Overview of Economics Jude Wanniski September 15, 2000

Memo To: Students of Supply-Side University
From: Jude Wanniski
Re: Overview of Economics

Since we began teaching supply-side economics at our virtual university in 1996, the pattern has been to cover three separate areas of political economics over three successive semesters, with the summer session open to all three areas. Last fall, we were in the “politics” area of the cycle. In the spring of this year we covered money and banking. This fall semester will concentrate on fiscal policy and public finance. As an introduction to the cycle, the opening lecture today is more general and is adapted from the opening lecture of the fall 1997 semester. There will be fresh material developed during the course of the semester, but for the most part we will be using edited and amended lectures from previous years.

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Those of you who have participated in SSU lessons through the spring and summer may find yourself going over old material in this fall semester. I’ve decided that a start from scratch would be useful all around, instructive to me as well. By now, you may know that I learned everything I know about economics outside the classroom, as my formal training was in political science and communications. SSU is based on the same peripatetic Socratic principle that gave me my economic education. This fall semester will be one extended conversation, while we stroll through the Internet. For the most part, the lessons will be driven by you, the registered students, asking questions as they occur to you. The first lessons, though, will provide a platform and foundation, so the new students will be able to begin at the beginning, and the sophomores will be able to extend the depth and breadth of their freshmen learning.

Supply-side economics, per se, is not systematically taught at any school of economics in the United States. In a general course of introductory economics, there may be a lesson or part of a lesson devoted to some part of supply theory, but even that is often taken out of context and presented with overtones of eccentricity. It is most frequently identified with cutting taxes and is represented pictorially by the “Laffer Curve,” named after Arthur B. Laffer, who first drew the curve on a napkin, in my presence, in December 1974. We’ll have several sessions on the Laffer Curve this semester, which will concentrate on fiscal policy and public finance. Simply put, it is the law of diminishing returns applied to taxation, graphically described. In the process of writing my book, The Way the World Works, in 1977, I named the curve drawn by Professor Laffer, then of the University of Chicago. In 1975, I applied the term “supply-side economics” to the systematic way of thinking about the world economy that had been taught me by Laffer and his mentor, Robert Mundell, a Canadian who last year (1999) was awarded the Nobel Prize in economics.

There are only two systems of thought at the root of the study of national or international economies and how they interrelate. The systems are branches of this study, known as macroeconomics, the economics of national economies. One begins with the idea that the supplier of goods, i.e, the producer, is the central actor in the economic system. The other begins with the idea that the demander of goods, i.e., the consumer, is the central figure in the economy. In American schools and schools throughout the world which have patterned themselves after American economic curricula, macroeconomic demand theory dominates, almost to the complete exclusion of supply theory.

The two so-called mainstream schools are the demand-side “Keynesian” school, which focuses on fiscal levers to manage the national economy, and the demand-side “monetarist” school, which focuses exclusively on monetary levers to manage the national economy. These schools did not exist prior to the Great Depression of the 1930s but, as we will learn, were conceived and took root out of the failure of classical supply-side economists to explain the Wall Street Crash of 1929 and the Depression which followed. Because government policymakers are most concerned with the management of national or international economies, governments are the main employers of macroeconomists.

Not all economics taught is macro. In fact, most economics taught is microeconomics, or the economics of the enterprise units that together comprise the national economies. It is the economics of the firm, rather than that of the nation, and we do not involve ourselves in microeconomics, except tangentially, because its principles are standard to all schools. At the micro level, there is no need to base a system of thought on either the producer or the consumer, the supplier or the demander. They co-exist in the competition of the marketplace.

At the micro level, for example, the mainstream economic schools explicitly teach the law of diminishing returns in pricing policy, with never a mention of the “Laffer Curve.” If there are two companies selling the exact same product, competition forces them to sell at roughly the same price, or the higher-priced product will lose market share to the lower-priced product. If one company has a monopoly on a product -- a new technology or computer software -- it must make the correct decision on pricing without the direct pressure of competition: If it raises its price, it will sell fewer goods, and potential competitors will soon learn to copy the product in order to sell to those discouraged by the higher-priced monopolist. With this thought, a company might sell its monopoly product at a very low price, to discourage those who might otherwise be thinking of entering the market to get a slice of the action.

The point I’m making here is that the behavior of consumers and producers figure together in the teaching of microeconomics. Alfred Marshall, a famous economist at the turn of the 20th century, described the consumer and producer as the equivalent of blades of a scissors -- they work together. In macroeconomics, there must be a primary focus in approaching the management of a national economy. This is because there are so few competitors when governments are involved. If you are in the market for an automobile and live in a big city, you can select from at least 200 different models and thousands of variations in color, sound systems, etc. There are, though, fewer than 200 nation states on the planet. The United States does not consider more than a few of these as serious competitors in the world of global commerce -- those that have economies as developed as ours. Because all nations regulate their borders in one way or another, it is not as worrisome to the United States that its tax rates -- the price paid for public goods -- might be too high, as it would be to General Motors, or Skippy Peanut Butter. A consumer in a shop easily chooses the next brand if Skippy is too high priced, and auto purchasers ordinarily spend serious time pricing the cars on the market, new or used. Taxpayers, on the other hand, take longer to be so demoralized by oppressive tax rates that they will move themselves and families or companies and flee to another jurisdiction.

Governing and managing a national economy is then a much more difficult task than managing a corporation or firm or shop. The signals that political leaders get from its consumers, the voters or “subjects,” are not interpreted so easily. In the current political season, the Republicans are offering major tax cuts and the Democrats are resisting, saying surplus tax revenues should be used for more public goods for the needy, or to pay down the national debt. If public finance were the only issue on the ballot, it would be easy enough to have the electorate divide on that issue and proceed. But because there are so many other issues of public policy and national security bound up in a national election, it is not so easy to read the political marketplace in order to set tax rates, regulations, tariffs and monetary policies.

Andrew Mellon, who was Treasury Secretary during the Roaring Twenties, once told a committee of Congress that Ford Motors could make the same profit by selling 500 cars at $1 million each, or 5 million at $100 each. It would be much easier to make the 500, wouldn’t it? But Mellon pointed out that the presence of other car makers forces Ford to produce as many as it can for as little as it can. Mellon went on to say that Government has the same problem, and would like to finance itself the easiest way it can, by charging the most for the least. The best check on that excess is to have at least two political parties in competition, one arguing for higher tax rates, the other promising lower tax rates. Just as the voters in the private marketplace for goods will shop around for their best buy, the voters at the ballotbox will similarly make wise decisions. Many may be fooled in both markets by vendors selling lemons or making promises they don’t intend to keep, but there is no real difference in the marketplace for goods and the marketplace for ideas. In the course of this semester, we will specifically discuss the philosophy of markets, a philosophy that has been developing rapidly in the past several decades.

Because we are in the realm of political economy, and because politicians are as eager to sell their goods as salesmen in the car market, there is a lot of noise about which brand is better than the other. Because of the political failures associated with certain applications of demand-side policies for the past 30 years, demand-side economists have scrambled to persuade the voters that the Reagan supply-side tax cuts are responsible for the federal deficits that followed, and that the tax increases of George Bush and Bill Clinton are the reason the economy is doing better today. Alas, the demand-side economists must then also argue that the political marketplace is inefficient, in that Reagan was elected by landslide proportions in promising lower tax rates, while Bush was turned out of office after he broke his promise not to raise taxes. In his recent celebrations of the economic good times, the President cites the 1993 tax increases which he pushed through with no Republican votes as the source of the national prosperity. He seems to forget that after he had campaigned in 1992 promising a middle-class tax cut and instead delivered a 1993 tax increase, the voters in 1994 gave Republicans control of Congress for the first time in 40 years. There are times when tax increases finance public spending which the market calculates will produce positive returns. Supply-side economics does not mean “tax cuts,” any more than the demand schools represent “tax increases.” The purpose of a political system is to allow all of society a way to determine the level of public goods it wishes and how it should assess members of society in financing those goods.

It is not the purpose of this course in supply-side economics to knock demand-side economics. You will find SSUniversity is as much about politics as about economics, but do not worry that you will get “Republican” politics here. President John F. Kennedy learned his economics in a supply model, which was still being taught when he was a boy. Kennedy was clearly supply-side in his economic thinking, far more so than Richard Nixon, who was easily led to the demand-side policies that undermined the economy and his administration in the early 1970s. The late economist Norman Ture, who died in 1997 at age 74, was the man who wrote the speech that introduced the Kennedy tax cuts to Congress in 1963, a speech thoroughly couched in the supply framework. Ture was also the Undersecretary for Tax Policy in the Reagan administration, using precisely the same analytic model he used as an assistant to Chairman Wilbur Mills of the House Ways&Means Committee in 1963. He is the one economist who bridged the Kennedy and Reagan administrations. Ronald Reagan, a Democrat in his youth, studied classical economics at Eureka College, Illinois, where he got a B.A. in economics in 1932. Classical economics then had no trouble in identifying the producer of goods as more important than the consumer, as goods must be produced before they can be consumed. There is no chicken and egg problem here.

In fact, when the focus is put on the producer of goods, the study of the creation of wealth spans the work of Adam Smith and Karl Marx and everyone in between. The production paradigm was at the center of Smith’s “Wealth of Nations” and of Marx’s “Capital.” As noted, classical theory broke down and became politically unpopular when it could not explain the Wall Street Crash of 1929 and the Great Depression that followed. The explanation I have offered since 1977, when I discovered it while researching my book, The Way the World Works, had not occurred to the economists of 1929-30. Nor did it occur to President Herbert Hoover, who was partly responsible for the mistake that caused the Crash. We can excuse Hoover and the economists of the time because the philosophy of markets had not yet developed to the point where it was obvious to anyone that the Smoot-Hawley Tariff Act of 1930 could cause the Wall Street Crash of October 1929. In the weeks ahead, we will learn how events that may occur next year will influence the course of the stock market today.

There is no tuition at SSU, although some day their may be, if we get to a point where the classes are large enough to engage guest lecturers who will wish to be paid. On the Internet, the sky is the limit. We had 98 registered students for the fall semester of 1997 and now have almost 2000. For myself, I’m prepared to share what I know with you at no charge, just as I learned what I know about the way the world works from men who asked for nothing in return, except for my curiosity and attention. My guess is that there will be young men and women who will be so interested and become so inspired by these web lectures and exchanges that they will branch out on their own. There are already young Ph.D. economists trained in the demand model who we see drifting toward our model to size it up. It is not realistic to imagine that an idea as successful as the renaissance of classical economics via the supply-side revolution will be ignored by the academics much longer. Professors of economics want their students to be able to go out into the world and perform useful services, for which they will be paid a living wage. These lessons here are not meant to provide a formal education, but rather to provoke discussion among those who would like to learn for the sake of learning.

For those of you who are serious about learning at SSU, a reading of The Way the World Works is essential. In the recent summer session, I’m afraid I became impatient with a number of students who were bombarding me with simple questions they would never have had to ask if they had taken the trouble to read TWTWW. I encouraged them to hie themselves to the public library and read the book, and then come back with questions they could not answer themselves. If you plan to return each weekend to study the lesson, you really should have a paperback copy of the book, the Fourth Edition of which is available at Amazon.com or through the form we provide at the link at the top of this home page. There are many other books I will be suggesting to you during this semester and in the spring semester that follows. It will not be necessary to acquire or read any of them, including mine, to benefit from the exchanges we will have here. You are free to proceed at your own pace and level of commitment. I will not grade you or test you, although from time to time I will ask you to comment upon some economic debate that we will find in the news media. It may hold special interest because we are going into national elections with raging partisan debates over the very issues we will discuss here. If you have or are in the process of obtaining a formal education in economics or business finance, what you learn here will add a dimension I can practically assure you will stimulate your success -- as it has mine.