Rediscovering Supply Side Economics

Posted: Apr 18, 2001 12:00 AM
A few days ago, The New York Times rediscovered supply-side economics. Every few years, either it or the Wall Street Journal does a piece about the revival of supply-side economics. It always amazes them to discover that it is still kicking around, since elite opinion holds that it is nothing but "voodoo economics," in George H. W. Bush's unforgettable phrase. Papers like the Times, therefore, treat its periodic sightings of supply-side economics like the discovery of a Japanese soldier still fighting World War II on some isolated Pacific island. They are curious about the phenomenon but cannot understand it. Part of the fascination with supply-side economics by its critics is that it doesn't fit into standard models of how ideas affect public policy. Elites always believe that they are the font of wisdom, and so they assume that the flow of ideas goes something like this: A professor at a prestigious university such as Harvard gets an idea. He writes a book or an article in a scholarly journal about it. The idea becomes a topic of academic interest, leading to conferences and symposia on its importance. The next step is for a newspaper with good contacts in academia, such as The New York Times or Boston Globe, to trumpet the importance of this new idea. Its originator will be invited to publish a popular version of it as an op-ed article. This will lead to discussion in popular journals with scholarly pretensions, such as the New Republic or New York Review of Books. Eventually, the ideas trickle down to members of Congress and administration officials, who act on the idea. The supply-siders, however, threw this whole model out the window. They managed to bring about major changes in tax policy without any base at a university -- Ivy League or otherwise -- or the usual circuit through obscure academic journals. The supply- siders leap-frogged the process by going straight to the Congress and the administration. This violation of the traditional model offends the Times because it leaves no role for it as an arbiter of what is right and what isn't. It's why its economic columnist Paul Krugman, also a professor at Princeton, can barely control himself when attacking supply-side economics. After al --horror of horrors -- none of its practitioners have ever gotten tenure at an Ivy League university, as he has. Therefore, their ideas must be illegitimate, by definition. Fortunately, no listens to Krugman, so his juvenile rantings have no impact on public policy. In any case, it is a gross distortion of reality to say that supply-side economics lacks a respectable scholarly pedigree. Indeed, it is the very fact that it is so solidly grounded in the work of the great economists that has been a key reason for supply-side economics' success. Clearly, Adam Smith was the first supply-sider. "The Wealth of Nations" is virtually a treatise on the subject. Its whole focus is on how to increase the supply of goods and services, because that is the source of wealth and prosperity. And Smith well understood the critical role of taxation in the production process. By reducing the rate of return on productive economic activity, high taxes impoverish society and even reduce the government's revenue. Said Smith, "High taxes, sometimes by diminishing the consumption of the taxed commodities and sometimes by encouraging smuggling, frequently afford a smaller revenue to government than what might be drawn from more moderate taxes." Building on Smith's insights, his French disciple Jean-Baptiste Say did much to draw out the supply-side implications of his work. Thomas Jefferson was particularly impressed with Say's work and got his "Principles of Political Economy" translated into English. He said it was "shorter, clearer and sounder" than Smith's book. Say's critical insight was in the role of the entrepreneur, who is the sparkplug for all economic activity. It is he, by spying a profit-making opportunity and undertaking to make it happen, who makes the economy run. (Hence, the word entrepreneur literally means undertaker in French.) Say also promulgated his famous law of markets. In his excellent new book, "The Making of Modern Economics," economist Mark Skousen describes Say's Law like this: "Production is the cause of consumption, or in other words, increased output leads to higher consumer spending." The importance of Say's Law is that it places production -- i.e., supply -- at the very center of the economic process. Subsequently, Keynesian economics elevated demand to the top of the economic ladder. In the view of John Maynard Keynes, supply takes care of itself as long as the government ensures that there is sufficient demand for goods and services. This is done by running budget deficits and an easy monetary policy. In short, producers produce because people spend, in the Keynesian system. Keynesian economics was eventually discredited by the high inflation and slow growth of the 1970s. Its critics had all along predicted that stimulating demand without increasing supply had to cause inflation. But until stagflation came long, elite opinion rejected the idea. Now, after 25 years of being discredited, Keynesian economics seems to have made a comeback, as Congress prepares to enact a tax rebate. This is almost classic Keynesian policy -- send out checks to everyone and hope they spend it, and this will raise growth. Ironically, Keynes himself knew better. In a 1933 article, he had this to say about excessive taxation: "Nor should the argument seem strange that taxation may be so high as to defeat its object, and that, given sufficient time to gather the fruits, a reduction of taxation will run a better chance than an increase of balancing the budget." It is probably too much to hope that supply-side economics will ever get the respect it deserves in academia or from New York Times columnists. But supply-siders are content with just being right and a continuing irritant to elitists.