Viewpoint: Supplying the Demand for Nonsense
An informed source reminds me that the source of the phrase "supply-side" economics was Nixon's chief guru, Herb Stein. It began as an epithet against Art Laffer, Bob Mundell, and their evangelist, Jude Wanniski (then associate editor of the Wall Street Journal). After a canned martini on the antiquated train to Morristown, New Jersey, I had mentioned to my neighbor, Jude, that Professor Stein had coined a sarcastic phrase, "supply-side fiscalism," at a conference at The Homestead in 1974. It sounded fine to me—simpler and more comprehensive than the "wedge" or "Laffer Curve." So, supply-side economics began to enter our consciousness through Wanniski's powerful editorials.
The basic idea that marginal tax rates affect behavior in unproductive ways is, of course, quite ancient. Among many other places, it was implied in my first article in National Review back in 1971, where I wrote that "what we are experiencing is more of a tax-pull than a wage-push situation. Inflated government has raised the cost of living through high regulated rates and excess money creation, while it reduced real incomes and economic growth with oppressive taxation."
We are all supply-siders now, but it means different things to different people. Prof. Martin Feldstein of Harvard is on everyone's list of supply-siders, yet look at what he writes in the Wall Street Journal (Nov. 5, 1980): "Slower growth of money dampens economic activity, creating excess capacity and unemployment.…Such slack directly slows the increase in prices and wages." This Phillips curve notion—that inflation is a matter of too much production and employment, rather than too much money spent—is almost the opposite of supply-side analysis.
Now we are blessed with a Commerce Department pamphlet, Growth Policy for the Eighties: Proceedings of a Workshop on Supply-Side Economics. Unfortunately, Commerce neglected to invite more than one out of 14 participants who had the vaguest idea what supply-side economics is all about.
The results are amusing. Otto Eckstein of Data Resources says, "I take supply economics to be a kind of catch-all which at one time related mainly to the desire for economic planning." Arnold Packer worries (with some justification) that "supply-side may be just another word for bailing out industries." Jerry Jasinowski somehow includes wage-price controls among "supply-side remedies." Barry Bosworth says budget deficits are needed to "soak up excess savings and maintain aggregate demand." That's about as far from the supply side as you can get.
Professor Eckstein goes on to present an elaborate excuse for his own "failure of inflation forecasting." He talks about core inflation, which simply describes inflation's effect in labor and capital markets. Then he pulls out other familiar symptoms of inflation—including falling exchange rates, rising import and farm prices—and unconvincingly calls those "supply shocks." Whatever is left is then defined as due to excess spending.
This embarrassing confusion of cause and effect is then mixed with an archaic long-term Phillips curve: "If you want to get the core inflation rate down by one or two percentage points," says Eckstein, "you have to create a near-depression and leave the economy there." Data Resources itself recently made a few trivial gestures toward supply-side analysis, but their "new" model remains demand-driven, hopelessly rigid, and consistently wrong.
After all this, the contribution of Michael Boskin was refreshingly sensible, though muddled in spots. "There is very little evidence," says Boskin, "that taxes have much effect on the hours of work or participation rates of prime age males.…Because of that, I question the conclusion that a cut in tax rates would be a large enough stimulus to the economy to actually increase tax revenues very quickly."
The trouble with that sort of assault on the Laffer curve is that Boskin himself correctly noted that "the effects of taxes on labor force participation rates are probably the least important effects of taxes on the supply of labor." More important, said Boskin, is "how hard people work, their investments in their human capital, their education, on-the-job training, and occupational choice. Things that affect their work effort." That is also what Professor Laffer means about marginal tax rates discouraging personal effort, so the proportion of prime age males who claim to be working or looking for work is largely irrelevant.
Everyone seems to feel obliged to criticize supply-side economics without first discovering what it means. It doesn't mean that the amount of money spent (demand) is unimportant, nor that any tax cuts are necessarily a "free lunch." Supply-side economics just means that people will provide more labor and capital to markets, and do so more efficiently, when they get to keep a larger share of any added earnings.
A reduction in government spending will transfer resources to market-determined uses, but it does not do much about the marginal incentive to add to production. A reduction in marginal tax rates, on the other hand, lets people keep more of any added earnings garnered from producing more, regardless of government borrowing. It is not a matter of dollars in consumers' pockets (which could as easily be printed), but of motivation to produce more of what others want. The deficit does not directly add to spending anyway, since the government borrows from X to give to Y—adding nothing to even nominal purchasing power, much less to real income (which is the same as real output). More money will add to spending, but that can't have any lasting effect on real, after-tax incentives.
Well, these are just hints. But it is frustrating to talk classical economics to quaint Keynesians. They accuse some of us of being 19th-century economists, when we're really 18th-century economists. Still, that's a lot more modern than the mercantilist ideas being revived over the past few decades.
Alan Reynolds is vice-president of research at a major US bank.