The Way the World Works: Simplified Jude Wanniski November 23, 1993

As the U.S. and most of the world economy continues to stumble along, the economics professionals and their agents in the financial press are becoming increasingly complex and prolix in their rationales and prescriptions. In trying to explain my own thinking to the political class, I've tried to go in the other direction, simplifying in the extreme. In this simplest of all world economic models, there are only three people: A rich old man; a poor but aspiring young man; and the government. Here's what it is all about:

  The rich old man has capital, but does not wish to work. The poor young man has labor, but no job and no capital. The rich man would invest in the poor man, but the government tax rate on investment income is so high that after considering the risks, the rich man is discouraged. The government comes upon this predicament and decides the poor man has to be sustained, with food, housing and health care, and borrows these from the rich man, giving him a bond and making the transfer. The government deficit increases. The rich man holds debt instead of equity. The young man might go to work, but when he sees that his investment in himself will be taxed at the same discouraging rate if not more, he remains idle, continuing to receive his subsidy. The unemployment rate remains high, and the government is soon faced with the problem of paying interest on the bond held by the rich man. It must either tax the rich man to pay him his interest, which discourages the rich man from buying more bonds from the government, or it borrows the interest from him with a new bond, which increases the deficit, et cetera. The government can also reduce its obligation to the rich man by devaluing the currency, which means it cheats the rich man out of principal. That also discourages the rich man from further investments in government bonds.

  Is this too simple to explain what's happening all over the world? Do you need a more complicated explanation of why government deficits are increasing, interest rates are rising, unemployment rates are climbing? Isn't it enough for you to see that if the government lowers the tax on equity income, the rich old man will invest in the poor young man, buying equity instead of debt. This would tend to drive up the stock market in this three-person economy, and drive down the bond market, since the rich man isn't buying debt. (This is why we're told the bond market doesn't like a strong economy.) But wait, the young, aspiring man now has capital, covering his food, housing and health care. This means the government doesn't have to issue the bond to cover a deficit, and in fact is able to tax the young man, who has chosen to invest in himself by working instead of remaining idle, because the government tax is no longer discouraging. This means the government revenues rise as the deficit falls, and unemployment declines, and stock markets and bond markets rise. The crime rate falls as idle young men are now occupied, getting rich.

Why don't our Nobel Prize winning economists see this? Because the concept of risk-taking does not exist in a demand model, and all our Nobel Prize winners live in a risk-free world, where debt and equity are interchangeable. If this simple world economic model were in place, think of how many economists, lawyers and accountants would be out of business, forced to work for a living. That's why it's all too simple.

COMING ATTRACTION: On or about February 1, Polyconomics will welcome as our new chief economist, Dr. James J. Brzycki (pronounced Brit-ski), who is now chief economist at Northwestern Mutual Life in Milwaukee. It was Brzycki who persuaded NML nine years ago to drop Townsend-Greenspan in favor of Polyconomics (sorry about that Alan). Jim, who is 41, got his Ph.D. at the University of Wisconsin only a year ago, in monetary theory and econometrics, having successfully hidden his supply-side predilections from the faculty. His all-time hero is Knut Wicksell, who is on my list soon after Bob Mundell and Ludwig Von Mises.    (JW)