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Tuesday, December 1, 1992

The Seven Fat Years and How to Do It Again

Supply-side economists have no inclination to take even the first steps toward dismantling the welfare state.

Robert Bartley has written a history of U.S. economic policy during the 1970s and 1980s from a supply-side perspective. Given his position as editor and vice president of The Wall Street Journal, he draws heavily from that publication for source material. Thus, it should not surprise us that his book reflects both the Journal’s disdain for most economic policies of the Nixon and Carter years and its stance as a cheerleader for Reaganomics.

The Seven Fat Years was written with two purposes in mind. The first was to counter the view of so much of the intelligentsia that the 1980s was a period of veritable economic disaster for all but the “rich.” Bartley does so by reminding us that the ‘80s was a decade of flourishing entrepreneurial activity and consequent economic well-being (31 percent growth in real GNP from 1982 to 1990, and the simultaneous massive reduction in the rates of inflation, unemployment, and interest), both in absolute terms and by comparison with the seventies and (so far) the nineties.

The second purpose Bartley had in mind in writing this book was to advocate the continuation and extension of the policies to which he credits these successes. He saw the 1980s as the apotheosis of supply-side economics and his book is a paean to the set of theories bearing that designation. While those theories are by no means without merit, they suffer from several blind spots which provide this reviewer reason to take issue with several of the book’s major points.

The author starts with the 1970s (he takes the liberty of defining his decades by policy regime rather than strict chronology, so that his ‘70s last until the end of 1982) to remind us just what we were up against as the ‘80s dawned. To quote him: “Still, the fat years were a striking contrast with the nine years between 1973 and 1982, when the economy grew at a rate of only 1.6 percent a year. That miserable period saw four years with actual declines in real GNP; productivity stagnated and poverty grew. By the way, inflation raged, with the consumer price index leaping by more than 10 percent in each of four years—1974, 1979, 1980 and 1981.”

Bartley assigns various degrees of blame for this state of affairs to Nixon’s New Economic Policy (wage-price controls and dollar devaluation), the Impoundment Act of 1974 (which reduced presidential power to limit government spending), excessive money creation, and rising taxes (mostly as a result of inflation pushing people into higher tax brackets as well as generating fictitious, but taxable, capital gains). Two other contributing factors, the increase of federal regulations (particularly the EPA and OSHA) and the burgeoning expenditures for the Great Society entitlement programs, were omitted but seem to belong here as well.

Against the backdrop of these events, Bartley introduces his readers to the policy discussions of the “inner circle” of the supply-side movement—Arthur Laffer, Robert Mundell, Jude Wanniski, and himself—at the New York eatery Michael 1. The author came away from these deliberations with three major policy prescriptions. To stop the price inflation caused by easy money, the consensus favored tying monetary policy to the price of some commodity, preferably, but not necessarily, gold. Since this price rule would apply to the international economy as well, it would restore fixed exchange rates and thus prevent the erosion of the international division of labor. To help revive the economic growth (which had slowed to a crawl), they called for steep reduction of tax rates, not only directly but also by indexing both tax brackets and, more importantly, the basis for computing capital gains. Finally, there was agreement that the growth of government spending must be restrained and despair of its being done in the absence of institutional constraints such as a line-item veto or balanced budget rule.

He proceeds to catalogue the implementation of these policies: the 1978 Steiger capital gains tax cut, the 1982 Reagan income tax cuts (which he characterizes as both smaller and more slowly implemented than desirable), and Volcker’s tight money policy, which targeted the money supply through 1982 and price level thereafter. This done, he asserts their efficacy, stating, “As 1982 drew to a merciful close, both sides of the Michael 1 prescription were finally coming into place. The Seven Fat Years started in November.”

The supply-side fiscal policies that Bartley advocates, namely lower tax rates and reduced government spending, are admirable. However, his enthusiasm for the policies actually enacted may be misplaced, given that he is settling for no more than half a loaf. As he himself recognizes, because of the much lamented quest for “revenue neutrality,” the justly acclaimed rate reductions of 1981 and 1986 were offset, to a large extent, by the elimination of many personal deductions and increases in business taxes in those very same bills, not to mention the increases in Social Security taxes and the tax increases of 1982 and 1984. And government spending fell only in relative terms, never in absolute terms.

On the controversial Laffer Curve, Bartley’s effort to rescue it from the caricature which would have it imply that any tax rate cut will increase government revenue is successful on its own terms, although his assertion that the prohibitive range starts at 35 percent seems unrealistically low. The real problem with the Laffer Curve is that it appears to accept the premise that the raising of tax revenue is the most important justification for reducing tax rates. Philosophical arguments, such as the presumption that taxpayers have first claim to what they have earned in the absence of compelling evidence to the contrary, have never been the supply-siders’ strong suit.

Perhaps the most serious weakness of supply-side economics is its treatment of monetary policy and the business cycle. That weakness manifests itself in this book in the notion that recessions are really independent of the booms that preceded them. To quote once more, “. . . we are not helpless before some inexorable ‘cycle.’ Without such artificial impediments as wage-price controls or Reg[ulation] Q, expansions can in theory go on indefinitely . . . .” This view rejects the lesson of Austrian business cycle theory that the seeds of recession are already planted by the credit expansion which generates the boom. Bartley makes this quite explicit by criticizing F. A. Hayek’s view that “you cannot stop inflation without causing a depression.” Indeed, he goes so far as to argue in the face of contrary evidence that “Somehow the abrupt end to inflation did not cause a depression. Somehow, indeed, vigorous growth emerged in 1983.” To claim that the 10.8 percent unemployment rate of 1982 was not a depression is to make far too much of the distinction between a recession and a depression.

By calling for price level stabilization as a proper goal of monetary policy, Bartley frees himself from the errors of the seventies only to embrace the errors of the twenties. As much as a monetary policy which stabilized prices is to be preferred to the more obviously inflationary policy currently in effect, it would nonetheless generate malinvestments and the boom-bust cycle. It did so in the 1920s, even though many prominent economists were fooled into declaring that period a “new era” in which we had rid ourselves of the cycle.

The view that price stabilization is an appropriate monetary policy ultimately rests on the belief that money is neutral. By taking money to be neutral, supply-side economics is oblivious to the extent to which the “seven fat years” were also seven years of fat, much of which would have to be shed in a subsequent recession. The recession which started in 1990 would have occurred even in the absence of the tax hike, S & L problems, and other factors to which Bartley attributes blame. None of this, however, should be taken as a failure to recognize that there were many healthy developments during this period. There were, indeed, and Bartley describes them, albeit incompletely. Conspicuous by their absence in his account were any mention of the deregulation movement (as halfhearted as it was) and the firing of the PATCO strikers, which set the stage for other events which weakened unions’ ability to keep wages above their equilibrium level.

To return, however, to the causes Bartley did choose to emphasize, I found his defense of the financial innovations which allocated capital to some of the most productive people in the country, particularly “junk” bonds and leveraged buy-outs, to be well done. He insightfully places those developments in a broader historical context. Indeed, it is interesting to learn here that the bonds of only 800 of the 23,000 largest U.S. companies would not be classified as “junk.”

The parts of this work which I found to be of greatest value were his critiques of two perennial bogeymen: the trade deficit and income inequality. Both have been used with no little success to provide cover for any number of perverse policies—protectionism, currency devaluations, and tax increases, to name only the most obvious. In each case, he shows the basic flaws in the concepts themselves and the substantive harm in enacting the policies they are used to advance. Here he points out the striking fact that a mere $53,711 placed a household in the highest 20 percent of the income distribution in 1989, and $91,751 placed it in the top 5 percent. Widespread knowledge of these figures combined with the realization that many of these incomes are produced by two earners should, I would hope, cool some of the zeal for taxing the “rich” which is currently at a fever pitch.

All in all, this book is a better source of information on the supply-side paradigm than it is of understanding this particular business cycle episode. It reveals the supply-side mindset to be one which favors piecemeal, even inconsistent, application of free market ideas. The message conveyed throughout this book is that supply-side economists have no inclination to take even the first steps toward dismantling the welfare state. They merely intend to make it more efficient. Anyone looking for a ringing affirmation of laissez faire in these pages will be as disappointed as he was by the policies of the Reagan years described therein.

Robert Batemarco teaches economics at Marymount College, Tarrytown, New York, and at Dominican College, Orangeburg, New York.

  • Robert Batemarco teaches economics on an adjunct basis at Fordham University and Manhattan College. He was formerly book review editor of The Freeman. He is a member of the FEE Faculty Network.