Joe Biden’s trickle-up economics may fail

President Joe Biden’s recently unveiled budget marks a new era in US economic policy making. Decades of trickle-down tax cuts are out the window; Biden is betting that trickle-up economics will deliver the kind of sustained and equitable growth we all want. But that’s a dangerously short-sighted strategy that in the long term will create far more stagnation than a Reaganomics agenda that overstayed its welcome.
Biden is proposing a very large expansion of government spending, to 25% of GDP from 20% before the pandemic. The plan represents a massive redistribution of wealth from companies and higher earners to middle and low-earning Americans. The White House wants to use tax increases on corporations and high earners to generate about $4 trillion in additional revenue over the next 10 years, then redistribute it to different sectors of the economy, including higher wages to caregivers and cash benefits to families with children, subsidies for more well-paid union jobs, and investment in infrastructure projects like repairing roads and bridges, with a lot of money ($186 billion) to “spark widespread adoption of electric vehicles.”
Those ideas are a big break from the last half century of government policy and how economists have viewed growth. Trickle-down economics was the signature of the Reagan era: the idea that if you cut taxes on companies and the wealthy, they would invest that money productively in the economy and we’d all benefit with more jobs and higher living standards.
We do have higher living standards than we did in the 1980s and we’re richer by many measures, but trickle-down didn’t live up to its full promise. Growth has slowed, so has innovation and productivity, and there is widening income inequality.
The Biden administration would like to try a new approach. One of the president’s economic advisors, Heather Boushey, favours a philosophy that aims to spark growth by redistributing wealth and income. She argues that because consumption accounts for 70% of GDP each year, it stands to reason if we take resources from rich people who save more of their money, and give it to poorer people who spend more, we’ll increase consumption and have a bigger economy. That’s the essence of Biden’s trickle-up strategy.
And there is some truth to it, at least in the short run. If you’re in a deep recession where people are afraid to spend, there’s a benefit to boosting consumption. But as a long-term growth strategy it’s deeply flawed. First, it’s inflationary and less sustainable because you have more demand chasing the same amount of goods. The only sustainable way to boost consumption is through innovation: creating new products or finding more productive ways to make things.
Second, it means there’s less money for investment because we’re spending instead of saving. Economists in the Boushey camp think the US economy has too much money locked away in savings. But that argument originated in the early 2000s when American financial markets were awash in capital from abroad. Foreign countries sent us enough of their savings that we could get away with saving less ourselves. That’s less true today — a reminder that international capital markets can be fickle and it’s risky to shape long-term policy around them. In the long to medium-run a nation needs a stable source of saving to finance the kind of innovation that drives growth.

—Bloomberg