Who Supplied the Supply Side?

The Power of the Financial Press: Journalism and Economic Opinion in Britain and America, Wayne Parsons (New Brunswick, N.J.: Rutgers University Press, 1990), 300 pages, $ 24.95. The Growth Experiment: How the New Tax Policy Is Transforming the U.S. Economy, Lawrence B. Lindsey (New York: Basic Books, 1990), 288 pages, $ 21.95. In 1944, an Australian taxi driver struck up a conversation with Colin Clark, an Englishman who was then one of the world’s leading development economists, just a step or two behind John Maynard Keynes himself. The taxi driver—as so often in stories like this, an economist-historian-philosopher—speculated that the soon-to-be-victorious Allied powers would eventually tax themselves into ruination, just like the great global empires of the past. The conversation triggered a somewhat more precise train of thought in Clark, which he wrote up with considerable excitement and published in England’s Economic Journal in 1945. Clark’s argument went something like this: people are always wondering what causes inflation in the late stages of empires; perhaps public finance is a dominating factor. Excessive taxation—levied suddenly or unequally or for payment of interest on public debt and therefore capable of being relieved (in terms of its real burden) by a general rise in prices—might cause “a temporary transfer of allegiance from the deflationary to the inflationary side on the part of a number of politicians, bankers, economists, and others, sufficient to alter the balance of power.” In other words, inflation would be used like a tide to float the burden of government off the backs of taxpayers. Once inflation had diminished the value of money sufficiently to render the burden tolerable again, the same administrative, political, and banking coalition that had contrived the inflation in the first place would revert to form, opposing all new acts it perceived as a threat to the purchasing power of money. Clark calculated that this informal limit on the fraction of national income that might safely be devoted to government spending before the lid came off was around 25 % , with variations depending on the circumstances. For a short time, Clark’s idea of an informal natural check on the size of government was hotly debated. Then it was dismissed as just plain wrong. It passed into limbo with similar rules of thumb formulated by historians from Edward Gibbon to Fernand Braudel. For the next 40 years, the economies of the social democratic welfare states of the industrial West grew more rapidly than ever before in history, and so did the size of their governments. Economists narrated this growth with unaccustomed confidence that they had somehow broken into a new dispensation. They dismissed as cranks the dissidents who criticized programs like Social Security, unemployment insurance, or defense spending. They endorsed, in fact, made a law of nineteenth-century German economist Alfred Wagner’s prediction that the proportion of national income devoted to government spending would continually increase. Most of them took for granted the gradual convergence of Western mixed economies with socialist economies. Meanwhile, inflation in the industrial world gradually accelerated. By the mid-1960s, the first faint glimmerings of backlash were visible; by the mid-1970s, they were unmistakable. Newspaper editorials complained about the effects of high taxation; tax revolts took place at the ballot box in Sweden, Denmark, England, New York, Massachusetts, and California; legislators began preparing and passing tax-cut bills. Sometimes mavericks couched their analyses in terms of the disincentive effects of marginal tax rates, sometimes in terms of the wedge that taxes created between pretax and aftertax prices, sometimes in terms of how much control the government should or, rather, should not exercise. Everybody knows what happened next. Margaret Thatcher was elected in England, Ronald Reagan in the United States. Deng Xiaoping put China on a “capitalist road.” In France, François Mitterrand executed an abrupt U-turn, privatizing industries he had nationalized only a few years before. Third-World leaders studied the “Four Tigers”—Singapore, Hong Kong, Taiwan, and Korea—for lessons in economic development. Led by Poland, Eastern Europe and finally even the Soviet Union seemed to turn dramatically in the direction of democracy and a larger role for market systems. In the meantime, however, inflation settled down again, and real government receipts stabilized at what were apparently permanently lower levels. What was it that had happened? Had Colin Clark been right? Now, at last, books have begun to appear that treat this lengthy episode in our economic history as a systematic whole. These two are among the first, and, not surprisingly, they are a mixed blessing. If they make anything clear, it is just how mysterious the evolution was, especially when seen, as we all saw it, from close up. Surely the most striking thing about the “turn to the right” of the last two decades was the mostly grass-roots quality of its origins. Where the Keynesian revolution of the 1940s and 1950s began in the universities, spreading from the seminar room to the press, the supply-side movement went mainly the other way. Outsiders to the economic profession began it, and various monied interests, not necessarily corporate, eventually supported them. But the graybeards of the economic establishment, conservative as well as liberal, sharply resisted the tax-cut gospel. The exception, of course, was the extended University of Chicago economics department. But, well, more of that in a moment. The story of the key role the press played in reversing the economic policy of 50 years is well told by University of London lecturer Wayne Parsons in The Power of the Financial Press. It seems odd that nobody has attempted to tell this story before, but Parsons is the first to lay out in any detail the saga of how a small band of writers clustered around the Wall Street Journal in New York—Arthur Laffer, Jude Wanniski, Paul Craig Roberts, George Gilder, and Jack Kemp chief among them—were able to whip up enthusiasm for the 1981 personal-income tax cuts. Parsons also skillfully tells how, on the other side of the Atlantic, Sam Brittan of the Financial Times and Peter Jay of the Times of London, among others, were instrumental in bringing Milton Friedman’s views to the forefront in Britain. That Oxford’s Robert Bacon and Walter Eltis wrote an extremely influential series of articles in the Sunday Times that had almost nothing to do with the writings of Brittan, Jay, the Wall Street Journal, and the rest underscores the spontaneous nature of the mid-decade combustion—and the fact that even the most respectable academics found it easier to state their views in the popular press than in the scholarly journals. Three key chapters describing this “golden age of economic controversy” of the mid-1970s are nestled in a narrative history of financial journalism stretching back to the Economist‘s legendary Walter Bagehot in the mid-nineteenth century, the coffeehouse exchanges of the early 1700s, and before. What Parsons leaves out of his account almost entirely is the corresponding evolution of the views of technical economists during the same period. Columbia University’s Robert Mundell does not appear in this chronicle, though it was he who in 1971 first suggested the tax cuts and tight money that became the preferred regime of supply-siders. Nor does Nobel laureate Lawrence Klein, whose credentials as a liberal are unsurpassed but whose 1978 presidential address to the American Economic Association was titled “The Supply Side” and called for a “revolution” in the way economists modeled aggregate supply. Parsons ignores Martin Feldstein’s work, which laid the basis for the 1978 capital-gains tax cut that then served as a model for the 1981 act, and he doesn’t mention Mervyn King, the London School of Economics professor who contributed greatly to the debate. The rational-expectations school, with its somber message about the difficulty of fine tuning the economy; the public-choice movement, with its profound skepticism of government aims; the analysis of how businesspeople tend to engage in “rent seeking” or directly unproductive activity, which formed the foundation of deregulation—Parsons omits all these as well. Not even H.A. Turner, Dudley Jackson, and Frank Wilkinson make an appearance here, though it was they who first raised the possibility that it was swiftly rising taxes for the English working class in the late 1960s that lay behind increasing trade-union militance. This neglect of the influence of academic theory on the press and on policymakers is not surprising, for it is Parsons’s thesis that economics doesn’t really matter anymore. It has been rendered obsolete. The experiments of monetarism and supply-side economics have left the public gun-shy, he says, and technological change is ushering in a new era with very different sources of authority anyway. The new kids on the block are the ubiquitous house economists from financial firms and trade associations who make themselves available to pundits and business talk shows at the drop of a hat. The advent of the Telerate machine and Quotron and other forms of financial electronics have rendered university economists superfluous. He cites with approval Patrick Sergeant’s remark that macroeconomics is fair game for journalists because “nobody knows anything about it,” whereas “you must be careful about the price of fish and chips.” Parsons goes on, “In this brave new world, ideas count for much less than knowing what is going on at the moment… In saying goodbye to Gutenberg, we may also be bidding farewell to gurus and worldly philosophers.” Well, maybe. But it seems to me that gurus are more common than ever before. It is true that no one has come forward to replace the nicely differentiated trio of economic celebrities that were Paul Samuelson, Milton Friedman, and John Kenneth Galbraith. But that doesn’t mean that economics is in eclipse. The discussion of national savings in the United States—which is what the deficit debate has become—is persuasively couched only in terms of life-cycle models of the sort favored by the younger generation of economists. The way we deal with our thorniest trade issues depends on strategic trade theory. Market deregulation, the international monetary system, the day-to-day analysis of derivative instruments, questions of corporate control—all these have their beginnings in current economic theory. The kids who comment on the nightly business report acquire the basis for their views at the London School of Economics, the Federal Reserve System, and other centers of financial technology, but that doesn’t mean they are immune to intellectual fashions emanating from economics departments at the great universities. Surveying the field at close range, one might come to the conclusion that, precisely because of the explosion in communications, economics is more important than ever. In The Growth Experiment, economist Lawrence Lindsey takes just the opposite tack. Instead of saying that economics doesn’t matter, Lindsey asserts most emphatically that it does—and that its recent applications by the White House have been right on track. He states that President Reagan’s program of tight money and tax cuts worked more or less as advertised, that on most of the issues the Keynesians were wrong and their supply-side critics were right, and that the whole tax-cut episode had the clarity of a controlled experiment. Lindsey’s views have force because he has the privilege of being an economist, and a fairly good one at that. He trained at Harvard with Martin Feldstein, and for several years was Feldstein’s chief teaching assistant, inculcating the new conservatism into hundreds of happy college freshman annually. He is typical of a large and growing number of young economists who came of age during the 1970s and 1980s and who view John Maynard Keynes as something of an embarrassment, a Depression-era theorist whose concerns all pointed in one direction—toward oversaving and unemployment—while equally acute dangers—inflation and underinvestment—loomed over precisely the opposite horizon. According to Lindsey, the story of economics in recent years is of “an economic orthodoxy in decline and a challenger from the fringes of economic thought.” By this he means the gradual encroachment on the economic mainstream of the public finance dynamics of his teacher, Professor Feldstein, not the triumph of the journalists who led the parade in the early years of the Reagan administration. Some of what Lindsey has to say is what geometry teachers sometimes describe as being intuitively obvious. For example, there is what he calls the mild form of supplyside doctrine, the proposition that “taxes matter.” Who will now say that they don’t? Or consider his estimate of the political situation, that “Reaganomics has been so successful in practice that only a handful of idealogues advocate a return to dramatically higher tax rates.” Notwithstanding the fact that many members of Congress would like to add a third and higher income-tax bracket for the very well-to-do, he’s probably right. It’s hard to believe that the high marginal rates of the past—70 % , 91 % , even 98 % in Britain—will ever be seen again. At the eight-year mark (in contrast to the usual three or so), the expansion that began in late 1982 has a rhetorical force all its own. And most people feel, at least deep down in their bones, that the wave of perestroika that began in the United States and England at the beginning of the 1980s had at least something to do with the more extensive loosening-up that followed in the rest of the world. On the other hand, much of what isn’t obvious in Lindsey’s analysis is fascinating, even astonishing, but wants to be proved. Inflation rates fell as much because of tax cuts that promoted investment as because of tight money, he says. The proportion of all taxes paid by the rich has increased, not fallen, he says. The tax cuts weren’t quite self-financing, as the most boisterous supply-side advocates predicted, but they did generate two-thirds of the revenue that was lost. All this is carefully written, well mapped and integrated into the rest of what the great body of other economists think. His discussion of the nature of “dynamic” revenue forecasts is the most lucid I have ever read. (The static estimates that dominate the headlines assume, mostly for the sake of avoiding arguments, that there will be no behavioral changes, no fall in interest rates, no speedup in economic growth, whereas Lindsey expects all three.) Lindsey seems to me to go too far in at least a couple of respects. He hangs his analysis on a single, novel computer simulation based on a state-of-the-art economic model and on tax returns from 34,000 taxpayers over six years. His analysis is full of the usual counterfactuals: suppose we did A and we didn’t do B, or C and not D. This rhetorical apparatus may be enough to persuade other economists, or at least get them into court, but it doesn’t do much for me. Economists’ dependence on a few great, highly undifferentiated measurements is well known, and as a result their analyses seem at times to float up off the surface of the earth. Here’s a striking example that Lindsey tosses off casually in the middle of a chapter on debt: “On the average, American households in the late 1980s could pay off all their debts, including credit card debt, auto loans, and mortgages on their homes with their ready cash. They would not have had to touch their houses, cars, stock portfolios, pension funds, life insurance, small business holdings, or other assets.” Do you believe that? I don’t. I don’t believe it paints a picture of the liquidity of U.S. households that is useful to policymakers or anyone else. It weakens—it very nearly dissolves—my trust in the rest of Lindsey’s numbers. The same thing goes for his analysis of England, which he says has enjoyed an “astounding recovery” from its stagnation in the 1970s. Indeed, he talks as though the returns are in. But the last time I looked, Britain—with serious inflation, a balance-of-payments problem, and slow economic growth—had decisively fallen behind most other leaders of the industrial world. When Lindsey tells me that the United States is a model of glowing economic health, headed toward a great surplus in the 1990s, and that all it needs are a few more tax cuts to make it nearly perfect, I am inclined to go count the silver. What I find really inappropriate is Lindsey’s resort to the language and the philosophic stance of the schoolroom. Toward the end of the book, he writes. “Now for a short civics test. Answer ‘true’ or ‘false.’ To balance the budget of the 1990s, the Congress must either raise taxes or cut spending from current levels. The right answer is ‘false.’ If you responded ‘true,’ I won’t take off too many points. There is probably no more widespread myth about the U.S. budget system than the supposed need to raise taxes or cut spending.” But where exactly does Lindsey think he gets his authority as society’s grader? He’s entitled to his opinion that the right answer to his question is to cut taxes yet again and leave spending more or less where it is. And I suppose locutions like these are in some sense understandable; he was a teacher for many years. But, after all, he was teaching just down the hall from Benjamin Friedman, whose book Day of Reckoning is right next to Lindsey’s on my shelf. No one who believed Friedman’s dire predictions about the economic consequences of the 1980s would score high on Lindsey’s quiz—and Lindsey acolytes would never pass Friedman’s course. What’s more, many economists of Lindsey’s generation believe that a balanced budget in and of itself is not enough: to raise the national savings rate, either people must change their habits dramatically, or the budget must show a considerable surplus. I would have more confidence that Lindsey “lays Keynesianism to rest with a thoroughness that is…stunning” or “shows conclusively why the tax cuts [worked]” if I heard it from less ideologically committed economists than the moneymen who fund the Manhattan Institute (where Lindsey wrote the book) and supply-side Congressman Newt Gingrich, respectively. I’d have more confidence if Lindsey, who now works as a White House aide, aimed his case at his peers, at least implicitly, instead of going over their heads to the general public 15 years after the debate over taxes began. This is no way to run a science, not even a social science. There probably are right answers to the questions we all have about the abrupt shifts of economic policy we’ve seen around the world in the 1980s, but no more than the very beginnings of them can be found in this book. Other economists will find them over the next few years—narrowing the issues, splitting hairs, slicing matters ever thinner—until the kind of dependable consensus emerges among knowledgeable practitioners that is the hallmark of a successful science. In thinking about the state of technical economics—especially now in one of its periodic fits of extreme relevance to politics and policy—it may help to look for parallels in other young sciences. Easy analogies are hazardous, of course, yet nineteenth-century biology offers a tempting mirror in which to view the circumstances enfolding these two books. For many years, the publication of Charles Darwin’s Origin of Species was taught as a kind of wonderful, high-science revelation. A lonely scholar sailed around the world in youth, reflected on his experiences in troubled isolation, then reluctantly, in old age, revealed truth from the Parnassus that was Cambridge University. But recently there has been a surge of interest in what people believed and taught in the turbulent strata “below” the empyrean realms of Oxford and Cambridge during the 30 years before Darwin published, that is, in precisely the kind of activist intellectual subculture from which the economic policy of the last 20 years has emerged. It turns out that for 30 years before Darwin, biology was seething with evolutionary theories. In a really extraordinary new book, The Politics of Evolution: Morphology, Medicine and Reform in Radical London, Adrian Desmond, an English historian of science, relates how these views of “comparative anatomy” were taught in off-price anatomy schools, at secular London University, and among poor general practitioners struggling to make a living in industrializing London. Desmond provides a thoroughly political view of how this science developed among would-be reformers. The impulse to hypothesize a steady “march of nature”—rather than a static creation periodically updated by God—came from Cuvier and Lamarck in France, home of the hated Revolution. By the desperate 1830s—the period of the Poor Law Act and of much incipient violence and repression—London was full of all sorts of people jumping to conclusions about the common ancestry of life, some even offering the familiar metaphor of the evolutionary “tree.” They included crackpots, neophytes, amateurs, bad scientists and good ones; all were fiercely resisted by hospitals and fancy universities because of the ideological baggage that accompanied them. The new views tended to be republican, atheist, furiously democratic, much interested in the prospects for reforming society and perhaps even for leveling it. Desmond writes that “upper-class scholars and surgeons feared in turn that talk of life being powered by base Nature rather than the Godhead would wreck the paternalistic system on which their privileges depended.” He believes that it was the sheer political disreputability of the evolutionary viewpoint, not its theological implications (as commonly supposed), that kept Darwin from publishing until Alfred Russel Wallace forced his hand in 1858. Might it be that something rather like this infinitely complicated process has been unfolding these last 30 years in economics? After all, the striking thing about most of the tax revolt of recent decades has been the amateur quality of so much of its theorizing, while the main body of university economics has had very little to say about the relationship of the economy and the government, at least until recently. Even the notion of a persistent emphasis on “supply side” is repugnant to a field that for a century has taught that supply and demand are like the two blades of a scissors, meaningless when separate. Meanwhile, of course, there is politics—the constant stream of decisions, large and small, that must be made by the men and women at whom Lindsey’s book is aimed. Early in 1990, with the U.S. economy tottering on the brink of recession, the supply-siders were once again in the van of the debate, urging their preferred prescription of tight money and tax cuts as medicine for what they saw as a developing case of stagflation. There was nothing academic about it; Federal Reserve governor Wayne Angell led a rump faction within the Fed, arguing against further easing on the monetary side. George Bush pushed ahead, seeking cuts in taxes on capital gains. Senator Daniel Patrick Moynihan countered with a proposal for a reduction in the Social Security payroll tax. Supply-side proponents said that tax cuts would extend the business expansion well into the 1990s and give the United States a sudden boost among its competitors. Are they right? Readers of Lindsey’s book will be inclined to think they are. But to the rest of us, including, I suspect, most economists, it smacks of the “fine tuning” so despised by anti-Keynesians. The United States needs to do something about its rate of savings and investment, and some form of grand compromise of spending cuts and tax increases is the place to start. So wise businesspeople will continue to follow the debate over “the growth experiments” of the 1980s in the media and, of course, in consultation with the experts close to home that they prefer. But they will avoid investing too much faith in books like this one (or, for that matter, the better written Day of Reckoning). Maybe we really are waiting for a new Keynes, who can ratify the various theoretical breakthroughs of the last few years, gather them into a single unified picture of the political and economic fundament, and persuade fellow economists that It and only It is The Truth. Perhaps simply a textbook with the authority of the entire profession behind it will do. What seems fairly clear today is that Colin Clark and his taxi driver were, in fact, onto something and that the intimations we have been hearing ever since will eventually add up to some fuller understanding of how the world works. It may be that for a complete appreciation of how this happy state of general agreement might come about, we will have to look not only to technical economics of the polite, responsible variety but also to angry, dissident, suppressed, sometimes even bought-and-paid-for views. In the meantime, I take comfort in my favorite aphorism on the subject, by the physicist Richard Feynman. He said, “A great many more things can be known than can be proved.”

Who Supplied the Supply Side?

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