Asia Times: Honor Bob Mundell as father of the supply-side revolution



	October 16, 1999	atimes.com

Editorials

Honor Bob Mundell as father of the supply-side revolution

In a press release dated October 13, 1999, the Royal Swedish Academy of Sciences announced that it had awarded the Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel, 1999, to Professor Robert A Mundell, Columbia University, New York, USA, ''for his analysis of monetary and fiscal policy under different exchange rate regimes and his analysis of optimum currency areas''.

There is nothing wrong with the cited motivation for the award of the Nobel Prize in Economics to Mundell as such. His work on monetary dynamics and optimum currency areas indeed constitutes a seminal contribution to economic science and - as the Swedish Academy points out - ''has inspired generations of researchers [and], although dating back several decades, . . . remains outstanding and constitutes the core of teaching in international macroeconomics''.

But there is something drastically wrong with the Academy's and a majority of commentators' failure to acknowledge the significance and impact of the practical side of Mundell's work with which - from the early 1970s onward and on the basis of his theoretical insights - he laid the foundations of the supply-side revolution in economic policymaking and, along with Art Laffer, developed that oft-maligned policy package called ''Reaganomics''. The economic policies pursued by the 1980s Reagan administrations are the basis of America's current prosperity and world-economic leadership and represent Mundell's most lasting legacy. But perhaps the politically correct Swedes, whose country has just begun to dig out from under the miseries of euro-socialism, would rather not be reminded or remind the world of such facts of real life.

In 1974, six years before Ronald Reagan became president, Jude Wanniski, a former Wall Street Journal editorial page editor and now President of Polyconomics Inc., a New Jersey-based economics research and investment advisory outfit, interviewed Mundell for the Journal and wrote up his observations under the title ''It's Time to Cut Taxes'' in the paper's December 11 issue. We quote parts of Wanniski's piece. It establishes Mundell's authorship of the basic policy precepts of ''Reaganomics'' in the clearest of terms. [Keep in mind, of course, that the historical economic context of Mundell's remarks is the ''stagflation'' of the 1970s.]

''Robert A Mundell, a Canadian economist now at Columbia University, does not believe the United States can Whip Inflation Now and climb out of the deepening recession by harking to either the classical economic advice of tight money and balanced budgets or to the neo-Keynesian nostrum of easier money, public-service employment and wage-and-price controls.

''The correct prescription, says Professor Mundell, is a $30 billion tax cut and the temporary halting of open-market operations by the Federal Reserve to assure monetary restraint.

''Professor Mundell's prescription is obviously not part of mainstream thinking in the United States . . . To deal with the immediate crisis of simultaneous inflation and recession, [he] departs from the traditional belief that monetary and fiscal policies should always be working in the same direction. He believes that inflation and unemployment are separable problems and that to combat them distinct policy instruments are required. He believes that tight money should be used to combat the inflation, while expansive fiscal policies - preferably through lower taxes - can be used to combat the recession in a way that also works against inflation.

''Real economic growth would be stimulated by [a] big tax cut on both personal and corporate incomes . . . 'The level of US taxes has become a drag on economic growth in the United States,' he says. 'The national economy is being choked by taxes - asphyxiated. Taxes have increased even while output has fallen, because of the inflation. The unemployment has created vast segments of excess capacity greater than the size of the entire Belgian economy. If you could put that sub-economy to work, you would not only eliminate the social and economic costs of unemployment, you would increase aggregate supply sufficiently to reduce inflation. It is simply absurd to argue that increasing unemployment will stop inflation. To stop inflation you need more goods, not less.'

''A tax cut not only increases demand, but increases the incentive to produce. 'The government budget recycles tax dollars into the spending stream through expenditures, but in so doing it reduces the incentive to produce and lowers total production. After all, if total taxes and expenditures become confiscatory, all economic activity would cease and the government tax bite would be 100% of nothing.' With lower taxes, it is more attractive to invest and more attractive to work; demand is increased but so is supply.

''The international effects of a tax cut are particularly important, he asserts. With announcement of a major tax cut, the capital market would instantly perceive that it is more profitable to do business in the United States than the rest of the world. Capital that is now flowing out would remain; foreign capital going elsewhere would come in. The increased real economic growth would mean the US would run a sizable trade deficit as the US would keep more of what it produces and buy more goods from abroad . . . [But] there would be a balance of payments equilibrium, he says, because the capital flows would cover any residual trade deficit until market opportunities were arbitraged world-wide. The US tax cut would help to pull the whole industrial world out of its slump, he maintains.

''In a real sense, he sees the $30 billion tax cut as a future public's investment in the current private, productive sector of the economy that is now unutilized. He argues that the unemployed sub-economy would respond not only by producing goods and services sufficient to repay the [tax-cut financing] bonds, but would meanwhile sustain itself with output and would not have to be carried by the government dole.''

Well, the Reagan administration implemented the tax cuts Mundell recommended, tightened monetary policy, and ignored the yelling and screaming and derisive comments of the naysayers. The rest is history and played out exactly as Mundell had foreseen and foretold: the US economy picked up, inflation subsided, foreign capital inflows increased dramatically, unemployment went down over time as investment increased; ultimately, budget deficits disappeared as the tax base grew dramatically. The basis for current prosperity, record-low unemployment and record-low inflation, had been laid. In 1974 it was too early for Mundell to speak about or anticipate the impact of information technology and the Internet that have further boosted US productivity and allowed the economy to sustain its non-inflationary growth path. But without the Mundell-inspired Reagan reforms the macroeconomic boundary conditions for decade-long expansion would not have existed.