Unfinished Revolution Jude Wanniski August 5, 2005

Memo To: Supply-Side Students
From: Jude Wanniski
Re: The Supply-Side Revolution

In the summer of 1981, only a few months into the presidency of Ronald Reagan, I wrote a letter to the editor of the Washington Post, which ran on July 27 under a headline, “We Will All Be Supply Siders.” Here it is, 24 years later, and I have to admit there are still a few demand-siders around. It takes an awful long time for the big wheel of history to make a revolution of this kind, where almost every teacher of economics in in the United States has been trained by Keynesian or Monetarist professors, who are “demand siders.” That is, they begin with the assumption that the primary economic actor is the consumer of goods (demander), not the producer of goods (supplier). If supply siders had made more progress since 1981, I would not have had to initiate this virtual school to teach classical economics, which was supply-side all the way.

How long will it take for the wheel to make the complete turn, where classical theory is taught in almost all schools of higher eduction, and demand-side theory is treated as an historical oddity? To be sure, every department of economics offers courses in "micro-economics" that is classical and supply-side. Micro-economics is the economics of the firm, which presents the idea, for example, that if Ford raises the prices on its cars past a certain point it will sell fewer and lose revenue, and it could lower the prices below that point and sell more and gain revenue. The same principle applies in the classical macro-economic model. If tax rates to supply revenue for public goods and services rise above a certain point, production will slow and revenues will decline. The correct solution would be to lower the tax rate to the level that will restore that lost production and revenue.

The demand-side Keynesian Revolution got its start when the classical economists of the 1930s failed to realize that the Wall Street Crash of October 1929 was caused by the Smoot-Hawley Tariff Act of June 1930. It was not until the spring of 1977 that I made that discovery, seeing that the tariff was practically a done deal by the last week of October, and the market did not wait for President Hoover to sign it into law on June 17 the following year. Classical theory fell into disrepute as Lord Keynes, observing the Great Depression unfold worldwide, argued that “production” was no longer the central issue in economics; it was a surplus of savings and too little consumption. Government, he argued, had to rectify the problem by taxing resources away from the savers and spending them in ways that would increase aggregate demand.

In the absence of an understanding of why the world had unraveled after the Crash, the Republican Party that had dominated politics since Abe Lincoln’s day fell into disrepute with the electorate. Throughout the 1930s, the GOP insisted Smoot-Hawley was a good thing, and where the Democratic New Deal taxed and spent in accordance with demand-side doctrine, Republicans simply declaimed against spending and federal deficits. It was not until Reagan, an ex-Democrat (as am I), ran for President on a supply-side platform and won two terms, that the wheel began turning in that new direction. The supply-side agenda also called for a return to the Bretton Woods gold standard that President Nixon abandoned in 1971, announcing “We are all Keynesians now.” President Reagan tried to move monetary policy back toward that classical idea, but was thwarted by the demand-side monetarists who had control of the conservative think tanks and filled the key posts in the administration with their followers.

What will it take to complete the Supply Side Revolution? The Democratic Party will have to throw in the towel on demand-side economics, realizing the GOP will otherwise remain the dominant party for decades to come. Bill Clinton interrupted the GOP run with two terms for the Democrats, but he first won over a GOP president who broke his “read my lips” promise not to raise taxes. Clinton’s second win was against Senator Bob Dole, who had spent much of his career as “the tax collector for the welfare state,” making fun of supply-siders through the Reagan years. When it came to Congress, though, the GOP has remained in the ascendance. The Democrats have watched both houses of Congress slipping away from them and it now looks that may be the case as far as the eye can see.

The DNC continues to look to Keynesians for its economic agenda, with the NYTimes and Princeton Professor Paul Krugman calling the shots. In his column today, Krugman blames Irving Kristol for promoting supply-side economics, having published my essay, “The Mundell-Laffer Hypothesis: A New View of the World Economy,” in his Public Interest quarterly in 1974. When Democrats finally get tired of losing, they will throw in the towel on Krugman & Co., and we will all be supply siders. Those public and private universities that still teach the Old Time Demand-Side Religion will lose student support and that will complete the turn of the wheel.

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The Washington Post
LETTERS TO THE EDITOR
July 27, 1981
We Will All Be Supply Siders
by Jude Wanniski

In their column "A Rare Democratic Tax Innovation" [op-ed, July 13], Rowland Evans and Robert Novak reported on Rep. William Brodhead's discovery that supply-side economics is not of Republican patent. The Democratic Party is in the process of making that discovery en masse, as evidenced by the "bidding war" between Democrats and Republicans for the support of their respective tax bills.

It was inevitable. Economic departments may be able to successfully market obsolete ideas for quite a while, but political parties have to utilize economic ideas that reflect the state of the art, or they themselves will become obsolete.

For almost 30 years, with the exception of John Kennedy's last year, Washington policy-makers have been dominated by the demand model, the notion that consumer purchasing power drives the economy. Democrats and Republicans struggled within that framework, the former devising policies to put more purchasing power into the pockets of lower-income consumers, the latter devising alternate strategies to preserve higher income wealth.

Keynesians deployed fiscal policy to manage this "demand." The monetarists pushed Federal Reserve and exchange-rate policies to manage demand. The Keynesians produced stagnation, as demand taxation destroyed productivity. The monetarists produced the great inflation: their prescriptions to float the dollar and try to control the quantity of money, instead of its price, greatly diminished the dollar's utility as a unit of account, a store of value.

President Kennedy was the last policy-maker to embrace supply-side prescriptions. His posthumous tax cuts were the most successful economic events of our time. He was the last president with a passionate belief in a monetary policy based on gold: "This nation will maintain the dollar as good as gold, freely interchangeable with gold at $35 an ounce, the foundation stone of the free world's trade and payments system," he stated in a July 1963 message to Congress.

In my conversations with Mr. Brodhead, he worried that he might never see a national health insurance program if he employed supply-side tax policies. I observed that liberals never came closer to realizing their dream of national health insurance than they did in 1965-66, when the Treasury brimmed with productivity-swollen revenues that flowed from the Kennedy tax cuts. They have never been further away from a national health plan than they are now, after 15 years of inflation-swollen tax rates.

The demand model is being shed, a tattered snake skin. Milton Friedman and his monetarist students, who occupy important ground in Reagan's Treasury, Stockman's OMB and Weidenbaums' Council of Economic Advisers, still believe that Austerity Is Just Around the Corner. And they may cripple Ronald Reagan with their high interest rates as they have Margaret Thatcher. But their days are numbered. The president may give Professor Friedman's ideas a few more months, for old times' sake, but monetarism will be buried too. And if it is not, the Democrats -- and the Keynesians -- have no theoretical or political grounds for opposing a return to a convertible gold-backed dollar. They would end the inflation.

Very soon, either before or immediately after the 1982 elections, we will all be supply-siders. Democrats and Republicans will struggle on the foundations of the supply-side idea, the idea that it is the individual producer, man or woman, who is at the center of the economy. As the idea fosters policies that result in a resumption of economic growth, an expanding tax base will permit Republicans to argue for a reduction in the national debt and an increase in the defense budget while the Democrats push national health insurance. On such political judgments, supply-side economics is neutral.