Trickle-Down Economy

2020 Tesla Roadster starting at $200,000

I love our trickle-down economy. Meaning, in our economy good things start at the top and trickle down to the bottom surprisingly fast. But before going any further, we have to talk about “trickle down theory” which is quite a different animal.

From time to time, proponents of cuts in tax rates argue that that would cause changes in economic behavior which would increase investments leading to increased employment, incomes and consequently greater total tax revenues. Therefore, cutting tax rates actually benefit the poor since the increase in tax revenues can be used for more social services.

Opponents of tax cuts push back saying that tax cuts merely benefit the already rich, and therefore it is like feeding the horse a lot of oats in the expectation that some of it would pass through and benefit sparrows.

Thomas Sowell has done a thorough debunking of the arguments of the opponents lower tax rates in his short monograph “Trickle Down” Theory and “Tax Cuts for the Rich”  (pdf) which I recommend without reservations.

With that taken care of, let me explain what I mean by “trickle-down economy.” The simple claim is that every innovation is made for the wealthy and initially only the wealthy benefit from them. Then in due course the innovations reach everyone in society.

Mobile phone evolution

Let’s take the most obvious example — the mobile phone. It was definitely not developed for the woman selling vegetables out of a cart in a little town in rural India. Mobile phones were meant for the rich and powerful in the US. They were huge, cost a bomb, did nothing but make expensive phone calls, and weighed a ton. Well, not literally a ton but the first Motorola model weighed 2 kilos (4.4 lbs). You got a reasonable workout carrying one around.

This is true for practically everything that is commonplace today — cars, computers, TVs, VCRs, cameras, laser gizmos, commercial aviation, the internet, synthetic fibers, and so on. They were all developed for the benefit of well-heeled people, and with time they trickled down to the unwashed masses.

A recent example comes from Tesla. The first Tesla car, the Roadster first introduced in 2006 had a base price of $80,000 to $120,000— but even that did not entirely cover production costs. Gradually, the cost came down (more about that in a bit) and the price was sufficient to yield profits.

The Tesla Model Y, first delivered in 2020, has a base price between $43,000 and $64,000. The trend is unmistakable: costs and therefore prices have decreased. And the volume of production has increased. Here are some numbers (source.)

      • Tesla has sold 473,136 electric cars in the first 8 months of 2021. More than any other electric vehicle manufacturer worldwide.
      • Since 2009, Tesla has produced a total of 1.91 million vehicles.
      • Tesla has manufactured 386,759 vehicles in the first two quarters of 2021 alone.
      • Tesla’s revenue in Q1 + Q2 2021 was $22.35 billion.
      • 70,757 employees work at Tesla worldwide.

There are three main reasons for the falling costs and prices. First, technology gets better with time. The components — batteries, electric motors, etc., in the case of electric vehicles — get cheaper and better. The second reason is the phenomenon called “learning by doing.” The 10,000th car produced takes less effort than the 1st car; the 1000th Boeing 747 took significantly less time to build than the first. And finally there’s the “increasing returns to scale”: the per unit cost decreases as the production size increases.

There’s positive feedback in manufacturing processes. Technological improvements speed up as the stock of already existing technology increases. The increasing returns to scale support lower prices that allow the market to grow because more people can afford to buy the product, and increasing sales increase learning by doing.

The basic lesson here is that things begin as luxuries because they are costly to produce and only the wealthy can be the early customers. The cost of development and manufacturing are heavily front-loaded. You have to pay for the production facilities up front before producing even one unit. In the initial stages, these costs have to be recovered through high prices. In effect, the very wealthy prime the pump for all the subsequent benefits that accrue to the not-rich, and eventually even the very poor get in on the act.

Today, a brief ride into “space” on Virgin Galactic costs around $450,000 — something that only a few thousand people can afford. But it won’t be long before prices fall and a few million people will be able to take joy rides to low earth orbit. Without the super-rich funding the development of technology and production capacity, the world would be significantly poorer.

All the bitching and moaning about inequality is really rather stupid. Inequality in itself is not the problem. There will always be rich and poor people because rich and poor are relative concepts. The problem is poverty, and poverty can be defined in absolute terms. You can easily have an extremely unequal world without any poverty, just as you can have an extremely equal world with everyone suffering extreme poverty.

Fortunately, world poverty has been steadily declining, especially in the last few decades. It won’t be long before even the poorest regions of the world would have no poverty. That’s certain to happen.

But it is also absolutely certain that inequality will grow as the world as a whole gets richer. Inequality is a feature of our modern world, not a bug. It’s that feature that allows the world to get richer in the first place. If the world did not have extremely wealthy people, the world would not have had the capacity to fund the early stages of the kinds of stuff that make our lives better.

Thank goodness that there are billionaires who can afford fancy stuff because eventually all of us benefit from their investments.

Author: Atanu Dey


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