Well, you might have already heard about this economic terminology numerous times. You also might have encountered the concept from the United States more recently. In televised US presidential debates last year, Donald Trump and other conservative Republicans, repeatedly spoke in support for trickle-down economics. Although its principles have been largely applied in real-life scenarios, as so far no persuasive empirical evidence has been found to prove the validity of success for this theory. Nevertheless, it is definitely useful to acknowledge why the premise of trickle-down effect has failed to be captured in real life, as anticipated from the advocates, and why it should not be encouraged.
THE HISTORY OF TRICKLE-DOWN ECONOMICS
The term “trickle-down” to be implemented in the application of economics was first conceptualized by the American comedian and political commentator Will Rogers in the 20th century. The term was used to criticize the revolutionary stimulus reform that was executed by President Herbert Hoover during the Great Depression. He believed that monetary assistance being given to the working class, the unemployed and the poor communities would be inefficient to the mutual development of the economy. In stark contrast, those funds should be granted to large financial corporations within the country, in the hope that a healthy elite class would eventually help the rest of the economy through the creation of jobs and public investment projects. Of course, even back then, there were indeed massive flows of public skepticism about the effective use of these distributed funds in the hands of the elites.
Under the presidency of Ronald Reagan, the term again gained popularity, albeit differently applied, as the Democratic Party showed their disapproval of his economic policy. The administration believed that this would be the revolutionary progress of supply-side economics, the ideology that dominated economic thinking at the time. Expansionary policies, such as tax cuts and other benefits to the wealthy, were highlighted as the primary concerns for the Democrats, however, as this allowed widened income discrepancies which indirectly led to the development of other societal problems.
Surprisingly, the scientific community seems to denounce the implementation of trickle-down economics into academia, as they believe that it should stay in the realm of other political debates (or even more so, should not be mentioned). As such, you might understand that despite its frequent appearances in the news, there is yet to be a formal definition of trickle-down economics in mainstream textbooks.
THE EXPLANATION
So, from these above-mentioned historical events, it can be understood that trickle-down economics should be portrayed as economic benefits that are offered to the wealthy, in anticipation that deductively this should enhance common welfare. In particular, these privileges are usually presented under either a direct injection of money supply (which is of course much less of a likelihood now) or alternatively, tax reductions to businesses and its owners, to high-income earners, to other capital gains and dividends. With the help of neoclassical economic theory, these “so-called” leading entrepreneurs would promote economic growth through the use of these funds by allocating more investment into capital and labor – in the most simplistic sense – and the creation of more job opportunities. In reality, there is much more to this argument. The mere existence of banking and financing makes lending and borrowing much more convenient than ever. Trickle-down proponents argue that a positive feedback loop of lending and borrowing will be facilitated much easier, and consequently prompt even more economic expansion. Ideally, the theory of trickle-down economics incorporated one fundamental assumption, that the distribution ratio of these funds to the society should remain unchanged compared to what was recorded before the implementation of the trickle-down program. This assumption is shown to be the underlying reason to why the concept has failed to materialize, although it had made sense on paper.
Besides the flawed logic of the assumption itself, several questions on how the trickle-down effect in economics has not been effective are also discussed. While the public opinion usually targets the misuse of the funds itself for individual benefits, there is more to that argument. Academic publications of the last century have identified some underlying causes for the downfall of trickle-down economics. In 1997, in their extensive discussion on income inequalities and capital, Aghion and Bolton discovered that the unpredictability and the instability of business investment returns made it extremely difficult for funds to “trickle-down” into the budget of the poor. Additionally, the owners of the projects are also in a vulnerable situation as they usually do not intend to cover themselves and their employees with income risk insurance. Secondly, policies that favored the accumulation of wealth for the rich also contributed to the weakening middle class all over the world, which has been long believed (and scientifically claimed) to be the solid foundation of the strength of one domestic economy. The economic/financial recession that exploded in 2008 dissolved the demographic and even until now, the US economy has yet to return to its prosperity recorded pre-crisis. The Obama administration’s response to that crisis is partly to be blamed as well. The rescue packages that went straight into the hands of corporate owners and bankrupt firms, instead of the middle class, did not aid the process of effectively revamping the economy.
ECONOMISTS’ RESPONSES?
There is a huge obstacle to the advancement of this topic during the early days of economics: the lack of available technological infrastructure to induce a comprehensive statistical report that would serve in defense, or attack, of one theory. Trickle-down economics also suffered the same destiny in the early 20th century. Although there was a nationwide effort of data collection for individual income for the sake of tax reporting, there was yet to be any sufficient academic work on the issue. The dispute could not be debated properly without the collection of large-scale empirical data. It was not until the 1950s that economist Simon Kuznets, famous for his work in his investigation of economic inequality, presented its first valid empirical data to make an argument for such case.
The development of computational technology has allowed more devotion into these kinds of researches of this issue, usually represented as the academic research into income inequality. More recently, in 2015, a collective effort of five IMF economists has declared that the benefits of the trickle-down effect were not observed during periods of less stringent regulations by the government. For example, tax rates for the rich fell drastically, from 70 percentage points to merely 28 percent, under Reaganomics. Under this regime, the US economy suffered from an extended period of stagflation, with absurdly high inflation figures and excessive unemployment across the country. The available funds were definitely not put into productive causes, as there was the increased concentration of public money to defense companies for their own military involvement in the Middle East. The IMF study showed the rising concentration of wealth for the top percentiles would lead to a decrease in GDP growth in the short run, and little improvement in the economic performance in the medium term. Therefore, the “trickle-down”, as inferred from their analyses, would do no good to the general welfare.
If you have ever looked through the detailed discussion of Thomas Piketty in his renowned work “Capital in the Twenty-first Century”, you might have realized the concept of r>g, or alternatively phrased, the rate of return of capital exceeded the growth of the economy. This development, per Piketty, was actually observed even as far back as the 19th century when colonization of European countries started to form all over the world. Major economic powers at that time (Britain, France, the Netherlands, etc.) started to collect “capital income” from their own colonies, but these private benefits were largely grasped by the wealthy society that had the means to establish their influence in its respective colonies. During the globalization era, using the collected statistical data that Piketty assembled, he also believed that this tendency of wealth accumulation had returned, with the “help” of favorable tax policies, and reinforced itself to be inherently dangerous to the social welfare of each citizen.
IS THERE STILL AN OPEN DISCUSSION…?
According to the academic researchers Aghion and Bolton (1997), there might be a hindering prospect for success of the trickle-down effect. Only when the government is equipped enough to establish an institutional framework that would appropriately adjust the system of capital redistribution, as they claimed, the negative impacts from the current trickle-down effect would only be mitigated. Each individual will benefit as a whole, as a result. In their lines of reasoning, this policy proposal would enable more capital to be distributed and accumulated by the working class.
There are definitely some rare occurrences on our planet, however, that show trickle-down economics was somewhat observed throughout the history. As almost all properties were destroyed during the aftermath of the Second World War and everything has to be reinvigorated, capital injection was again utilized to revive the macroeconomic outlook. The published work of Simon Kuznets about inequality in 1953 showed that the trickle-down effect was observed, as inequality shrank and growth blossomed in the 35-year period from 1918. However, the event should not be considered as an empirical validity to the theory. Firstly, the difference, in terms of personal wealth, between social classes was narrowed down as the direct consequence of the destruction of the wars. Private properties were severely damaged, and barely any economic activity could be in operation during the time. The capital distribution, as such, was much more balanced, compared to the economic reform in the Great Depression. It also could be mentioned that since there was much less risk involved in the process of reconstruction rather than involving in new developmental projects, so the distributed funds for the former purpose were indeed inherently much more efficient.
The answer to the question whether there is still an open discussion about trickle-down economics will then be: probably no. Or at least, not compatible with our socio-economic outlook, not just yet.