The confidence fairy con-trick hits Kansas

After Greece, Portugal and the UK, the supply siders are intent on another failed and costly experiment, this time in Kansas. It's about time the economics profession stopped their childish belief in the confidence fairy.

Even in 1982, up the back of the lecture theatre playing Battleships with Don Maclennan, the economics lessons covering supply-side theories seemed far-fetched. What was the point of theorising about supply if people didn’t have the means or confidence to purchase stuff – the demand?

Economists, often reluctant to let common sense get in the way of a new theory, especially one that offers popularity and more lucrative career paths, saw it differently. And so for the past 35 years we’ve been living under the spell of what Paul Krugman calls the confidence fairy.

If a government lowers taxes and deregulates, so the story goes, people will feel more confident about the future and the spending that follows will kick start economic growth.

And so in the 1980s the economics profession began a deep but abusive love affair. Led by Frederick Hayek, the Austrian school had opposed Keynesianism and lost. But the flame was kept alive in Chicago, home of Milton Friedman, Gary Becker and Eugene Fama, he of the efficient market hypothesis, which value investors the world over disprove every day.

The Chicago School’s moment came in 1979 with the election of Margaret Thatcher and acolyte Keith Joseph – the original Mad Monk - who had undergone a road-to-Damascus conversion, ditching small ‘c’ conservatism in favour of free markets and small government.

That's how the grand experiment began. Governments did get smaller, taxes were lowered, the welfare state was reduced and global trade boomed. The post-war consensus was no more and the great moderation began. Until, of course, the Global Financial Crisis, which undid just about every supply-side theory that preceded it.

Real-life experiments are rare in economics but over the past few years we’ve gone close. The austerity package imposed on Greece was designed to help the country pay down its debt at the expense of unemployment and economic growth. But whilst growth collapsed and unemployment skyrocketed even more than predicted, debt actually increased and another bailout was needed.

Portugal had a similar experience whilst in the UK a commitment to lower taxes and smaller government spending provoked a triple-dip recession.

And so to Kansas, where Governor Brownback is again trying to summon the confidence fairy by slashing corporate and income taxes. Planet Money reports that the measures were expected to cost state coffers about $300m a year but the real figure will be twice that. Tax revenues are down 45%, which means the state has to get smaller, exactly what supply-siders recommend.

Schools and other government services are being shut down but, in flagrant disregard for the theory, economic growth is less than the US average and the state’s growing deficit will now cost more to service due to a ratings downgrade (for a street-level explanation try this Planet Money episode).

This is Greece all over again, without the Germans pulling the strings. For every dollar a government takes out of the economy through budgetary cuts, up to $1.70 in real GDP is lost. That’s why cutting your way to growth doesn’t work. Jobs are lost, lives become more precarious and debt, the totem on which all this suffering is pinned, still increases.

Interviewed on the Planet Money podcast, Arthur Laffer (of the Laffer Curve), one of the first to pump hot air into the confidence fairy, suggests Kansans give it time. Governor Brownback, facing mid-term elections, hasn’t got it. And the Greeks and Portuguese lost patience with the theory a long time ago.

It’s about time the economics profession found their way back to the Yellow Brick Road and admitted their mistakes. Three decades of failed experiments is surely enough.

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