Saturday, May 18, 2013

A Walk on the Supply Side

Establishment historians of economic thought—they of the Smith-Marx-Marshall variety—have a compelling need to end their saga with a chapter on the latest Great Man, the latest savior and final culmination of economic science. The last consensus choice was, of course, John Maynard Keynes, but his General Theory is now a half-century old, and economists have for some time been looking around for a new candidate for that final chapter. For a while, Joseph Schumpeter had a brief run, but his problem was that his work was largely written before the General Theory. Milton Friedman and monetarism lasted a bit longer, but suffered from two grave defects: (1) the lack of anything resembling a great, integrative work; and (2) the fact that monetarism and Chicago School Economics is really only a gloss on theories that had been hammered out before the Keynesian Era by Irving Fisher and by Frank Knight and his colleagues at the University of Chicago. Was there nothing new to write about since Keynes?

Since the mid 1970s, a school of thought has made its mark that at least gives the impression of something brand new. And since economists, like the Supreme Court, follow the election returns, “supply-side economics” has become noteworthy.

Supply-side economics has been hampered among students of contemporary economics in lacking anything like a grand treatise, or even a single major leader, and there is scarcely unanimity among its practitioners. But it has been able to take shrewd advantage of highly placed converts in the media and easy access to politicians and think tanks. Already it has begun to make its way into last chapters of works on economic thought.

A central theme of the supply-side is that a sharp cut in marginal income-tax rates will increase incentives to work and save, and therefore investment and production. That way, few people could take exception. But there are other problems involved. For at least in the lands of the famous Laffer Curve, income tax cuts were treated as the panacea for deficits; drastic cuts would so increase revenue as allegedly to yield a balanced budget. Yet there was no evidence whatever for this claim, and indeed, the likelihood is quite the other way. It is true that if income-tax rates were 98% and were cut to 90%, there would probably be an increase in revenue; but at the far lower tax levels we have been at, there is no warrant for this easy assumption. In fact, historically, increases in tax rates have been followed by increases in revenue and vice versa.

But there is a deeper problem with supply-side than the inflated claims of the Laffer Curve. Common to all supply-siders is nonchalance about total government spending and therefore deficits. The supply-siders do not care that tight government spending takes resources that would have gone into the private sector and diverts it to the public sector. They care only about taxes. Indeed, their attitude toward deficits approaches the old Keynesian “we only owe it to ourselves.” Worse than that: the supply-siders want to maintain the current swollen levels of federal spending. As professed “populists,” their basic argument is that the people want the current level of spending and the people should not be denied.
Even more curious than the supply-sider attitude toward spending is their viewpoint on money. On the one hand, they say they are for hard money and an end to inflation by going back to the “gold standard.” On the other hand, they have consistently attacked the Paul Volcker Federal Reserve, not for being too inflationist, but for imposing “too tight” money and thereby “crippling economic growth.”
In short, these self-styled “conservative populists” begin to sound like old-fashioned populists in their devotion to inflation and cheap money. But how to square that with their championing of the gold standard?

In the answer to this question lies the key to the heart of the seeming contradictions of the new supply-side economics. The “gold standard” they want provides only the illusion of a gold standard without the substance. The banks would not have to redeem in gold coin, and the Fed would have the right to change the definition of the gold dollar at will, as a device to fine-tune the economy. In short, what the supply-siders want is not the old hard-money gold standard, but the phony “gold standard” of the Bretton Woods era, which collapsed under the bows of inflation and money management by the Fed.
The heart of supply-side doctrine is revealed in its best-selling philosophic manifesto, The Way the World Works by Jude Wanniski. Wanniski’s view is that the people, the masses, are always right, and have always been right through history.

In economics, he claims, the masses want a massive welfare state, drastic income-tax cuts, and a balanced budget. How can these contradictory aims be achieved? By the legerdemain of the Laffer Curve. And in the monetary sphere, we might add, what the masses seem to want is inflation and cheap money along with a return to the gold standard. Hence, fueled by the axiom that the public is always right, the supply-siders propose to give the public what they want by giving them an inflationary, cheap-money Fed plus the illusion of stability through a phony gold standard.

The supply-side aim is therefore “democratically” to give the public what they want, and in this case the best definition of “democracy” is that of H. L. Mencken: “Democracy is the view that the people know what they want, and deserve to get it good and hard.”

Murray N. Rothbard

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