The General Concept Jude Wanniski September 12, 1997

Fall Semester 1997: Supply-Side University Economics Lesson #1

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

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. You probably 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 undoubtedly have several sessions on the Laffer Curve, but for now I could 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 is now a tenured professor at Columbia University, but is spending this year on sabbatical, teaching at the University of Bologna, in Italy.

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. 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 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. Here 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 high 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 to demoralize to a point where 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 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 tarifFtrade 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, except the competitive market of other car makers forces it to produce as many as it can for as little as it can. Government, he says, 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, and the voters gave Republicans control of Congress for the first time in 40 years, after Bill Clinton promised a tax cut and raised tax rates instead.

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 "Republican11 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 economist Norman Ture, who died last month 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 y!963. 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." 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 the book, as a telephone student of Professors 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 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 in 1999 and 2000 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 have 98 registered students for this fall semester, but could have 980 or 9800. 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 PhD 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. 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. 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.