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Economics
on Trial
IDEAS ON LIBERTY
February 2000
A
Much-Deserved Triumph in Supply-Side Economics
by Mark Skousen
"After
occupying center stage during the 1980s, the supply-side approach
to economics disappeared when Ronald Reagan left office."
-- Paul Samuelson (1)
Until
Robert Mundell won the Nobel Prize in 1999, supply-side economics
had been a school without honor among professional economists.
Established textbook writers such as Paul Samuelson (MIT),
Greg Mankiw (Harvard), and Alan Blinder (Princeton) frequently
condemned the supply-side idea that marginal tax cuts increase
labor productivity, or that tax cuts stimulate the economy
sufficiently to increase government revenues.
The Laffer
Curve -- the theory that when taxes are too high, reducing
them would actually raise tax revenue -- is dismissed. "When
Reagan cut taxes after he was elected, the result was less
revenue, not more," reports Mankiw in his popular textbook.(2)
Never mind that tax revenues actually rose significantly every
year of the Reagan administration; the perception is that
supply-side economics has been discredited. Arthur Laffer
isn't even listed in the 1999 edition of Who's Who in Economics,
although the Laffer Curve is frequently discussed in college
textbooks.(3)
Now that
is all about to change with Columbia University economist
Robert A. Mundell's Nobel Prize in economics. According to
Jude Wanniski, Mundell, 67, is the theoretical founder of
the Laffer Curve.(4) In the early 1970s he told Wanniski,
"The level of U.S. taxes has become a drag on economic growth
in the United States. The national economy is being choked
by taxes--asphyxiated."(5)
Mundell
offered a creative solution to stagflation (inflationary recession)
of the 1970s: impose a tight-money, high-interest rate policy
to curb inflation and strengthen the dollar, and slash marginal
tax rates to fight recession. Mundell's prescription was adopted
by Reagan and Fed chairman Paul Volcker in the early 1980s.
"There's been no downside to tax cuts," he told reporters
recently.
Yet,
oddly enough, Mundell isn't accorded much attention compared
to supply-siders Laffer, Paul Craig Roberts, and Martin Anderson.
In their histories of Reaganomics, Roberts and Anderson mention
Mundell only once.(6) Two major studies of supply-side economics
in 1982 don't cite his works at all. Nevertheless, Mundell
has accomplished a great deal worth lauding. In fact, he is
considered the most professional scholar of the supply-siders.
Robert
Mundell has had an amazing professional career. A Canadian
by birth, he has attended, taught, or worked at over a dozen
universities and organizations, including MIT, University
of Washington, Chicago, Stanford, Johns Hopkins, the Brookings
Institution, Graduate Institute of International Studies in
Geneva, Remnin University of China (Beijing), and the IMF.
Before going to Columbia in 1974, he was a professor at the
University of Chicago and editor of The Journal of Political
Economy. Thus the Chicago school can once again claim
a Nobel, although Mundell differs markedly from the monetarist
school.
Monetary
vs. Fiscal Policy
Famed
monetarist Milton Friedman says, "I have never believed that
fiscal policy, given monetary policy, is an important influence
on the ups and downs of the economy."(7) Supply-siders strongly
disagree. Cutting marginal tax rates and slowing government
spending can reduce the deficit, lower interest rates, and
stimulate long-term economic growth.
Mundell
counters, "Monetary policy cannot be the engine of higher
noninflationary growth. But fiscal policy-both levers of it
can be. . . . The U.S. tax-and-spend system reduces potential
growth because it penalizes success and rewards failure."
Mundell
favors spending on education, research and development, and
infrastructure rather than government welfare programs. He
advocates reducing top marginal income tax rates, slashing
the capital gains tax, and cutting the corporate income tax.
Such policies would sharply raise saving rates and economic
growth-"an increase in the rate of saving by 5% of income
(GDP), say from 10% of income to 15%, would increase the rate
of [economic] growth by 50%, i.e., from 2.5% to 3.75%."(8)
Mundell
as Gold Bug
Supply-siders
also take a different approach to monetary policy. They go
beyond the monetarist policy of controlling the growth of
the money supply. Unlike the monetarists, supply-siders like
Mundell resolutely favor increasing the role of gold in international
monetary affairs. "Gold provides a stabilizing effect in a
world of entirely flexible currencies," he told a group of
reporters in New York in November 1999. According to Mundell,
gold plays an essential role as a hedge against a return of
inflation. He predicted that the price of gold could skyrocket
in the next decade, to as high as $6,000 an ounce, if G7 central
banks continue to expand the money supply at 6 percent a year.
"I do not think this an outlandish figure. Gold is a good
investment for central bankers." He did not foresee central
banks selling any more gold. "Gold will stay at center stage
in the world's central banking system," he said.
In awarding
Mundell the prize, the Bank of Sweden recognized him as the
chief intellectual proponent of the euro, the new currency
of the European Community. He considers the euro a super-currency
of continental dimensions that will challenge the dollar as
the dominant currency. The benefits of a single currency include
lower transaction costs, greater monetary stability, and a
common monetary policy. Mundell advocates an open global economy,
expanded foreign trade, and fewer national currencies. Ultimately,
he envisions a universal currency backed by gold as the ideal
world monetary system. Under a strict gold standard, "real
liquidity balances are generated during recessions and constrained
during inflations."(9)
Mundell
is an optimist as we enter a new century. He's bullish on
the global stock markets, the gold standard, globalization,
and downsized government. He's my kind of economist.
1. Paul
Samuelson and William D. Nordhaus, Economics, 16th
ed. (Boston: Irwin/McGraw-Hill. 1998) p. 640.
2. N. Gregory Mankiw, Principles of Economics (Fort
Worth, Tex. Harcourt/Dryden Press, 1998), p. 166.
3. Mark Blaug, compiler of Who's Who in Economics (Northampton,
Mass. Edward Elgar, 1999), determines the top 1,000 names
in the book based on frequency of citation in scholarly journals.
Among the famous economists missing the cut are Arthur Laffer,
Paul Craig Roberts, and Murray N. Rothbard.
4. Jude Wanniski, The Way the World Works, rev. and
updated (New York: Simon and Schuster, 1983), p. x.
5. Wanniski, "It's Time to Cut Taxes," Wall Street Journal,
December 11, 1974.
6. Paul Craig Roberts, The Supply-Side Revolution (Cambridge,
Mass.: Harvard University Press, 1984) and Martin Anderson,
Revolution (Stanford, Calif.: Hoover Institution Press, 1990).
7. Milton Friedman, "Supply-Side Policies: Where Do We Go
from Here?" Supply-Side Economics in the 1980s Conference
Proceedings (Federal Reserve Bank of Atlanta, 1982), p. 53.
8. Robert A. Mundell, "A Progrowth Fiscal System," The
Rising Tide, ed. Jerry J. Jasinowski (New York: Wiley,
1998), pp. 198, 203-204.
9. Mundell, The New International Monetary System (New
York: Columbia University Press, 1977), p. 242.
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