TWTWW Jude Wanniski August 13, 2005

To: SSU Students
From: Jude Wanniski
Re: The Way the World Works

The publisher of the most recent edition of my 1978 book, "The Way the World Works," tells me they have almost run out of the printing and plan a new one this fall. Amazon still has some in stock and we have some limited edition, leather-bound books we can get to you quickly. If you would like one of the new printing, let me know and we will get it to you, autographed, when it is available.

It is not a difficult book, designed to be read by a curious, bright high school graduate, but it really has to be read a chapter at a time. The more young people understand the way the world really works in terms of political economics, the more quickly they will be able to understand the cycles of peace and war, poverty and prosperity that have come before us and will continue into the future. If you are an SSU student and have not yet read the book, the summer session is a good time to take it on, because it does require attention you may not have when you are dealing with your regular school work. There are 13 chapters and each should be read in one sitting, with a day between each one, so you can think about what you have read. A month is a good target for completion.

I got the nicest note from a man I'd never heard from before, replying to one of my memos on monetary policy. Here is what he wrote: "On a more positive note, I bought TWTWW back in 1987. I found it at a 2nd hand charity book sale and bought it because I noticed it had been owned by a client of my father. Without sounding too gushing for a 39-year-old father of three, your book was the BEST book I have ever read. As an econ/business major in college, I think I was pretty good at filtering out the swill that I was taught and keeping the good stuff. But I knew there was a lot missing from what I had learned. Your book filled in the missing pieces. I now recommend it to any one who asks as the single most influential book in my life after the Bible."

To whet your appetite, here is the "Epilogue" to the first edition, which I wrote in one day, the last day of September 1977. Whenever someone tells me they are thinking of reading TWTWW, I suggest they begin with this epilog, which represented a prediction of what would happen in the decade ahead. In the place where I predict the end of communism in China, the quote from a Chinese official left out the fellow's name, but it was Deng Xiao Peng.

* * *

Epilogue

To the global electorate, the most important book of the eighteenth century was Adam Smith's Wealth of Nations. The most important book of the nineteenth century was Karl Marx's Capital. Their importance lay in their ability to assist political leaders in understanding the workings of the political economy, which in turn assists them in fathoming the desires of the global electorate. Can it be a coincidence that both Smith and Marx closed out their monumental books with an almost identical discussion of the pitfalls of public debt, with Smith almost, but not quite, articulating the essence of the Laffer Curve?

How much further coincidence that the most important book of the twentieth century, in the same vein, has been Keynes's General Theory, which does nothing less than argue the benefits and magic of public debt? This is a magic that will work briefly, as Keynes intended, when it relies on useful government expenditure. But more importantly, it is a magic that works beautifully, by accident, in a way Keynes did not foresee, when it operates through policies of tax-rate reduction.

Entering the last quarter of the twentieth century, the global electorate has a multitude of experiments in political economy going at once-each a variation on the seminal ideas of Smith, Marx, or Keynes. Smith and Marx will endure as the foundations of experimentation. But the age of Keynes is ending as it must. It has served the global electorate through its successes and failures, which have illuminated the basic insights of Smith and Marx. The global electorate can only choose among alternative paths drawn by individual minds, and Keynes has helped individual minds grope closer to the path desired by the global electorate. How do we, all of us who belong to the global electorate, solve that primordial problem that confronts society when the fisherman breaks his leg? How do we maximize growth while redistributing, and do so without straining the planet? How do we maximize freedom while promoting equality?

There is some combination of Smith and Marx that will dominate the next century and be further refined in centuries thereafter. The likelihood, as the age of Keynes draws to a close in the West, is of a drift back to an age of Smith and Marx. The global electorate will push the West toward a Pax Americana as the United States emerges from adolescence. It has already made headway in pushing the East in the direction of classical Marx, away from the grotesque forms spawned under pressure by Lenin, Stalin, and Mao. Both Smith and Marx would be pleased with this drift, although Marx would see that his idea will almost certainly have to remain subordinate.

Not second-best, merely subordinate, in the sense that output must precede redistribution. By denying itself the productive efficiencies of a free-market economy, the Soviet Union can only match the United States and other market economies of Europe and Japan if the political leaders of the West make gross errors in economic management. The relative advance of the communist nations in the past decade has occurred in just such a fashion.

But not entirely so. The youthful nations of Eastern Europe, rambunctious in young adulthood, can no longer be considered "satellites" of Moscow. It is more appropriate to apply an analogy of family. Sons Hungary and Czechoslovakia fought for freedom in 1956 and 1968 by rebellion against the authoritarian Kremlin father and were slapped down. Daughter Poland, in 1970, threw a tantrum over internal policies, not demanding the right to leave home or join a new church, but simply insisting on a new outfit. And Moscow held still while Polish leader Edward Gierek introduced economic reforms that in every way moved toward a broader market economy, including the reduction of tax rates on personal incomes and the decentralization of economic planning, transferring power to allocate capital from the central bureaucrats in Warsaw to the regional state bankers. In the years since, Poland has been among the fastest growing nations on the planet and is now the tenth leading industrial nation. In addition, the Polish electorate learned how to deal with Daddy. In 1976, having absorbed the reforms of 1970 and again feeling hemmed in, Poland threw another tantrum over food prices and Gierek put through a new set of internal reforms while Moscow watched, again cutting personal tax rates and permitting free enterprises of twenty-five employees or less. Adam Smith would give Poland higher marks today than he would his native Britain, at least in economics.

While Moscow has acted apprehensively, it does not seem accurate any longer to say it is being dragged unwillingly by Eastern Europe. While Daddy is still slow to change his ways, he is discovering the comforts of productive sons and daughters. And as similar economic reforms spread through the rest of Eastern Europe, quietly, in the wake of Poland's tantrums, the Soviets are drawing courage to test ideas along similar lines. If Brezhnev would ever realize that his stature as a passable leader was secured by his restoration of one-acre private plots to the peasantry, he would aim for heroic stature by permitting two-acre plots-or in some other way moving Soviet agriculture off the top of the Laffer Curve. He should realize, too, that the nationalism of the Baltic states would not intensify, but abate, if they were permitted internal experimentation along Polish lines without having to throw tantrums. Nationalism is not a natural instinct of the electorate, but a form of voting, of rebellion.

Another shade of Marxist experimentation, closer to the original classical version that envisioned democratic evolution through the experience of the working class, is Eurocommunism. The Italian communists, then the French, Spanish, and Japanese, have shaken themselves free of the Leninist dictum that the party, must have monopoly power. Instead, they are prepared to contest for power through democratic means. Their strength, especially in Italy and France, has grown dramatically in the past several years as the "free-enterprise" democrats consistently failed to understand the source of the problem: That the global inflation had caused their already too-high tax rates to be pushed even higher. Both Italy and France submitted themselves to "austerity" plans (upon the advice of the International Monetary Fund) that made matters worse. Still, the Eurocommunists find that electoral victory always barely eludes them. They have opposed austerity, which is the source of their strength, but the public does not desire the alternatives they offer, i.e., expansion of the public sector through nationalization.

Eurocommunism would fade today as quickly as it did in the early 1950s if the non-communist parties offered the electorate the kind of tax-cutting policies Ludwig Erhard used in West Germany to expand the economy through the private sector. It is only a matter of time before this happens. At this writing, in the autumn of 1977, Britain's Conservative Party leader Margaret Thatcher is steadfastly pledging to sharply reduce the progressivity of Britain's personal tax rates as soon as her party returns to power. If the Labour government fails to co-opt this issue, it will surely lose the next national elections. Already, the Tories are steadily winning by-elections on this issue, capturing seats in Parliament that have long been considered "safe" for Labour. Once Britain takes this step, the expansion of its economy will have rippling effects through Western Europe, giving courage to conservative coalitions in other capitals to follow her lead. It will then occur to European political leaders in general that the Common Market idea can move ahead only if the internal tax structures of the European nations are made roughly similar, so that a European common currency will not have variable impacts on output and employment through its effects on tax progressions.

In China, the passing of Mao Tse-tung has given that vast electorate of 900 million an opportunity to "vote" in new leadership, through internal consensus-shaping. The result has been a relatively rapid drift in the direction of classical economic forms. Peking has openly embraced the idea of using individual incentives as a means of expanding production, going so far as to twist a Marxist slogan into one more appropriate to Adam Smith: Instead of Marx's idea of communism, "From each according to his abilities, to each according to his needs," Peking proposes, "From each according to his abilities, to each according to his work." If China can find a way to unlock the nation's intellectual capital through incentive systems, for industry as it has for agriculture, rapid growth can follow. Unity with Taiwan is historically inevitable, as is unification of North and South Korea. But it is now not outlandish to consider the possibility that the completed results will mean a China and Korea that more closely resemble Taiwan and South Korea than Marxist models, which has been the conventional assumption by both liberal and conservative intellectuals in the West.

The advantage China has over the Soviet Union in developing a more efficient political economy (which means a freer one both in the market for goods and the market for ideas) is that it did not go through the Great Depression of the 1930s as a communist system. The conventional myth is that Russian authoritarianism has racial connotations built on centuries of despotic rule, as if the Russian people underwent genetic alterations in the process. In opting for their own brand of communism, the Italian and French communists offer this racial argument as a prime reason for variation. But what really happened is that a more pacific form of Marxism became impossible during the global contraction of the 1930s, when Stalin used liquidation of all opposition, real and imagined, and slave labor camps to repress impulses that were primarily economic in origin. Having shaped the system in this grotesque manner, Stalin left this as his institutional legacy. His successors, the Soviet ruling class, have continued to view dissent as ideological rather than economic in origin, unable to "think on the margin." But on a glacially descending line the Kremlin ruling class has been shedding this paranoia, and is beginning to sense that the Laffer Curve exists independent of ideological systems-as with Brezhnev's restoration of the one-acre plots. The next generation of Soviet leadership should progress more rapidly along this line, being even further removed from the conditioning of the 1930s. And they must be, if the Soviet Union is to withstand the competition of a broad economic expansion by both the West and the People's Republic of China.

How surprising it is to Western intellectuals that the Third World has come through the global economic convulsions of the past several years with so few defections to Marxist variations. Since the 1950s, when China and the Soviet Union openly proclaimed their intention to woo the developing nations to their political/economic systems, only Vietnam and Cuba have defected. Yet the largest part of the Third World, in retaining capitalist forms, has been moving toward closer political alignments with Russia and China in international debates. The Third World demand for a "New International Economic Order" is aimed squarely at the West, which is viewed as an exploiter in a way the communist nations are not.

The reason for this, in our model, is that the West is a creditor in a way the communist nations are not. There are no Moscow or Peking banks, private or public, demanding that developing nations squeeze their peasantry and proletariat with higher taxes in order to meet debt schedules. The essence of a New International Economic Order is a plea for debt moratoriums by Western banks, for the Third World sees clearly that as long as its finest intellectual capital is absorbed in the process of meeting debt payments, it is unable to get on with the task of development. Chinese or Soviet aid to the Third World has been of a different order, grants of financial and intellectual capital that can be repaid through political support, which does not require raising the taxes and the squeezing of peasants and proletariat. This was the single most important insight of classical Marx, as he observed close-up the British exploitation of India, and it has remained the greatest advantage over the West of those communist nations that build on Marx. It is an insight the global electorate must preserve, even if it means preserving otherwise unpalatable Marxist systems.

The solution to the Third World development question is in the hands of the United States, the creditor nation. The answer is not debt moratoria, at least in the sense the Third World directly puts the demand. For those who have come this far in this book, it must be self-evident that our model cries out for universal tax reforms, especially oil progressive personal rates. The U.S. private banks and the International Monetary Fund they control through Washington cannot remain blind to the Laffer Curve or resist its implications, for their only salvation ultimately lies in its understanding. There will be the predictable arguments that the banks and the U.S. State Department cannot "dictate" tax reforms in the developing nations, but this is nonsense. Having already dictated the terms of development to the Third World that brought the present tax structures in their train, the United States merely has to announce its political and financial support of the opposite policy to bring a stampede of Third World political leaders anxious to produce greater revenues through lower rates.

Resistance in the United States will come from those single-entry bookkeepers in American business and-labor who fear that an expansion of Third World intellectual capital will just mean more competition. Do we really want Peruvians to be manufacturing steel instead of catching anchovies? It is this fear of the Third World that led the U.S. Congress in 1976 to change the tax treatment of U.S. citizens working abroad, increasing the burden on them to such levels that, when it takes full effect, the intellectual capital we had been privately exporting will be forced home. Little Smoot-Hawley bills are passing through Congress, with the Democratic Party now doing the damage.

The Republican Party is now in dismal condition. But if there is to be a Pax Americana during the next century, its foundation will rest on a Republican renaissance. The solutions to domestic and global economic problems now require primary commitments to income growth, not redistribution, and the GOP will always win a competition with the Democrats over which is more passionate over growth. The decline and fall of the GOP since 1930 resulted not from its lack of passion, but from its failure to understand the nature of the Laffer Curve. Its worst mistake, of course, was to expand the international wedge via Smoot-Hawley in 1930. Then, when it had learned from this mistake and became an internationalist party instead of an isolationist one, it somehow forgot the nature of the domestic wedge. Now only 17 percent of American voters are willing to say they are Republicans. The decline began in earnest when, in 1953, President Eisenhower killed H.R. 1, the GOP bill providing for a 20 percent across-the-board tax cut on personal incomes. The growth prescription of tax-rate cutting was not picked up again by a Republican until 1974, when Representative Jack F. Kemp of Buffalo, New York began promoting the idea. It was only after the Republicans lost the White House that Kemp began enjoying success in selling his plan, which was adopted formally by the Republican National Committee in New Orleans, Louisiana, on September 30, 1977. This was the necessary first step toward a renaissance of the GOP.

The model of the global political economy presented in this book is meant only as a framework of ideas for global policymakers. The author does not pretend that it is a "correct" model, but offers it merely as one that he has found more reliable than competing models as a way of looking at the world. And it is meant as an analytical tool rather than a forecasting tool.

Will there be a third world war? The Chinese leadership in Peking say one is inevitable, that it will take war to resolve the competition among systems just as it has before. But the Chinese also say that the world's political leaders must work to at least push this inevitable war into the next century. Our model can't tell us whether or not war will come, but it certainly does not hold that it is inevitable. And surely the Chinese goal of working to push conflict into the future can be realized by adjustment of economic policies as suggested by the model. Most of the political tensions in the world today are the result of the global inflation and contraction of the past decade. A global effort at tax reform, especially in the developing world, would free intellectual resources that have been locked up at least since the Second World War. It may well be that the global electorate arranged the inflation as a way of forcing the attention of the developed world to the unnecessary, burdens it placed on the Third World, the burdens of grossly incorrect economic theories.

And if these prescriptions are followed and a genuine worldwide expansion follows global tax and monetary reform, what about the planet and its resources? Will wars occur as nations compete for an ever-diminishing supply of natural resources? Our model says no. The planet's bounty is for all practical purposes unlimited, but it yields this bounty stubbornly, at a pace determined by the intellectual resources of mankind. The past decade of inflation and contraction have made it seem that the planet has shriveled in its resources. A reconstruction of a world monetary system tied to the planet through gold or silver or oil or something real, matched by an understanding of the Laffer Curve that did not exist at Bretton Woods, would enable the world to grow without straining the planet. Nor will the world's population continue to expand as rapidly, given these economic conditions, for as individuals can more easily develop their intellectual potential and increase the quality of human capital, they will independently choose to reduce the quantity of human capital they are now forcing. The exponential population growth the Malthusians fear will not occur where there is real economic growth.

Conflict is more likely to come as a result of uneven advance. If all members of a family unit save one are developing, the one left behind will cause trouble, drain the resources of those who have been advancing, and create tensions and strife that will block the advance of the unit as a whole. If the West, China, and the Third World manage a major economic advance in the 1980s as the result of simultaneous moves down the Laffer Curve, but the Soviet Union is unable to break through the crusts of ideological dogma that would enable it to advance as well, one would expect an increase in the potential for conflict. A happier outcome would be general global advance, with the fresh economic and political impulses of Eastern Europe spreading into the heartland of Russia.

More important than the Laffer Curve, after all, is the persistence of the global electorate in pushing toward concord. It will not for long permit the smallest part of its membership from being left behind, economically or politically, in this historic trek. For thousands of years the world has been moving toward more, not less, democracy, and it will continue to do so. It will, as it always has, ultimately reject all systems that do not revolve around the individual, for the survival of all ultimately depends on the survival of the least of its members. In this sense, the global electorate is the good shepherd.

Morristown, N.J.
September 30, 1977