Whose Side? Supply Side!

In the last post, I touched on supply-side, or "trickle-down" economics. I noted that the fact that both the Great Depression of the 1930s, and the Great Recession of 2008-09 were caused by asset bubbles that imploded the "top" of the economy - the higher-paying jobs in the financial and other sectors. That resulted in a "trickle-down" (or, more accurately in the case of those downturns, a cascade down) effect that took out the "bottom" of the economy - the relatively lower-paying jobs in the service sector. Those jobs depend on spending by those higher up on the economic ladder to sustain those service businesses. In turn, the employment provided in the service sector creates the ability for all participants in the economy to have funds available for discretionary spending (depending on how well they manage their finances, at all levels regardless of income).

This illustrates that supply-side, or "trickle-down" economics does indeed work as stated. However, there are many detractors who claim it's a farce, a hoax, a myth, that it doesn't work. Unfortunately, the vast majority of those folks don't really understand economics, and the detractors who do are big-government politicians and policy wonks trying to gin up the folks who don't understand it, so they'll be opposed to any politician who supports it. Those politicians and the folks who, unfortunately, believe them, would rather deploy big-government social programming.

The fundamental premise of supply-side economics is that if you apply stimulus to the supply side of the economy - the side where jobs are created and goods are produced - that will eventually "trickle down" to the lower end of the economy. A simple example is a cut in the corporate tax rate that allows companies to price more competitively. That stimulates demand, and those companies then have to hire more workers to keep up with the demand, which creates jobs, which provide income, which stimulates further demand, etc.

The detractors make the usual tired claim that if you cut the corporate tax rate, the tax expense savings just wind up in the executives' pockets. This is a liberal myth, though there may be some indirect truth. Those executives have no incentive to just pocket the savings and do nothing to grow the companies' revenue. However, they probably have stock options that result in increased personal income if they do things to drive the stock price higher, and then exercise those options at a gain. And to drive the stock price higher, they generally have to increase net income, which means working harder and smarter to expand market share, increase revenue, etc. So to the extent they use the tax savings to grow revenue, market share, etc., they may indeed be compensated for that, on a performance basis.

President Reagan was a strong proponent of supply-side economics, as was Dr. Art Laffer, one of Reagan's top economic advisers and one of the great economic minds of our time. At some point, some bright aide probably got the idea that voters couldn't grasp what "supply-side" economics meant, and coined the term "trickle-down" economics to make it more understandable to the public at large.

That actually had the opposite effect. People thought they understood what it meant, but they didn't. They expected it to do something it was never intended to do, and when it didn't do that, they grumbled that it was a myth. Also, opposing politicians had a field day with the "trickle-down" term, and used it to derisively oppose supply-side economics in favor of policies that would stimulate the demand side (such as the recent government handout of $1,200 per person, whether the recipient's income had been affected by the COVID-19 shutdown or not).

So what, you ask, do these detractors expect "trickle-down" economics to do? They expect it to eradicate income inequality. And because income inequality still exists - and by some measures is increasing - they blindly assume cause and effect, and assert that as proof that "trickle-down" economics doesn't work. They're wrong.

I'm not going to go into a treatise of the various causes of income inequality, other than to make a couple of points. First - I'll pick on Apple CEO Tim Cook here - if Apple's board believes that Tim Cook brings at least $3 million in value to Apple's shareholders, then he's "worth it." (His salary last year was $3 million, and he earned another $7.6 million in incentive-based pay - meaning he either met and exceeded bonus targets, or he drove the stock price higher and profited from exercising options, or both.)

Apple's stock price doubled in 2019. Based on the number of shares outstanding, that means the value of its shareholders' aggregate investment increased by more than $650 billion. It employs nearly 140,000 people. It created 7,000 jobs in 2019, a 5% increase in its workforce. Its total payroll expense is in the billions of dollars. It provides many more thousands of jobs for its suppliers and manufacturers of accessories. So a lot of workers benefited from Apple's growth.

If I represented Apple's shareholders, and Tim Cook came to me and said, "I can increase your aggregate wealth by $650 billion, but it'll cost you a cool $3 million just to take a chance on me - and if I hit that target, I'll want another $7.6 million" - I'd make that trade every day. Especially if his strategy and execution also created thousands of jobs and spawned additional business formation that also created jobs - all of which trickles down as those new employees spend money in the service sector, pay taxes, etc.

The detractors, of course, will deride the "fat-cat" shareholders. Guess what? If you have an IRA or a 401(k), there's a very good chance you own Apple stock, through mutual funds or exchange-traded funds (ETFs) in your account. Apple's largest shareholder isn't some evil rich guy, it's The Vanguard Group, which is the market leader in passive index ETFs. Those funds buy the stocks that are components of underlying indices like the Dow Jones Industrial Average or the S&P 500, and are used by vast numbers of investors to passively invest in the broader markets without making bets on individual stocks.

In fact, 9 of Apple's 10 largest shareholders are mutual fund companies (the 10th is Warren Buffett's Berkshire Hathaway holding company, which is arguably a mutual fund itself). Vanguard manages 5 of the 10 largest mutual fund holders of Apple stock; its aggregate share of the Apple pie (pun intended) is about 7.4%. That's more than $80 billion of Apple stock - directly owned by Vanguard, but indirectly by you, me and a lot of other retirement savers. We doubled our money on Apple in one year. That doesn't happen often.

The most profoundly immutable law of economics is the law of supply and demand. And given the results Tim Cook has delivered at Apple, if its board suddenly went woke and told Cook he's only worth $500,000 (still too much for some of the income equality crowd), Samsung or another competitor would snatch him up in a Silicon Valley minute. The market price of anything is whatever the next person is willing to pay for it - supply and demand. That and that alone determines private-sector compensation, as the laws of supply and demand apply equally to talent.

Here's an example. Early in my career, I worked for a large savings and loan association that had an incredibly complex investment portfolio. We employed a number of Ivy League MBAs and engineering PhDs to help manage and analyze the portfolio. (I hold an MBA degree, but from a small Midwestern state university - far from Ivy League. That job provided my real education in the investment world.) We had developed a fairly extensive library of research materials - this was before the internet really took off - and our Vice Chairman, himself a Wall Street alumnus and U. of Chicago Finance PhD holder - wanted to hire a librarian to manage it.

I was on a committee that graded jobs for purposes of pay ranges. We used a vendor-supplied system to do that. As we were grading out the Research Librarian job, which required a Masters' degree in Library Science, someone on the committee asked whether that degree was to be valued the same as an MBA. The head of HR said yes. The Chief Marketing Officer and I nearly fell out of our chairs.

As we explained to the committee, based on the laws of supply and demand, there just aren't as many jobs that require an MLS degree as an MBA. MBAs, being higher in demand, command greater compensation. And if the two degrees held equal value, there would be a mass exodus out of relatively more difficult MBA programs, and into MLS programs, which, in the days before the internet, big data and data mining, were a whole lot easier to complete.

(No disrespect to librarians intended; these are just the facts. If you're looking at grad school and are undecided between an MLS and an MBA, and it's money you're after, pick the MBA. But if your passion is to be a librarian, choose the MLS degree - your earnings will be lower than, say, a portfolio manager's, but the most important thing is to love what you do.)

Look, the reality is that there are a lot fewer people who can successfully run a company like Apple than there are people who are qualified to flip burgers. So supply and demand, as well as performance and results, are going to dictate that Apple's CEO will make more than a burger-flipper at McDonald's. Yes, the economy needs both. No, they shouldn't receive the same pay, unless McDonald's believes a lone burger-flipper can add $650 billion to the firm's market capitalization.

Income equality was never promised as part of the American Dream. Opportunity equality was. What each individual does with that opportunity is what determines their income potential, by and large. Not everybody has the ability to be a Tim Cook. But an awful lot of people do, if they put in the work to get where he's gotten. The business world abounds with rags-to-riches stories like that of Sam Walton, who built the Wal-Mart empire. There are also a lot of near-rags-to-success stories, like my own. To be sure, there are some who do not have equal opportunity, and I'm all for addressing that. Opportunity is the most valuable commodity a society can offer. But that isn't related to supply-side economics, nor does it (nor should it, nor can it) bring the promise of income equality. The system isn't perfect in terms of opportunity equality, but it's pretty darn good.

Those who argue for income equality can never achieve what they really want. What they want is for the Tim Cooks of the world to have their pay capped at a level low enough that their own compensation can be raised to match his. Their premise is that everybody would be equally compensated, and at a pretty high level.

Not only would the math not work, but it wouldn't work economically, either. The Tim Cooks would find some country that didn't enforce such policies and run a business there - or move Apple's headquarters offshore. The U.S. economy would be decimated from companies leaving our borders. Corporate tax rates would shoot up for small businesses in an effort to make up the lost tax revenue from larger corporations, and unemployment would go through the roof. And the supply of available burger-flippers would suddenly skyrocket.

The only true path to income equality is through a totalitarian regime, either Socialist or Communist. That's happened before. However, instead of providing equal prosperity, those regimes have produced equal poverty, as the powers that be at the top of the regime enrich themselves far beyond anything Tim Cook could imagine and leave the crumbs for their subjects. In fact, those regimes tend to have much higher income inequality than free-market democratic republics.

They also carry carry nasty side benefits like pogroms and ethnic cleansing and imprisonment (or worse) for exercising rights we all take for granted, like free speech, freedom of religion, liberty, and the pursuit of happiness. Be careful what you wish for.