The General Concept Jude Wanniski September 11, 1998

Fall Semester 1998:

Supply-Side University Economics Lesson #1

Memo To: Students of Supply-Side University
From: Jude Wanniski
Re: The General Concept

This first lesson of the new semester will be familiar to those who began these supply-side studies in the fall semester a year ago. Where we had roughly a hundred students a year ago, the number now has grown to several hundred, which means we should begin by working through the basics. As we get deeper into our studies, we 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, and so was Karl Marx, and that Milton Friedman is a demand-side economist, and so is Paul Samuelson. 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. But 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. It is as simple as that, yet nearly every economics department of every school in the United States teaches only the economics of consumption.

A year ago we could still say supply-side economics, per se, was not systematically taught at any school of economics in the United States. There now is a course at Georgia State University, which I understand has developed quite a following, and which gives students credit for participating in this Internet class. Of course, I hope the idea spreads. 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 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 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 1975,1 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 now is a tenured professor at Columbia University, and on everyone's short list to be a recipient this year or next of a Nobel Prize. At 65, Mundell this semester is on paternity leave at Columbia, with a new son Nicholas "produced" last spring by Bob and his wife, Valerie.

In the course of our studies last year, we were able to discuss the monetary deflation already underway in the developing world. This semester affords us an opportunity to look at the deflation as it has caught up with the developed world in general and the financial markets on Wall Street in particular. 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 for 18 months. This is one of the reasons our "student body" has expanded this year, 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, of course.

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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 our 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 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.

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 Fm 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 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. 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. Fve 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 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. 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 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 policies of government 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, now available in a 4th edition. For those of you who are serious about learning at SSU, a reading of the book 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 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. I've also written a new book that will be published and available in November, The Last Race of the 20th Century , a personal perspective on the 1996 presidential race that I think is almost a prerequisite to understanding the forces at work in the world leading up to the 2000 race. It will be available here, through Amazon.com or at the better bookstores. 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. 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.