Trickle-Down Theory – Economic Theory or Political Straw Man?

▪ Trickle-down theory

Trickle-down theory, or trickle-down economics, is a term for the idea that when more money is given to the rich or less is taken from them in taxes, their wealth will somehow trickle-down onto the poor and improving their lives. However, there is a problem with the trickle-down theory. It doesn’t exist and never has. There is no economic theory called the Trickle-down theory, and no economist has ever postulated such solutions. The trickle-down theory is a populist political buzzword used by opponents of economic freedom to ridicule the opposing party’s demands and avoid discussing the merits. It is a straw man fallacy, a logical fallacy of giving the impression that you are refuting an opponent’s argument in a discussion, when in fact you are refuting a twisted or exaggerated version of it. You build your own weakened version of the opponent’s argument – the so-called straw man – after which you attack and overthrow it.

The economist Thomas Sowell challenged anyone to name a single economist from any school of economics who actually advocated the “trickle-down theory.” After a year, when no one could point out such a name, he wrote:

“A year ago this column defied anyone to quote any economist — in government, academia, or anywhere else outside an insane asylum — who had ever argued in favor of a “trickle down theory.”

Many people quoted David Stockman as saying that others had made that argument. But David Stockman was not even among the first thousand people to make that claim. What is crucial is that not one of those who made the claim could provide a single quote from anybody who had advocated a “trickle-down theory”.1

▪ “Giving” to the rich

No proponent of economic freedom argues that you should “give” something to anyone by coercion, but let’s assume for a moment that this is the case. If there really was an idea to help the poor by giving to the rich, the obvious question immediately springs to mind: What would be the purpose for these kind of combinations? First of all, this money should first be taken away from all taxpayers (including the poor, because if it were taken only from the rich and then returned to them, there would be no question of “giving”), then it should be given to the rich only to be partially recieved by the poor. This very twisted line of reasoning cannot be logically justified. If advocates of a free-market economy would like to help the poor by giving them money, why would they resort to such a roundabout way of giving money to the rich first in the hope that some of it will go to the poor instead of bypassing the middleman and giving the money to the poor directly?

Economic freedom is based on voluntary relations. The only time a rich man “gets” something in the market is when he offers someone a good he wants, and the person who wants that good pays for it. Among supporters of economic freedom, there is a sharp and determined opposition to special privileges for any group and regulatory barriers that make it difficult or impossible to compete with large economic entities for market position. There is opposition to bailing-out failing enterprises with taxpayers’ money or subsidizing the activities of selected entities. The market economy is not for the rich, but for the consumers, that is, for all of us. No supporter of it will miss a corporation that has lost its market share as a result of competition to small but numerous innovators who better meet the needs of the consumer (that is, ours) and use scarce resources more efficiently.

What the supporters of economic freedom postulate is to enable people to get rich through the voluntary exchange of value for value, regardless of the level from which they start, providing them with the protection of property rights and other individual rights necessary to achieve this goal, while maintaining the principle of equality before the law. Here we come to the crux of the matter: economic freedom is not about giving money to other groups of people than previously, but about removing barriers that prevent or hinder people from earning money and spending it according to their preferences. Opponents of economic freedom try to reduce the discussion to the argument: “we want to give to the poor and they want to give to the rich, and they try to convince us that the poor will benefit from it.” In fact, however, the dispute is on the line of “voluntarism vs. coercion”.

▪ “Giving” through tax cuts

It should be emphasized that the tax cut is not a gift. To say that a tax cut is a kind of grant would mean that all money people earn belongs to the government by default, and that any tax cut is merely an agreement for people to keep government money. In fact, it’s exactly the opposite. The money implicitly belongs to the people who earned it and the tax cut is to leave more of their money in their pockets. Another thing is that the proponents of economic freedom are not calling for tax cuts only for the rich, but for everyone. If there is still a belief that they are “advocates of the rich”, then let the remedy for this claim be the words of Ludwig von Mises:

“Those fighting for free enterprise and free competition do not defend the interests of those rich today. They want a free hand left to unknown men who will be the entrepreneurs of tomorrow and whose ingenuity will make the life of coming generations more agreeable”2

It should be noted, however, that the fact that advocates of economic freedom are not “advocates” for the rich does not mean that they are “advocates” for the poor. If such an analogy could be used, they should be called “advocates” of consumers (all of us – it is worth emphasizing this at every step) and the greatest possible efficiency in meeting their needs. The way to this goal – the goal of subjecting the economy to the effective satisfaction of consumer needs – is the aforementioned freedom of action and minimization of coercion, including tax coercion. Low taxes – the ability to keep more of the money you earn – is the best incentive to work hard and take risks. Another positive effect of lower tax rates is greater accumulation of capital, which is the basis for investment. By no means is this capital only for the rich. It serves every person who has an idea for a profitable investment and is ready to take risks. He no longer has to accumulate capital on his own for many years. He can borrow it from the people who have accumulated it.

▪ Trickleling-down wealth

As we mentioned in the introduction, there is no economist who would postulate a ” trickle-down theory”, because there is no such theory. Merely calling it a “straw man”, without explaining what the supporters of economic freedom really postulate, would be an answer as poor as the accusation. We have already rejected accusations of wanting to “give” money to the rich and have made it clear that the tax cut is not a gift. Now let’s deal with the very concept of “trickeling-down”.

The point on which to object at the outset is how people are divided into “classes” of poor and rich, which are set in stone. Of course, we will not deny the fact that there are people who have much more wealth than other people – this is indisputable. It is not a problem to state this fact. The problem is the suggestion that this state of affairs is permanent and predetermined. It is suggested that, as in a caste society, roles in society are fixed once and for all. If someone is poor, they will remain poor and the only thing they can count on is the “trickle-down” of wealth from the table of the rich. On the other hand, if someone is rich, he will remain so regardless of everything, and possibly, through his own inattention, he will “lose” something of his wealth to the poor. This creates the impression of a “class struggle”, a great conflict between two groups with conflicting interests. Such a picture of the world is false for at least two reasons.

The first is that in a market economy roles are not defined once and for all. People can act freely and their material status will depend on their actions. It is probable that both the poor will get rich and the rich will lose their wealth (and one does not have to lose for the other to gain). Everyone has a chance to get rich and his current financial status does not determine tomorrow’s. The amount of capital accumulated so far does not guarantee success on the market, just as its lack does not determine failure. Past successes do not matter. Entrepreneurship is of key importance – action focused on an uncertain future. Before it, all are equal, for no one has knowledge of future events. You hear a lot about the richest 1%, but rarely remember that there is a rotation at the top. The proof of this is the fact that nearly 70% of people from the list of the 400 richest American businessmen, prepared by Forbes magazine in 2014, made their fortune on their own, i.e. they did not inherit it from their rich parents.3

The second reason is that the interests of the rich and the poor are not in conflict. The market is not a zero-sum game. There is no one, established centuries ago, amount of wealth to be divided, as the popular myth says. The easiest way to find out is to trace the world’s real GDP per capita (PPP) from 1600 to 2008. The enormous gains in new value in the economy since the industrial revolution finally dispel this myth. This is particularly evident in the countries of the Occident, where the principles of market economy were adopted the fastest and most consistently.

No wonder people who believe in a fixed amount of wealth to distribute speak of “class warfare.” Indeed, if the amount of wealth could not increase, the only way someone could have more of it would be to take it from someone else or wait for it to “trickle-down”. In such a situation, the enrichment of one would be at the expense of the other. It would then be legitimate to worry about the disproportionate distribution of wealth in society. However, this situation does not occur in the real world. The amount of wealth is not constant, and getting rich for one person does not mean that another will fall into poverty. It’s quite the opposite. We will support this with further data, this time on people living in extreme poverty. As we can see in the chart below, despite constant media reports that the rich are getting richer, the level of poverty in the world continues to decrease. In 1820, those living on less than $2 a day accounted for a staggering 94% of the world’s population. At the time the chart was created, it was projected that in 2015, those living on less than $1.9 a day would account for 9.6%.

A more recent chart, which sets the extreme poverty line at $2.15, shows that in 2019 only 8.44% of the world’s population lives in extreme poverty. Too many? Sure, anything above 0% is too much, but it’s a process that won’t happen overnight. However, it is worth noting what has already been achieved and that we are moving in the right direction very quickly. However, one could undermine this data by saying that it is only a relative approach. The percentage of the poor may decrease, but they may increase in number, as the world population is still growing. This is also not the case, as the chart below shows. This was the case until the 1970s, but since the 1970s the number of poor people has also been declining in absolute terms. As we mentioned earlier, this is a process and it is going in the right direction.

The only way to get rich in an unregulated market is to efficiently meet the needs of consumers and thus raise their standard of living. The profit achieved proves the creation of new value for consumers; about the efficient use of scarce resources. It doesn’t require further proof. To understand the role of the for-profit entrepreneur, all you have to do is look around the room you are in and ask yourself: How much of the things I see have I produced myself? How much time and resources would it take to produce them if I had to do it myself now? Was I forced to buy them, or were they desired by me?

So the postulate is simple: let people get rich by serving one another. This requires freedom of action.

▪ Let’s not forget about work

It would seem, however, that talking about the entrepreneur-consumer relationship so far, we forget about the important issue of employment. After all, the more common reason for opposing free enterprise is not “care” for the consumer, but for the employee (even though it is one and the same person). Perhaps its opponents even admit that the needs of the consumer are better met than if the economy were run by bureaucratic methods, but their objection is raised by profit, which the owner of the enterprise dares to keep for himself instead of giving it entirely to his employees or spending it on consumption to “stimulate the economy”.

In fact, wages are not arbitrarily set by the employer or by the invisible hand of the market. It is determined by the visible hand of the consumer who reaches for this or that product. The problem of low wages does not result from the situation of competing entrepreneurs who want to pay their employees as little as possible. Competition for employees on the market has the opposite effect – it raises wages. If anything, the problem stems from the “greed” of consumers who demand the highest quality for the lowest price. The entrepreneur cannot afford charity at the expense of consumers. Technically, of course, he can, but then he will quickly lose his livelihood. 4 (on the page we provide links to two interesting examples of this) We will not find a better explanation of this fact than in Ludwig von Mises, who wrote:

“The real bosses, in the capitalist system of market economy, are the consumers. They, by their buying and by their abstention from buying; decide who should own the capital and run the plants. They determine what should be produced and in what quantity and quality. Their attitudes result either in profit or in loss for the enterpriser. They make poor men rich and rich men poor. They are no easy
bosses. They are full of whims and fancies, changeable and unpredictable. They do not care a whit for past merit. As soon as something is offered to them that they like better or that is cheaper, they desert their old purveyors. With them nothing counts more than their own satisfaction. They
bother neither about the vested interests of capitalists nor about the fate of the workers who lose their jobs if as consumers they no longer buy what they used to buy.5

Thus, by criticizing entrepreneurs for “too low” wages, one directs one’s criticism in the wrong direction. In principle, anyone who laments low wages should direct this criticism at himself as a consumer who cares for nothing but his needs when shopping. If the entrepreneur spent all his profit on salaries, he would not even be able to replace the capital, let alone reinvest to increase productivity, to even better match the demands of the consumer.

On “too low” wages…

One would expect that with such huge increases in the world’s population, as seen in the chart below, and the continuous automation of production processes, wages would fall and unemployment would skyrocket.

However, it’s not the case. In the long run, real wages are rising all over the world, even though this is not the purpose of entrepreneurs, nor is it the result of consumers overpaying for the goods they buy. In the charts below, we see an increase in real wages on the example of unskilled construction workers. Here again, special attention should be paid to developed countries, where these increases are particularly spectacular.

In the next chart, we see the distribution of income in the world in 1820, 1970 and 2000. Just as in 1820 the vast majority of people lived in extreme poverty, achieving incomes similar to those in today’s poorest African countries, so in 2000 the “hump” of the graph moves 6to the right which illustrates the increase in the income of this majority.

Globally, the unemployment rate has fluctuated between 5-6% since the 1990s with an exceptional jump during lockdowns from 2020.

And this is the employment situation in the United States in a much longer period. Here, too, despite large fluctuations related to recessions, we do not see a worryingly high unemployment rate at the current (still falling) level of 3.4%.

One can complain that creative destruction eliminates some jobs. It is regrettable that there are situations in which a man who has worked all his life in one place is suddenly replaced by a machine. This can be a big problem for him. However, new, often better paid and more productive jobs are created to replace them. If we were consistent in protecting jobs from technology, we’d still be driving carriages and having our wheels repaired by a wheelmaker. In order to communicate something to others, we would have to go to the town crier. If we were to visit a bowling alley, we would have to spend a lot more time there waiting for our pinsetters to set the pins, a profession that existed before this activity was automated. In fact, without technology, it would be quite likely that we would still be among the 94% of people living in extreme poverty.

▪ Summary

Thanks to the accumulation of capital and entrepreneurial action, we live in times of unprecedented prosperity in the scale of history. After more than 200 years of rapid development, automation and massive population growth, unemployment is relatively low, real wages are rising in the long term, and prosperity is increasing for all.

As humanity, we have freed ourselves from doing many boring, routine activities that no one would want to do today. Anyone who sees this enormous material progress as evil should be labeled an enemy of civilization. Despite still many barriers to free enterprise, everyone has a chance to improve their fate. This should not be taken lightly, as not all generations have had this privilege. Still striving for greater freedom of action, it is worth appreciating the present times and realizing that we could have been born in much worse.

We do not owe all this to the absurd and non-existent “trickle-down theory”. We owe this to centuries of accumulation of capital and the use of the available freedom to dispose of it for building prosperity from the bottom-up, through participation in the division of labor and the exchange of value for value. Realizing that there is still much to be done, because we still see the possibility of improving the current situation, all that remains is to continue this work and oppose the tendencies that want to thwart this effort. And what can spoil it is a topic that we will cover in the next episode, so subscribe, click the bell and watch the notifications, because it will appear soon.

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