DEFINITION: “Supply-side economics” refers to a controversial macroeconomic theory advanced in the late 1970s in response to the combination of high inflation and low or negative growth (“stagflation”) prevailing at that time.
ETYMOLOGY: The proponents of supply-side economics held that the most important factor driving economic activity is productive capacity—that is, the supply of goods and services—and not consumer demand.
USAGE: Supply-side advocates accordingly recommended policy measures designed to stimulate productivity as the best way out of the stagflation quagmire.
These measures, which were adopted in part beginning in 1981 by the incoming administration of President Ronald Reagan, included lowering taxes, repealing duties and tariffs, and abolishing unnecessary regulations on business formation and activity.
Immediately after the Reagan administration’s implementation of supply-side policies, there was a difficult period of economic pain as the economy adjusted. However, after a couple of years, Reagan’s policies produced sustained economic growth and increased employment, as predicted by the theory.
It is important to note that, as we have described it so far, supply-side economics scarcely differs from classical free-market economic thinking.
Indeed, the idea that economic growth is primarily a function of the supply of goods and services on offer in the marketplace was already expressed in the early nineteenth century by the French economist Jean-Baptiste Say, whose insight was later dubbed “Say’s Law.” Say’s Law basically says that “supply creates its own demand.”
What made the supply-side economics of the 1970s and 1980s controversial was not so much its central classical-liberal ideas as the additional claim that the tax-rate cuts it recommended would pay for themselves through the extra taxes generated as a byproduct of economic growth.
This claim, which was based on the Laffer curve devised by American economist Arthur Laffer, has not been widely accepted by the academic economic profession. Given that the federal deficit ballooned by around $100 billion during Reagan’s eight years in office, it seems hard to argue with the academy’s skepticism on this point.