James Faulkner on the “trickle down” myth

When I tuned into The Super Rich and Us on BBC2 last week, I wasn’t surprised to see Jacques Peretti deriding the apparent evils of economic inequality. I was a little disappointed however that he didn’t have anything constructive to add to the argument. The whole programme seemed to be premised on an (unsubstantiated) assumption that the prevailing mantra among liberal economic circles is a “trickle-down” theory, whereby the poor become better off by allowing the rich to become richer (through lower taxes). Further to this, it is assumed that it is through consumption and spending that this “trickle-down” mechanism is purported to work.

First, let us examine the so-called trickle-down theory itself. In fact, the earliest recorded use of the term is attributed to social commentator Will Rogers, who said of the New Deal – a Keynesian economic undertaking to put people back to work through state-sponsored enterprises – that “money was all appropriated for the top in hopes that it would trickle down to the needy.” As economist Thomas Sowell explains, no economist has ever advocated a “trickle-down” theory of economics – a fact that Peretti negligently (or wilfully) glosses over. The term “trickle-down” itself is in fact a pejorative misnomer thrown around usually by left-wing commentators at policies they either intentionally distort or misunderstand.

And that brings us to the next point.

Peretti assumes that liberal economists believe that it is through spending money and consuming more that the wealth of the rich benefits the poorer folk in society. This is wrong on a number of levels. For starters, let’s try to apply a bit of good old common-sense. “Why”, Sowell asks, “would anyone advocate that we “give” something to A in hopes that it would trickle down to B? Why in the world would any sane person not give it to B and cut out the middleman?” So why is it that politicians are so bent on making the rich richer? Are they simply dancing to the tune of their capitalist puppet-masters? Or is there something a little more subtle at play here?

The reality is that in a market economy people generally become rich by building a successful business. In doing so, the business owner has proven him/herself to be an efficient allocator of capital. This in turn will lead to more capital flowing that person’s way – through dividends, loans to start new businesses etc. It is in the interest of the wider public that the person in question be endowed with high levels of resources at their disposal vis-a-vis the rest of us, as they are able to add a high level of value to the economy as a whole through their economic activities.

Through doing things better and/or more efficiently, the businesses created by these capital allocators benefit us all, by producing more goods and services we want, at a lower cost. Herein lies the cornerstone of liberal economic theory: capital is better allocated by individuals than by the state. Don’t believe me? Just take a look at China, a country where the shift from a centrally planned to a market based economy has lifted more than 500 million people out of poverty since 1978, according to the World Bank. A by-product of that process has been a massive increase in Chinese millionaires and billionaires.

The idea that we are all worse off because the rich aren’t spending enough of their money to ‘trickle-down’ to the rest of us is preposterous. It stems from the poisonous assumption that consumption = good; and savings/investment = bad. Consumption that is not backed by saving & investment is akin to eating one’s seedcorn. Of course, we would all like to consume more, but if that consumption is based on eating into the capital stock – as would be the case with a wealth tax – then we will all be worse off in the long run.