The General Concept Jude Wanniski February 5, 1999

Those of you who have participated in SSU lessons through the summer and fall will not find yourself going over old material in this Spring Semester. In the 18 lessons just concluded, we concentrated on money and banking, with only tangential notes and comments on taxation, regulation or politics. In this semester, we will move the focus to taxation. Or more formally, public finance. Coincidentally, the government of the United States will spend a great deal of time on public finance during our semester lessons, so we will be able to constantly relate the classical supply-side theory of taxation to the debate as it unfolds. How much more interesting that we get to do this with budget surpluses stretching as far as the eye can see. The supply model of course does not change from deficit periods to surplus periods, so we will be able to learn about why the deficits appeared in the last 25 years and why they have suddenly disappeared. With only a few exceptions, you cannot learn this in any of the schools of economics anywhere in the world.

There would be no need for Supply-Side University if the concepts you learn here were routinely taught in college economics departments. Supply-side economics, per se, is not systematically taught at any school in the world. This is undoubtedly why, without any publicity, we now have more than 1000 registered students around the world. 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 a graphic description of the law of diminishing returns applied to public finance, Next week's lesson will be the first this semester devoted to it.

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, I 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. Mundell, now 65, is one of the great economists of the century, but has not won a Nobel Prize for his work because it is so dramatically different than the demand-side paradigm that dominates academic economics everywhere. In a 1974 essay I wrote about "The Mundell-Laffer Hypothesis: A New View of the World Economy," I compared Mundell to Copernicus, whose insight that the earth revolved around the sun provoked an intellectual revolution that we can today relate only to the breakthroughs of the Internet.

The metaphor is useful if we understand that the most important intellects of the Ptolemaic era were the astronomers who were schooled in Euclidean geometry and the calculus. They had the cushiest jobs with the highest pay, because they knew how to predict the seasons and chart navigation on the high seas, even though their basic paradigm was wrong. It was tough work to do what they had to do with a starting assumption that the sun revolved around the earth. When Copernicus came along, he was a threat to the entire scientific establishment. It took a long, long time for the world to shift to the new paradigm, and a great many people were burned at the stake by the Establishment for advocating the sacrilegious Copernican view. The term paradigm is one of the most important in political and economic philosophy. In astronomy, the Copernican paradigm is the assumption that the earth revolves around the sun, and not vice versa. That paradigm anchors the starting assumptions that undergird all the astronomical sciences.

In economics, as in astronomy, there can be only two paradigms. Either the universe revolves around the producer of goods or it revolves around the consumer of goods. A producer supplies goods. A consumer demands goods. These 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 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 concerned most with the management of national or international economies, governments are the main employers of macroeconomists. It is natural for the state to prefer demand-side economics, because it provides a political rationale for the government to manage aggregate demand.

Not all economics taught is macro. In fact, most economics taught is microeconomics, or the economics of the enterprise units that in combination comprise the national economies. Micro or small is a study of the supply and demand for shoes, for example, in a community shoe store. Or it is a study of the economics of Amazon versus Yahoo, as they compete for global market share in the WalMart of the Internet. So "micro" means small only in the sense that it is less than the aggregate of all the units, as small as a shoe store or as big as IBM. At the micro level, 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. 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 he will move himself and his family or company 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 the political class gets from its consumers, the voters or "subjects," are not as easily interpreted as the signals that come to a shoe manufacturer. When they think they see the signals and understand them, it is not easy to put to them to use in changes in pricing, i.e., tax rates, regulations, or other forms of national economic management -- monetary policy and tariff/trade policy tools. The best way I can put this into an image was first described by Andrew Mellon, who was Treasury Secretary during the Roaring Twenties.

Mellon in 1924 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, he pointed out, except the competitive market of other automakers forces Ford to produce as many as it can for as little as it can. It is no wonder that when General Motors and Chrysler compete, the Big Three together produce the widest array of autos at roughly similar prices for what you get. Government, Mellon argued, would like to charge most by offering 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 ballot box will similarly make wise decisions. When the price for private goods gets so low that producers cannot make a profit, they will not produce and the public will then accept a price increase. In the public sector, it is not unusual for voters to support tax increases in order to get the public goods they desire.

Many may be fooled in both markets by vendors selling "lemons" or making promises they do not 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. Due to 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 then also must 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 how do we explain the voters giving Republicans control of Congress for the first time in 40 years, after Bill Clinton promised a tax cut, raised tax rates instead, and tried to socialize medicine when he had not campaigned on that idea.

It is not the purpose of this course in supply-side economics to criticize demand-side economics. You will find SSUniversity is as much about politics as about economics, but do not worry that you will get "Republican" 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 late economist Norman Ture 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 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 my 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 2000 may influence the course of the stock market today.

We had 978 registered students for the Fall Semester, and more than 1000 now. 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 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.

For those of you who are serious about learning at SSU, a reading of The Way the World Works is essential. It is now 20 years since it was first published, now in a 4th edition published last year by Regnery, which you can easily purchase in paperback via our home page link, or through Amazon. It is not the kind of book you can read in one sitting, but it is also not a difficult book. I originally told my first publisher I was going to write it for "the inquisitive high school graduate or the average congressman." If you are serious about SSU and learning what I have to teach, you owe it to yourself to get a copy of TWTWW as this semester begins. There are other books I will be suggesting to you during the semester. 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. The easiest way to participate is through our "TalkShop," which you can access on this home page. You will be asked to register if you wish to participate in the classroom discussions, if only to ask a question. There will be no charge and no pain or embarrassment. We now have a sizeable cadre of graduate students who have been through the last five semesters and summer sessions, who are beginning to blossom on their own. They are as eager to teach what they have learned as I have been to initiate the process. Put aside your apprehensions, jump in and discover the joys of learning about this "lost continent of economics," as Bob Bartley of the WSJournal once put it.