a dialogue of the deaf. What matters more are the basics. Speculation does not work the way it is commonly assumed to work. You cannot just enter a market, mess around with the prices a bit, and then walk out with loads of money. Who would give it to you, and for what? In a genuine market economy, all transactions are voluntary. If you want to sell something, you need to find a willing buyer, if you want to buy something, you need to find a willing seller. If I suggested to buy something from you for £100, and then sell it back to you for £130 next month, you would obviously not consent, and the transaction wouldn't happen. But how about this: Suppose you own something which is currently worth £100, and you expect the value to go down to £70 next month. I, in contrast, believe that the value of the same thing will go up to £130. We could now make a contract: Whatever happens next month, I promise to buy it from you for £100. If your prediction is more accurate, I take a loss. If mine is more accurate, you forego a gain. If you are risk-averse, and I am a risk-taker, the transaction could make sense for both of us. THAT is speculation. Nothing magical, no con trick. It happens because people make different predictions about the future under conditions of uncertainty, and people differ in their willingness to take risks. Think of it as an insurance contract, where you, the producer, insure against a drop in the price of your produce, and I, the speculator, sell that insurance policy to you. I don't do that for free, of course. I'm not a Samaritan. But I nevertheless perform a useful function; if I didn't, you wouldn't agree to the transaction. People are emotionally hostile to speculation, because it somehow FEELS wrong to them. Anti-speculation sentiments also make a good story, because it fits into the grander narratives of our times (Third World farmers as victims of rich Westerners). But it is nevertheless harmful, because it distracts attention from the real causes of global poverty. Unfortuneately, those real causes don't make a good story. They are mostly to be found in dry economics.

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