To: Students of Supply-Side University
From: Jude Wanniski
Re: The General Concept
Welcome to Supply-Side University, new students and old, for this first lesson of the fall semester. This is the 16th full semester of this experiment in virtual classes, which began the spring of 1997. Those of you who have poked your noses in just to see what is going on are welcome to take a seat and audit the course. There are no examinations, so you don't have to worry about flunking. You don't even have to identify yourself, although if you do "register" for the semester, you will automatically receive the lesson instead of having to remember to link to the website every Friday. Each lesson runs from Friday to Monday, which gives you plenty of time to fit the lesson into your weekend plans. And if you miss one or more, you can catch up, as the lessons are archived in the University library.
Registering also will entitle you to receive special items from time to time that will not appear on this website -- including occasional letters we send our clients in the financial community. Since 1978, when I founded Polyconomics, we have used our distinctive supply model to advise the major institutional investors of the United States. I encourage you to forward this lesson to friends and associates who you think might benefit from SSU and suggest they register for these free lessons.
The success of the model as a forecasting tool has meant success for Polyconomics and our clients. We now have more than 150 clients who are managing assets aggregating more than $5 trillion -- including major money-center banks, pension funds, and asset management departments of the Wall Street brokerage firms.
There is today almost no market on Wall Street for Ph.D. economists in the United States because the material they learn is being taught by tenured professors trained in obsolete demand theory that has no forecasting power. The American Economics Association now actually is trying to promote the idea that economists should not be expected to forecast, but simply to explain the past. As you can imagine, businessmen who only are interested in the future have no need to be told by professional economists why they lost money last year. If you take these lessons seriously, you will learn enough about the way the world works to make more efficient use of your own capital -- your time, energy, and basic talent. You also will find these lessons enjoyable, because they will make sense to you far more than the charts and graphs and mathematical equations that are the stuff of most college courses in economics.
Economics is not a mathematical science, in my view, but a behavioral science. The mathematical approach requires that human beings be treated as if each were as identical to one another as hydrogen molecules. The problem is that hydrogen molecules never change. They are the same now as they were a billion years ago. Humanity, though, changes every minute of every day, never quite repeating the same motions as it did a day ago or a millennium ago. This is why "economics" cannot be separated from "politics," and why you will learn "political economics" at SSU. Once you become engaged, you will find new friends here, from all over the world, as our student body is scattered throughout 50 states and 50 countries. Your interaction with the rest of the class occurs in two ways. You are always free to ask me or our guest lecturers questions directly -- or challenge us if you like -- and we will answer in periodic Q&A sessions. Or, you can raise the questions in our TalkShop, where other participants, students who have been with us for several semesters, will help you out.
This first lesson of this fall semester will be familiar to those who began these supply-side studies in political economics in the fall of 1998. Our rotation the next 15 weeks or so will concentrate on "money," what it is, how it has evolved, and how it matters in banking and trade, domestically and internationally. This initial lesson is meant to give you a general feel for our analytical model. You will find that "supply-side economics" is nothing like its representation in the major news media, which have learned all their economics in obsolete classrooms and for the most part are unable to cope with the ideas we present here.
As we get deeper into our studies, for example, you will see there is room for wide variation in the supply-side framework, just as there are a great many branches of demand-side economics. It may surprise you to know that Adam Smith was a supply-side economist, as was Karl Marx, but that Milton Friedman, the godfather of modern monetarism, is a demand-side economist, as is Paul Samuelson of MIT, the godfather of the neo-Keynesian system. In the supply framework, you will soon see all the economic “actors” are producers of goods and services. Producers are people who “supply,” hence “supply side.” Consumers are peripheral in the supply model. One producer makes bread and another makes wine. They exchange their surplus production with each other and we must assume they do so in order to consume the other’s surplus. This simple concept explains supply-side economics in its broadest outline. The easier government makes it for producers to produce and exchange, the more production and exchange will occur, and the greater will be the living standards of all involved. I will repeat this concept frequently in the lessons that follow.
Among my many friends who are supply-siders, there are none who agree completely with my framework, and I know of no two who agree with each other. Where we all do agree is on the axiom that production, or "supply," must precede consumption, or "demand." Production must occur before consumption can occur. There are myriad possibilities of how to optimize or maximize production -- through "free markets" or through state intervention and management. If the focus is not on a philosophy of "production," but rather on the management of "demand," all supply-side economists agree that national economies or the world economy will deteriorate. Smith and Marx were supply-siders in the sense that both were devoted to increasing the wealth of nations, with different ideas on how the means of production should be activated. It is as simple as that, yet nearly every economics department of every school in the United States teaches only the economics of consumption.
In a general course of introductory economics today, there may be a lesson or part of a lesson devoted to some part of supply theory, but even that often is 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 Professor Arthur B. Laffer, who first drew the curve on a napkin, in my presence, in December 1974. We'll have at least one lesson on the Laffer Curve, but for now I'll simply say 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 to me by Laffer and his mentor, Robert Mundell, a Canadian who now is a tenured professor at Columbia University. In this parallel lesson in 1998, I noted that Mundell was "on everyone's short list to be a recipient this year or next of a Nobel Prize." It finally did happen in October 1999, when the Swedish Academy named Mundell its Nobel Laureate in economics, recognizing his contribution to supply theory, but mainly celebrating his work in "money," i.e., "optimal currency areas." Mundell not only is the "godfather" of modern supply theory, but also the inspiration for the monetary integration of Europe and its new common currency, the "euro."
In the course of our studies these last several years, we were able to discuss the monetary deflation underway in the developing world beginning in 1997. Commodity prices fell and fell and fell, following the decline in the dollar price of gold. This semester affords us an opportunity to look at why the reversal took place, with commodity prices climbing in as gold rebounded, and why the price of oil has gyrated as it has.
Because demand-side economists have no theory of monetary deflation, they are at a loss everywhere to explain the phenomenon we have been discussing at Polyconomics since early 1997. This is one of the reasons our "student body" has expanded, with a great many participants from the developing world joining us. Those of you who register for this semester's lectures will receive a series of client letters on the subject of deflation that we sent during the last year to clients who subscribe to our consulting service. Those who prefer to audit the lessons are free to do so without registering.
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The two distinct systems of thought at the root of the study of national or international economies and how they interrelate are known as macroeconomics. 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 U.S. schools and schools throughout the world which have patterned themselves after the U.S. economic curricula, macroeconomic demand theory dominates, almost to the complete exclusion of supply theory. 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. Here, 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. In other words, economists who have been taught only the economics of the firm can much more easily grasp supply-side concepts at the macro level. Ph.D. economists, who usually have to be able to master macro, have a much more difficult time getting out of their framework into a supply-side framework. It is a foreign language, or the equivalent of an astronomer who has been trained to think the sun revolves around the earth being told it is quite the opposite. In the last 20 years, I can't say I've met Ph.D. economists who have been able to completely shed their early training and see the world purely in a supply framework. It’s exceedingly hard for person to be taught one paradigm and to win the highest honors at the university to mastering it, and then be able to understand the paradigm that is its exact opposite.
At the micro level, for example, the economic schools explicitly teach the law of diminishing returns in pricing policy, with no 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. There are 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 highly priced, and auto purchasers ordinarily spend serious time pricing the cars on the market, new or used. A taxpayer, on the other hand, takes longer getting demoralized over his country's tax regime to a point where he will move his family or company and flee to another jurisdiction.
Governing and managing a national economy then is a much more difficult task than managing a corporation or firm or shop. The signals it gets from its consumers, the voters or "subjects," are not so easily interpreted and put to use via changes in pricing, i.e., tax rates, regulations, or other forms of national economic management, i.e., monetary policy and tariff/trade policy tools. 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? It is the competitive market of other car makers that forces Ford to produce as many as it can for as little as it can. Government, said Mellon, has the same problem. It 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 ballot box 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. Both are extremely efficient when they are not only big, but permit an open, unfettered flow of information about what is available. In our broad and deep democracy, voters in the aggregate will vote for higher tax rates when they know existing rates are insufficient to pay for the public goods they desire. 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.
You will not find a partisan tilt toward more or less government intervention in these lessons. I've spent enough of my life in the Democratic Party and enough in the Republican Party to know there is validity to liberal opinion and conservative opinion of almost all variations. Twenty years ago I came to believe that both political parties should completely convert to supply-side economics in finding a path to the most productive national and world economy. Conservatives and liberals would separate into different factions to provide the political market with choices on how much intervention the electorate desires. In other words, if correct macroeconomic policy yields the highest level of production and government revenues at a given policy system, I would leave it up to the voters to decide whether they wish to have public or private health insurance, or some combination of the two. On those kinds of issues, I would remain neutral. This is the spirit of Supply-Side University.
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 were responsible for the federal deficits that followed, and that the tax increases of George Bush and Bill Clinton are the reason the economy did better afterward. This means the demand-side economists then must 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. And the voters gave Republicans control of Congress in 1994 for the first time in 40 years, after Bill Clinton promised a tax cut but raised tax rates instead.
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 Norman Ture was the economist 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 to the economy than the consumer -- if only because 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 all the classical economists. The production paradigm was at the center of Adam Smith's Wealth of Nations and of Marx's Capital. 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 as a telephone student of Mundell and Laffer, 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 progress through the Congress of the Smoot-Hawley Tariff Act , eventually passed in 1930, could cause the Wall Street Crash of October 1929. In the semester ahead, we will discuss the interplay of government policies that impact the national and the world economy. Those of you who take the material and opportunity seriously will be richly rewarded throughout your lifetime in whatever your field of endeavor.
There is no tuition at SSU. I'm delighted 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.
The only money outlay I would recommend would be for the purchase of a copy of The Way the World Works, which I wrote in 1977 and is now available in a 4th edition. The National Review honored me in 2000 by naming it one of the 100 most influential books of the 20th century.
For those of you who are serious about learning at SSU, a reading of the book is essential. In an earlier summer session, I'm afraid I became impatient with a number of students who were bombarding me with simple questions they never would 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. There are other books I will be suggesting to you from time to time. 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 now and then I will ask you to comment upon some economic debate that we will find in the news media. You also will benefit greatly by joining the discussions we have in our TalkShop. Please don't worry that your English may not be "good enough" to participate in TalkShop. Start by asking questions and you will soon find that we are able to get your meaning. 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 that I can practically assure you will stimulate your success -- as it has mine.