Book Review: The Making of Modern Economics

Click here to purchase The Making of Modern Economics by Mark Skousen

Click here to purchase The Making of Modern Economics by Mark Skousen

From an online book review on BillyBush.Net:

I recently finished “The Making of Modern Economics” by Mark Skousen.  I found this book quite intriguing.  It provides a powerful foundation and historical background to economic thought by offering the histories of the individuals that most contributed to modern schools of economics and public policy.

A Year of Miracles — 1776

Personal Snapshots
Forecasts & Strategies
August 2002

“The cause of America is in great measure the cause of all mankind.”

— Tom Paine, Common Sense (1776)

A Year of Miracles

Like most Americans, I’ve always been fascinated by the events of 1776. It was a year of earth-shattering events that transformed forever the Western world.

It is, of course, the year the American colonies broke off relations with the Mother Country, declared political independence from monarchy, and established the words of Thomas Jefferson that “all men are born equal” and endowed with certain “inalienable rights.”

It is the year that Adam Smith’s monumental Wealth of Nations was published, a powerful declaration of economic independence. Smith proclaimed the establishment of a “system of natural liberty” and the “invisible hand” doctrine that private enterprise would benefit the public wealth.

It is the year the eminent British historian Edward Gibbon published the first volume of his classic history, The Decline and Fall of the Roman Empire. It was considered a scandalous book because it blamed the decline and fall of Rome after it adopted Christianity as its state religion. Through his review of the Roman world, Gibbon emphasized the principles of “liberty, virtue and courage.”

Last but not least, 1776 is the year Thomas Paine’s Common Sense was printed, and Paine, more than any other revolutionary figure, symbolized the Age of Enlightenment. Paine’s philosophy encompassed the entire compass of liberty. He was a radical who advanced democratic emancipation, individual rights, religious tolerance and competitive capitalism.

Just as Adam Smith, Thomas Jefferson, Edward Gibbon and Tom Paine were radicals of their day, so the Foundation for Economic Education and its supporters are the radicals of our day, supporting maximum political, economic and religious freedom.

 

Where Are the Best Schools in Austrian Economics?

Ideas On Liberty
Economics on Trial
July 2001

by Mark Skousen

“We must raise and train an army of fighters for freedom.”
—F. A. Hayek

Frequently students or parents approach me at investment or economics conferences with the question, “Can you recommend an undergraduate or graduate program in free-market economics?” With the explosive interest in a degree in economics, it’s imperative that students get a topnotch education.* In my experience, if students aren’t exposed early to the principles of Adam Smith and Ludwig von Mises, it is often difficult for them to shed the philosophies of John Maynard Keynes, Karl Marx, and other interventionsts later on.

Here in the United States most colleges and universities have a goodly number of “neoclassical” economists with a free-market bent. (There are a number of “free market” colleges and universities in Latin America, Europe, and Asia, a topic I shall pursue in a future column.) The American schools include the University of Virginia; the University of California, Los Angeles (UCLA); Florida State University; and the University of Chicago. However, anyone pursuing a degree in economics from these institutions will need to be well-versed in advanced mathematics in order to understand the professional language. As New York University Professor Mario Rizzo wrote me, “Contemporary economics has become a branch of applied mathematics.”

Graduate Schools in Austrian Economics

Fortunately, there’s a growing number of schools that specialize in Austrian economics. The best-known program is located at New York University, ranked as one of the top 20 economics departments in the country. The Austrian Economics Program, under the tutelage of Israel Kirzner, David Harper, and Rizzo, has been functioning at NYU since the days of Mises. The Austrian course work attracts students from around the world.

NYU also offers a weekly Austrian Economics Colloquium and an annual summer course held at FEE. (Go to www.econ.nyu.edu/dept/austrian.) However, it should be noted that the NYU program is small, and most of the teachers there are non-Austrian.

George Mason University (in northern Virginia) is also attracting undergraduate and graduate students who want to specialize in Austrian economics, although Professor Peter Boettke, who also edits The Review of Austrian Economics, says that “what makes GMU particularly attractive are its affiliated fields of Public Choice, history of thought, and constitutional economics.” Boettke and Karen Vaughn teach the Austrian theory of the market process; Richard Wagner offers a course in institutional economics; and Walter Williams serves as chairman of the department. (Go to www.gmu.edu/departments/economics.) The Institute for Humane Studies is also located at GMU (www.theihs.org).

Another graduate Austrian program that is gaining prominence is at Walsh College of Accountancy and Business Administration in Troy, Michigan (near Detroit). Walsh College (www.walshcol.edu) specializes in business degrees—in marketing, management, finance, and economics. Under the direction of Harry Veryser, the school now offers a two-year bachelor’s degree and a master’s degree in economics. The entire faculty consists of free-market economists, with a special emphasis on Austrian economics. Students are assigned books and readings by Mises, Hayek, Henry Hazlitt, Wilhelm Ropke, Paul Heyne, and me, among others. Walsh’s program is impressive.

The Expanding Austrian Universe

With the Ludwig von Mises Institute (www.mises.org) next door, Auburn University (www.auburn.edu/business/economics) has attracted a large number of students over the years. The most prominent Austrian economist on campus is Roger Garrison, author of the new advanced macro text Time and Money. Garrison teaches the main course in macroeconomics. (Leland Yeager, former Ludwig von Mises Professor of Economics at Auburn, is now retired.) Unfortunately, Auburn recently discontinued its Ph.D. program. There are a goodly number of colleges offering solid undergraduate courses. Two mainstays are Hillsdale College in Michigan and Grove City College, near Pittsburgh. Grove City College (www.gcc.edu) no longer has Hans Sennholz as chairman of the department, but Hans indicates that the school is still free-market oriented, and John Moore, the president, is an economist. Hillsdale College (www.hillsdale.edu/dept/economics) has several free-market professors, the most well-known being Richard Ebeling, who runs the annual Ludwig von Mises lecture series. Hillsdale also houses the Mises library.

I should also mention Northwood University, an associate- or full-degree business school with campuses in Midland, Michigan; West Palm Beach, Florida; and Cedar Hill, Texas. Founded by Gary Stauffer and Arthur Turner in 1958, Northwood stresses free-market and Austrian economics. (Go to www.northwood.edu.)

In California, there are two universities with an Austrian bent. Santa Clara University, under the guidance of Daniel Klein, offers the Civil Society Institute (www.scu.edu/csi), which involves a weekly colloquium, lectures series, and “coffeehouse” for libertarian ideas. Other prominent members of the faculty are Laurence Iannaccone, Henry Demmert, Fred Foldvary, and David Friedman. Charles Baird, labor economist and Ideas on Liberty columnist, is the co-chairman of the department at California State University at Hayward (www.sbe.csuhayward.edu) and director of the Smith Center for Private Enterprise Studies. According to Baird, half the tenure-track economists there are “unabashedly free-market.”

Lawrence H. White, a specialist in free banking, was recently appointed the first F A. Hayek Professor of Economic History at University of Missouri-St. Louis (www.umsl.edu/divisions/artscience/economics). According to his colleague David C. Rose, “a number of economists are either outright Austrian or are very sympathetic to the Austrian school and free market ideals.”

If you want year-round sunshine, you can always come to central Florida and take one of my courses in investments, history of thought, or Austrian economics at Rollins College in Winter Park, Florida (near Orlando). (See www.rollins.edu.)

Austriae est imperare orbi universo!

*See Jon E. Hilsenrath, “In Hot Pursuit of Economics Ph.D.s—Short Supply and Big Demand Mean Young Graduates Are Courted Like Royalty,” Wall Street Journal, February 20, 2001, p. B1.

Pulling Down the Keynesian Cross

Ideas On Liberty
Economics on Trial
June 2001

by Mark Skousen

“The circle had come right round; it was as though Keynes had never been.”
-Robert Skidelsky1

“Textbooks have to be rewritten in the aftermath of each scientific revolution.”
-Thomas S. Kuhn2

In his third and final volume on John Maynard Keynes, Robert Skidelsky comes to the shocking conclusion that the Keynesian revolution was temporary, that Keynes’s General Theory was really only a “special” case, and that “free market liberalism” has ultimately triumphed. This is all the more amazing given that Lord Skidelsky has spent the past 20 years of his professional career studying Keynes and resides in Keynes’s old estate, Tilton House. Few scholars would have the guts to repudiate the theory of the man they adore.

It’s even tougher for old dogs to learn new tricks, and that refrain applies to Paul Samuelson, the “American Keynes” who introduced millions of students to the “new economics” of the master. He continues to hang his hat on the Keynesian cross, even as he publishes the 17th edition of his world-famous textbook. The pedagogical paradigm keeps shifting further toward the classical model of Adam Smith, and as each edition of Economics moves in that direction, Samuelson resists the change. He cites his mentor more than any other economist; only Keynes, not Adam Smith or Milton Friedman, is measured as a “many-sided genius.” His textbook still begins macroeconomics with the Keynesian model, even though most other textbook writers have adopted Greg Mankiw’s method of starting with the long-run classical model.3 According to Samuelson, Adam Smith’s invisible-hand doctrine-that laissez-faire behavior maximizes social welfare-“holds only under very limited conditions.”4 On the final page (755) of his massive textbook, he renders “two cheers to the market, but not three.”

Two Cheers for Hayek and Friedman

Having reviewed all 17 editions of Samuelson’s magnum opus, I conclude that his textbook has gradually shifted, albeit grudgingly, from one cheer to two cheers for the market. Much of this improvement is due to Yale’s Bill Nordhaus, his co-author since 1985. (He writes the entire text now, which Samuelson then reviews.)

What’s new about the latest edition? More free-market economists are cited, including Julian Simon, Ronald Coase, James Buchanan, Arthur Laffer, Robert Mundell, and Gary Becker. Samuelson and Nordhaus devote an entire page (41) to F.A. Hayek and Milton Friedman, “guardians of economic freedom.” They recommend Hayek’s The Road to Serfdom and Friedman’s Capitalism and Freedom, saying, “All thoughtful economists should study his arguments carefully.”

In chapter 2, “Markets and Government in a Modern Economy,” the authors highlight the benefits of globalization and the importance of property rights, noting that Russia and other former communist nations have suffered because of a failure to enforce “the legal framework.”

They also add an entire new page on the issue of lighthouses as public goods. For years Samuelson used the lighthouse as a prime example of market failure; only government could build and operate lighthouses. Several years ago I chided Samuelson for ignoring Ronald Coase’s famous essay, “The Lighthouse in Economics,” which proved that the Trinity House and other lighthouses in England were built and owned by private firms that imposed tolls on ships docking at nearby ports.5

Now, finally, Samuelson and Nordhaus have responded to Coase’s challenge in the 17th edition (pp. 37—38). They admit that privately operated lighthouses existed in England, but then point to the east coast of Florida as a case where “there were no lighthouses until 1825, and no private-sector lighthouses were ever built in this area.” According to Nordhaus, the only response to shipwrecks was a thriving private “wrecking” industry that charged high fees for “saving lives and cargo.” Nordhaus goes on to note that lighthouses have become obsolete, replaced by the satellite-based Global Positioning System, a service provided by the government.

In sum, the paradigm in economics has definitely shifted from Keynesianism to classical economics, but the case for complete laissez faire is still raging in the halls of academia.

1. Robert Skidelsky, John Maynard Keynes: Fighting for Britain, 1937-1946 (London: Macmillan, 2000), p. 506.
2. Thomas S. Kuhn, The Structure of Scientific Revolutions, 2d ed. (Chicago: University of Chicago Press, 1970), p. 137.
3. See N. Gregory Mankiw, Principles of Economics, 2d ed. (Ft. Worth, Tex.: Harcourt College Publishers, 2001). I still regard Roy J. Ruffin and Paul R.Gregory, Principles of Economics, 7th ed. (Boston: Addison Wesley Longman, 2001) as the best mainstream textbook on the market today.
4. Paul A. Samuelson and William D. Nordhaus, Economics, 17th ed. (New York: McGraw-Hill Higher Education, 2001), p. 325.
5. Mark Skousen, “The Perseverance of Paul Samuelson’s Economics,” Journal of Economic Perspectives, Spring 1997, p. 145. Coase’s article appeared in the Journal of Law and Economics, October 1974, pp.357-76.

It All Started with Adam

Ideas On Liberty
Economics on Trial
May 2001

by Mark Skousen

Adam Smith, that is. Having just completed writing a history of economics,1 I have concluded that, despite the protestations of Murray Rothbard and other detractors, the eighteenth-century moral philosopher and celebrated author of The Wealth of Nations deserves to be named the founding father of modern economics.

The reason: Adam Smith is the first major figure to articulate in a profound way what has become known as the first fundamental theorem of welfare economics: that the invisible hand of competition automatically transforms self-interest into the common good. George Stigler rightly labels Smith’s model of laissez-faire capitalism (Smith never used the phrase) the “crown jewel” of The Wealth of Nations and “the most important substantive proposition in all of economics.” He states, “Smith had one overwhelmingly important triumph: he put into the center of economics the systematic analysis of the behavior of individuals pursuing their self-interests under conditions of competition.”2

In short, Smith’s thesis is that a “system of natural liberty,” an economic system that allows individuals to pursue their own self-interest under conditions of competition and common law, would be a self-regulating and highly prosperous economy. Eliminating restrictions on prices, labor, and trade meant that universal prosperity could be maximized through lower prices, higher wages, and better products. Smith assured the reader that his model would result in “universal opulence which extends itself to the lowest ranks of the people.”3

Indeed it has. Published in 1776, The Wealth of Nations was the intellectual shot heard around the world, a declaration of economic independence to go along with Thomas Jefferson’s declaration of political independence. It was no accident that the industrial revolution and sharply higher economic growth began in earnest shortly after its publication. As Ludwig von Mises declares, “It paved the way for the unprecedented achievements of laissez-faire capitalism.”4

For or Against Smith

The most amazing discovery I made in researching and writing over the past three years is that every major economic figure—whether Marx, Mises, Keynes, or Friedman—could be judged by his support of or opposition to Adam Smith’s invisible-hand doctrine. Karl Marx, Thorstein Veblen, John Maynard Keynes, and even British disciples Thomas Robert Malthus and David Ricardo denigrated Adam Smith’s classical model of capitalism, while Alfred Marshall, Irving Fisher, Ludwig von Mises, and Milton Friedman, among others, remodeled and improved on Smithian economics.

For example, Keynes is unsympathetic to Adam Smith’s worldview. “It is not true that individuals possess a prescriptive ‘natural liberty’ in their economic activities. . . . Nor is it true that self-interest generally is enlightening. . . . Experience does not show that individuals, when they make up a social unit, are always less clear-sighted than when they act separately.”5 The basic thesis of Keynes’s magnum opus, The General Theory of Employment, Interest, and Money (1936), is that laissez-faire capitalism is inherently unstable and requires heavy state intervention to survive. Keynesian disciple Paul Samuelson correctly understood the true meaning of Keynes: “With respect to the level of total purchasing power and employment, Keynes denies that there is an invisible hand channeling the self-centered action of each individual to the social optimum.”6 Thus, I conclude that Keynesian economics, rather than its savior, is an enemy of Adam Smith’s system of natural liberty.

Karl Marx went even further. Instead of creating a system of natural liberty, Marx set out to destroy it. Modern-day Marxist John Roemer agrees. The “main difference” between Smith and Marx is: “Smith argues that the individual’s pursuit of self-interest would lead to an outcome beneficial to all, whereas Marx argued that the pursuit of self-interest would lead to anarchy, crisis, and the dissolution of the private property-based system itself. . . . Smith spoke of the invisible hand guiding individual, self-interested agents to perform those actions that would be, despite their lack of concern for such an outcome, socially optimal; for Marxism the simile is the iron fist of competition, pulverizing the workers and making them worse off than they would be in another feasible system, namely, one based on the social or public ownership of property.”7

Adam Smith as a Heroic Figure

By measuring economists against a single standard, Adam Smith’s invisible-hand doctrine, I found a fresh way to unite the history of economic thought. Virtually all previous histories of economics, including Robert Heilbroner’s popular work, The Worldly Philosophers, present the story of economics as one conflicting idea after another without resolution or a running thread of truth. This hodgepodge approach to history leaves the reader confused and unable to separate the wheat from the chaff.

My approach places Adam Smith and his system of natural liberty at the center of the discipline. Think of it as a story of high drama with a singular heroic figure. Adam Smith and his classical model face one battle after another against the mercantilists, socialists, and other enemies of liberty. Sometimes even his “dismal” disciples (Malthus, Ricardo, and Mill) wound him. Marx and the radical socialists attack him with a vengeance and leave him for dead, only to have him resuscitated by the leaders of the marginalist revolution (Menger, Jevons, and Walras) and raised up to become the inspiration of a whole new science.

But the “neo-classical” model of capitalism faced its greatest threat from the Keynesian revolution during the Great Depression and the postwar era. Fortunately, the story has a good ending. Through the untiring efforts of free-market advocates, especially Milton Friedman and F. A. Hayek, Adam Smith’s model of capitalism is re-established and in the end triumphs. As Milton Friedman proclaims, “To judge from the climate of opinion, we have won the war of ideas. Everyone-left or right-talks about the virtues of markets, private property, competition, and limited government.”8

Long live Adam Smith!

1. The Making of Modern Economics (Annonk, N.Y.: M. E. Sharpe Publishers, 2001).
2. George Stigler, “The Successes and Failures of Professor Smith,” Journal of Political Economy, December 1976, p. 1201.
3. Adam Smith, The Wealth of Nations (New York: Modern Library, 1965 [1776]), p. 11.
4. Ludwig von Mises, “Why Read Adam Smith Today,” in The Wealth of Nations Washington, D.C.: Regnery, 1998), p. xi.
5. John Maynard Keynes, “The End of Laissez-Faire,” Essays in Persuasion (New York: Norton, 1963 [1931]), p. 312. Keynes’s speech was given in 1926, a full decade before The General Theory came out.
6. Paul A. Samuelson, “Lord Keynes and the General Theory,” The New Economics, ed. Seymour Harris (New York: Knopf, 1947), p.151.
7. John E. Roemer, Free to Lose (Cambridge, Mass.: Harvard University Press, 1988), pp. 2-3. Note the title, imitative, albeit negatively, of Milton and Rose Friedman’s popular Free to Choose (New York: Harcourt Brace Jovanovich, 1980).
8. Milton and Rose Friedman, Two Lucky People (Chicago: University of Chicago Press, 1998), p. 582.

The Anti-Capitalistic Mentality, Updated

Economics on Trial
Ideas on Liberty
November 2000

by Mark Skousen

“In the excitement over the unfolding of his scientific and technical powers, modern man has built a system of production that ravishes nature and a type of society that mutilates man.” -E. F. SCHUMACHER (1)

In 1956, Ludwig von Mises countered myriad arguments against free enterprise in his insightful book, The AntiCapitalistic Mentality. “The great ideological conflict of our age,” he wrote, “is, which of the two systems, capitalism or socialism, warrants a higher productivity of human efforts to improve people’s standard of living.” (2)

Unfortunately, Mises’s counterattack has done little to stem the tide of anti-market sentiments. One that continues to be popular is E. F.Schumacher’s 1973 book, Small Is Beautiful which has recently been reprinted in an oversized text with commentaries by Paul Hawken and other admirers. Schumacher has a flourishing following, including Schumacher College (in Devon, England) and the Schumacher Society (in Great Barrington, Massachusetts). Hawken hails Schumacher as a visionary and author of “the most important book of [his] life.” (3) Schumacher’s message appeals to environmentalists, self-reliant communitarians, and advocates of “sustainable” growth (but not feminists the old fashioned Schumacher cited favorably the Buddhist view that “large-scale employment of women in offices or factories would be a sign of economic failure” (4) ).

From Austrian to Marxist to Buddhist

Oddly enough, Fritz Schumacher’s background is tied to the Austrians. Schumacher was born in Germany in 1911 and took a class from Joseph Schumpeter in the late 1920s in Bonn. It was Schumpeter’s course that convinced Schumacher to become an economist. While visiting England on a Rhodes scholarship in the early 1930s, Schumacher encountered F. A. Hayek at the London School of Economics and even wrote an article on “Inflation and the Structure of Production.” (5) But his flirtation with Austrian economics ended when he discovered Keynes and Marx. He renounced his Christian heritage and became a “revolutionary socialist.” The Nazi threat forced him to live in London, where he was “interned” as an “enemy alien” during World War II. After the war, he worked with Keynes and Sir William Beveridge and supported the nationalization of heavy industry in both Britain and Germany. But his real change of heart came during a visit to Burma in 1955, when he was converted to Buddhism. “The Burmese lived simply. They had few wants and they were happy,” he commented. “It was wants that made a man poor and this made the role of the West very dangerous.” (6)

Schumacher greatly admired Mahatma Gandhi and his saying, “Earth provides enough to satisfy every man’s need, but not for every man’s greed.” Eventually he wrote a series of essays that became his classic, Small Is Beautiful, published in 1973. In the 1970s, he became passionate about trees and began a campaign against deforestation. After a successful book tour in the United States, including a visit with President Jimmy Carter, he died in 1977 of an apparent heart attack.

The Lure of Buddhist Economics

Schumacher’s message is Malthusian in substance. Small Is Beautiful denounces big cities and big business, which “dehumanizes” the economy, strips the world of “nonrenewable” resources, and makes people too materialistic and overspecialized. According to Schumacher, individuals are better off working in smaller units and with less technology.

His most important chapter is “Buddhist Economics,” with its emphasis on “right livelihood” and “the maximum of wellbeing with the minimum of consumption.” Foreign trade does not fit into a Buddhist economy: “to satisfy human wants from faraway places rather than from sources nearby signifies failure rather than success.” (7) In sum, traditional Buddhism rejects labor-saving machinery, assembly-line production, large-scale multinational corporations, foreign trade, and the consumer society.

There are two problems with Schumacher’s glorification of Buddhist economics. First, it denies an individual’s freedom to choose a capitalistic mode of production; it enslaves everyone in a life of “nonmaterialistic” values. And second, it clearly results in a primitive economy. Mises responded to both these issues: “What separates East and West is . . . the fact that the peoples of the East never conceived the idea of liberty . . . . The age of capitalism has abolished all vestiges of slavery and serfdom.” And: “It may be true that there are among Buddhist mendicants, living on alms in dirt and penury, some who feel perfectly happy and do not envy any nabob. However, it is a fact that for the immense majority of people such a life would be unbearable.” (8)

I have no objection to preaching the Buddhist value that sees “the essence of civilization not in a multiplication of wants but in the purification of human character.” Nor do I disapprove of localized markets (see my favorable review last November of the Grameen Bank, which makes small-scale loans to the poor). But none of this idealism should be forced on any society. Ultimately we must let people choose their own patterns of work and enjoyment. Clearly, whenever Third World countries have been given their economic freedom, the vast majority have chosen capitalistic means of production and consumption. As a result, poor people have been given hope for the first time in their lives-a chance for their families to break away from the drudgery of hard labor, to become educated, see the world, and enjoy “right living.”

Freedom is beautiful!

1. E. F. Schumacher, Small is Beautiful Economics as if People Mattered: 25 Years Later with Commentary (Point Roberts, Wash.: Hanley & Marks, 1999 (1973)), p. 248.
2. Ludwig von Mises, The Anti-Capiaadatie Mentality (South Holland, Ill.; Libertartan Press, 1972 [1956]),p. 62.
3. Paul Hawken, Introduction to Schumacher, p. xiii.
4. Ibid., p. 40.
5. Sec The Economics of Inflation, ed. by H, P. Willis and J. A Chapman (New York: Columbia University Press, 1935).
6. Quoted in Barbara Wood, E. F. Schumacher: His Life and Thought (New York: Harper & Row, 1984), p. 245.
7. Schumacher, p. 42.
8. Mises, p. 74.

Having Their Cake

Economics on Trial
Ideas on Liberty
October 2000

Having Their Cake
by Mark Skousen

“The duty of ‘saving’ became nine-tenths of virtue and the growth of the cake the object of true religion.” -JOHN MAYNARD KEYNES (1)

In his 1920 bestseller, The Economic Consequences of the Peace, John Maynard Keynes made a profound observation about the success of capitalism before the Great War. He lauded “the immense accumulations of fixed capital” built up by the “new rich” during the half century before the war and compared the huge capital investment of this golden era to a “cake,” noting how “vital” it was that the cake “never be consumed;” but continue to “grow.”

Keynes was intensely optimistic about the prospects of humanity, “if only the cake were not cut but was allowed to grow in the geometrical proportion predicted by Malthus for population.” Rapid capital accumulation would result in the elimination of “overwork, overcrowding, and underfeeding,” and workingmen “could proceed to the nobler exercises of their faculties.”

Alas, it was not to be. The First World War destroyed Keynes’s dream of universal progress. The cake was consumed. “The war has disclosed the possibility of consumption to all and the vanity of abstinence to many.” (2)

War isn’t the only enemy of capital accumulation. Since World War II, the greatest threat to capital formation (the growth of the cake) has been the direct and indirect taxation of capital.

Take, for example, the federal estate tax. The estate tax is often viewed as an “inheritance” tax and even a “death” tax. But it’s much worse than that. It’s also a tax on capital. An estate’s taxable property includes stocks, bonds, business assets, real estate, coins and collectibles-all after-tax, afterconsumption investments.

If your net worth exceeds $675,000, your heirs will be forced to pay at least 18 percent to the IRS. The tax rate hits a confiscatory 55 percent at a mere taxable estate of $3 million.

Capital is the lifeblood of the economy. Capital investment finances new technology, new production processes, quality improvements, jobs, and economic growth in general. When those investment funds are taxed-$28 billion in 1998-the funds are removed from the investment pool and transferred to Washington, where they are consumed. For the most part the funds are consumed through government expenditures and “transfer payments” (welfare, salaries of government workers, and so on).

The estate tax also creates economic distortions. It encourages individuals to engage in “estate planning,” expensive legal exercises to avoid the death tax. It forces individuals to buy insurance policies they would not otherwise buy and create tax-exempt trusts and foundations that they would not ordinarily create. Undoubtedly, millions of fiends are transferred every year into foundations and charities just to avoid estate taxes. Charitable giving and public foundations have become big business, but what is the price? Mismanagement and waste are common features in these nonbusiness organizations.

Another Inefficient Tax: Capital Gains Taxes

Perhaps an even more sinister tax is the capital gains tax. If you sell an asset (stock, bond, commodity, real estate, or collectible), the profits are taxed between 20 and 40 percent, depending on how long you held the asset. (If you hold for more than a year, the maximum rate is 20 percent.) This is a terrible penalty on capital. It means that every time a stock or other asset is traded outside a taxexempt vehicle, 20 to 40 percent of the profits are removed from the private economy and sent to Washington, never to be invested again. With the recent bull market on Wall Street, annual capital gains taxes have exceeded $100 billion. What a terrible drain on the economy.

Capital gains taxes also result in economic inefficiency. Because of the high tax on capital gains, many investors refuse to sell their assets. They may prefer to switch into a potentially more profitable investment, but they stay with their original investment because they hate the idea of paying Uncle Sam. Clearly, capital would be more efficiently allocated to its more productive use without this burdensome profits tax.

The United States can learn a lot from foreign nations. Hong Kong has a flat 15 percent personal income tax, a 16.5 percent corporate income tax, and no tax at all on capital gains. In fact, most of the New Industrial Countries in Southeast Asia do not tax capital gains.

Thus capital can move freely throughout Hong Kong and around the world without distortion. And the cake has grown rapidly because of capital’s tax-free status. Hong Kong does have an estate tax on values exceeding HK$7 million, but the maximum rate is only 18 percent. (3)

Fortunately, the U.S. government has recently recognized the negative drain these taxes have on the economy. It has reduced long-term capital gains, and Congress has even entertained a bill to abolish federal estate taxes altogether.

Eliminating taxes on estates and capital gains has been criticized as a break for the rich. Moreover, critics say, estate taxes should be kept in order to establish a level playing field. They argue, “Children and grandchildren of wealthy people didn’t earn inherited money. They should have to work for it, just as their parents did. Inheritances create disincentives to work.”

But these critics fail to understand the broader implications of a large tax-free estate and tax-free capital gains. Everyone-not just the rich-benefits from eliminating these taxes because wealthy people’s capital would be left intact, invested in the stock market, businesses, farms, banks, insurance companies, real estate, and other capital assets, thus insuring strong economic growth and a high standard of living for everyone. As Ludwig von Mises once stated, “Do they realize that every measure leading to capital decumulation jeopardizes their prosperity?” (4)

As an investment adviser, I share the concern that unrestricted inheritances to children or grandchildren can be morally corrupting, but there are other solutions besides a confiscatory tax. For example, a will can limit the use of inherited funds until a certain age of responsibility is reached, or a trust can offer matching funds as a way to encourage work and responsibility.

1. John Maynard Keynes, The Economic Consequences of the Peace (New York: Harcourt, Brace, 1920), p. 20.
2. Ibid., pp. 20-21.
3. For an excellent summary of tax policies throughout the world, see International Tax Summaries, published annually by Coopers & Lybrand (New York: John Wiley & Sons).
4. Ludwig von Mises, Planning for Freedom, 4th ed. (South Holland, Ill.: Libertarian Press, 1980), p. 208.

A Much-Deserved Triumph in Supply-Side Economics

Economics on Trial
IDEAS ON LIBERTY
February 2000

by Mark Skousen

“After occupying center stage during the 1980s, the supply-side approach to economics disappeared when Ronald Reagan left office.” – Paul Samuelson (1)

Until Robert Mundell won the Nobel Prize in 1999, supply-side economics had been a school without honor among professional economists. Established textbook writers such as Paul Samuelson (MIT), Greg Mankiw (Harvard), and Alan Blinder (Princeton) frequently condemned the supply-side idea that marginal tax cuts increase labor productivity, or that tax cuts stimulate the economy sufficiently to increase government revenues.

The Laffer Curve — the theory that when taxes are too high, reducing them would actually raise tax revenue — is dismissed. “When Reagan cut taxes after he was elected, the result was less revenue, not more,” reports Mankiw in his popular textbook.(2) Never mind that tax revenues actually rose significantly every year of the Reagan administration; the perception is that supply-side economics has been discredited. Arthur Laffer isn’t even listed in the 1999 edition of Who’s Who in Economics, although the Laffer Curve is frequently discussed in college textbooks.(3)

Now that is all about to change with Columbia University economist Robert A. Mundell’s Nobel Prize in economics. According to Jude Wanniski, Mundell, 67, is the theoretical founder of the Laffer Curve.(4) In the early 1970s he told Wanniski, “The level of U.S. taxes has become a drag on economic growth in the United States. The national economy is being choked by taxes–asphyxiated.”(5)

Mundell offered a creative solution to stagflation (inflationary recession) of the 1970s: impose a tight-money, high-interest rate policy to curb inflation and strengthen the dollar, and slash marginal tax rates to fight recession. Mundell’s prescription was adopted by Reagan and Fed chairman Paul Volcker in the early 1980s. “There’s been no downside to tax cuts,” he told reporters recently.

Yet, oddly enough, Mundell isn’t accorded much attention compared to supply-siders Laffer, Paul Craig Roberts, and Martin Anderson. In their histories of Reaganomics, Roberts and Anderson mention Mundell only once.(6) Two major studies of supply-side economics in 1982 don’t cite his works at all. Nevertheless, Mundell has accomplished a great deal worth lauding. In fact, he is considered the most professional scholar of the supply-siders.

Robert Mundell has had an amazing professional career. A Canadian by birth, he has attended, taught, or worked at over a dozen universities and organizations, including MIT, University of Washington, Chicago, Stanford, Johns Hopkins, the Brookings Institution, Graduate Institute of International Studies in Geneva, Remnin University of China (Beijing), and the IMF. Before going to Columbia in 1974, he was a professor at the University of Chicago and editor of The Journal of Political Economy. Thus the Chicago school can once again claim a Nobel, although Mundell differs markedly from the monetarist school.

Monetary vs. Fiscal Policy

Famed monetarist Milton Friedman says, “I have never believed that fiscal policy, given monetary policy, is an important influence on the ups and downs of the economy.”(7) Supply-siders strongly disagree. Cutting marginal tax rates and slowing government spending can reduce the deficit, lower interest rates, and stimulate long-term economic growth.

Mundell counters, “Monetary policy cannot be the engine of higher noninflationary growth. But fiscal policy-both levers of it can be. . . . The U.S. tax-and-spend system reduces potential growth because it penalizes success and rewards failure.”

Mundell favors spending on education, research and development, and infrastructure rather than government welfare programs. He advocates reducing top marginal income tax rates, slashing the capital gains tax, and cutting the corporate income tax. Such policies would sharply raise saving rates and economic growth-“an increase in the rate of saving by 5% of income (GDP), say from 10% of income to 15%, would increase the rate of [economic] growth by 50%, i.e., from 2.5% to 3.75%.”(8)

Mundell as Gold Bug

Supply-siders also take a different approach to monetary policy. They go beyond the monetarist policy of controlling the growth of the money supply. Unlike the monetarists, supply-siders like Mundell resolutely favor increasing the role of gold in international monetary affairs. “Gold provides a stabilizing effect in a world of entirely flexible currencies,” he told a group of reporters in New York in November 1999. According to Mundell, gold plays an essential role as a hedge against a return of inflation. He predicted that the price of gold could skyrocket in the next decade, to as high as $6,000 an ounce, if G7 central banks continue to expand the money supply at 6 percent a year. “I do not think this an outlandish figure. Gold is a good investment for central bankers.” He did not foresee central banks selling any more gold. “Gold will stay at center stage in the world’s central banking system,” he said.

In awarding Mundell the prize, the Bank of Sweden recognized him as the chief intellectual proponent of the euro, the new currency of the European Community. He considers the euro a super-currency of continental dimensions that will challenge the dollar as the dominant currency. The benefits of a single currency include lower transaction costs, greater monetary stability, and a common monetary policy. Mundell advocates an open global economy, expanded foreign trade, and fewer national currencies. Ultimately, he envisions a universal currency backed by gold as the ideal world monetary system. Under a strict gold standard, “real liquidity balances are generated during recessions and constrained during inflations.”(9)

Mundell is an optimist as we enter a new century. He’s bullish on the global stock markets, the gold standard, globalization, and downsized government. He’s my kind of economist.

1. Paul Samuelson and William D. Nordhaus, Economics, 16th ed. (Boston: Irwin/McGraw-Hill. 1998) p. 640.
2. N. Gregory Mankiw, Principles of Economics (Fort Worth, Tex. Harcourt/Dryden Press, 1998), p. 166.
3. Mark Blaug, compiler of Who’s Who in Economics (Northampton, Mass. Edward Elgar, 1999), determines the top 1,000 names in the book based on frequency of citation in scholarly journals. Among the famous economists missing the cut are Arthur Laffer, Paul Craig Roberts, and Murray N. Rothbard.
4. Jude Wanniski, The Way the World Works, rev. and updated (New York: Simon and Schuster, 1983), p. x.
5. Wanniski, “It’s Time to Cut Taxes,” Wall Street Journal, December 11, 1974.
6. Paul Craig Roberts, The Supply-Side Revolution (Cambridge, Mass.: Harvard University Press, 1984) and Martin Anderson, Revolution (Stanford, Calif.: Hoover Institution Press, 1990).
7. Milton Friedman, “Supply-Side Policies: Where Do We Go from Here?” Supply-Side Economics in the 1980s Conference Proceedings (Federal Reserve Bank of Atlanta, 1982), p. 53.
8. Robert A. Mundell, “A Progrowth Fiscal System,” The Rising Tide, ed. Jerry J. Jasinowski (New York: Wiley, 1998), pp. 198, 203-204.
9. Mundell, The New International Monetary System (New York: Columbia University Press, 1977), p. 242.

Economics for the 21st Century

Economics on Trial
IDEAS ON LIBERTY
January 2000

Economics for the 21st Century
by Mark Skousen

“Nature has set no limit to the realization of our hopes.” — Marquis De Condorcet

Recently I came across the extraordinary writings of the Marquis de Condorcet (1743-94), a mathematician with an amazing gift of prophecy in l`age des lumieres. Robert Malthus (1766-1834) ridiculed Condorcet’s optimism in his famous Essay on Population (1798). Today Malthus is well known and Condorcet is forgotten. Yet it is Condorcet who has proven to be far more prescient.

In an essay written over 200 years ago, translated as “The Future Progress of the Mind,” Condorcet foresaw the agricultural revolution, gigantic leaps in labor productivity, a reduced work week, the consumer society, a dramatic rise in the average life span, medical breakthroughs, cures for common diseases, and an explosion in the world’s population.

Condorcet concluded his essay with a statement that accurately describes the two major forces of the twentieth century — the destructive force of war and crimes against humanity, and the creative force of global free-market capitalism. He wrote eloquently of “the errors, the crimes, the injustices which still pollute the earth,” while at the same time celebrating our being “emancipated from its shackles, released from the empire of fate and from that of the enemies of its progress, advancing with a firm and sure step along the path of truth, virtue and happiness!”(1)

As we enter the year 2000, the public has focused on the history of the twentieth century. Condorcet’s essay reflects two characteristics of this incredible period. First, the misery and vicious injustices of the past hundred years, and second, the incredible economic and technological advances during the same time.

The Crimes of the Twentieth Century

Paul Johnson’s Modern Times, by far the best twentieth-century history of the world, demonstrates powerfully that this century has been the bloodiest of all world history.* Here is a breakdown of the carnage:

Civilians Killed by Governments (in millions) Years
Soviet Union 62 (1917-91)
China (communist) 35 (1949- )
Germany 21 (1933-45)
China (Kuomintang) 10 (1928-49)
Japan 6 (1936-45)
Other 36 (1900- )
Total 170 million
Deaths in War (in millions)
International wars 30
Civil wars 7
Total 37 million

Economists use a statistic to measure what national output could exist under conditions of full employment, called Potential GDP Imagine the Potential GDP if the communists, Nazis, and other despots hadn’t used government power to commit those hateful crimes against humanity.

Another great French writer, Frederic Bastiat (1801-50), wrote an essay in 1850 on “What Is Seen and What Is Not Seen.”(3) We do not see the art, literature, inventions, music, books, charity, and good works of the millions who lost their lives in the Soviet gulags, Nazi concentration camps, and Pol Pot’s killing fields.

The Economic Miracle of the Twentieth Century

Yet the twentieth century was also the best of times, for those who survived the wars and repression. Millions of Americans, Europeans, and Asians were emancipated from the drudgery of all-day work by miraculous technological advances in telecommunications, agriculture, transportation, energy, and medicine. The best book describing this economic miracle is Stanley Lebergott’s Pursuing Happiness: American Consumers in the Twentieth Century (Princeton University Press, 1993). Focusing on trends in food, tobacco and alcohol, clothing, housing, fuel, housework, health, transportation, recreation, and religion, he demonstrates powerfully how “consumers have sought to make an uncertain and often cruel world into a pleasanter and more convenient place.” As a result, Americans have increased their standard of living at least tenfold in the past 100 years.

What should be the goal of the economist in the new millennium? Certainly not to repeat the blunders of the past. In the halls of Congress, the White House, and academia, we need to reject the brutality of Marxism, the weight of Keynesian big government, and the debauchery of sound currency by interventionist central banks. Most important, ivory-tower economists need to concentrate more on applied economics (like the work of Lebergott) instead of high mathematical modeling.

As far as a positive program is concerned, the right direction can be found in an essay on the “next economics” written by the great Austrian-born management guru Peter F. Drucker almost 20 years ago: “Capital is the future . . . the Next Economics will have to be again micro-economic and centered on supply.” Drucker demanded an economic theory aiming at “optimizing productivity” that would benefit all workers and consumers.(4) Interestingly, Drucker cited approvingly from the work of Robert Mundell, the newest Nobel Prize winner in economics, who is famed for his advocacy of supply-side economics and a gold-backed international currency.

Beware the Enemy

Market forces are on the march. The collapse of Soviet communism has, in the words of Milton Friedman, turned “creeping socialism” into “crumbling socialism.” But let us not be deluded. Bad policies, socialistic thinking, and class hatred die slowly. Unless we are vigilant, natural liberty and universal prosperity will be on the defensive once again.

We need to deregulate, privatize, cut taxes, open borders, stop inflating, balance the budget, and limit government to its proper constitutional authority. We need to teach, write, and speak out for economic liberalization as never before. Let our goal for the coming era be: freedom in our time for all peoples!

1. Marquis de Condorcet, “The Future Progress of the Human Mind,” The Portable Enlightenment Reader, ed. Isaac Kramnick (Penguin Books, 1995), p. 38. Several of Condorcet’s writings can be found in this excellent anthology.
2. Paul Johnson, Modern Times: The World from the Twenties to the Nineties, rev. ed. (New York: Harper, 1992). The best survey of the horrors of communism is The Black Book of Communism: Crimes, Terror, Repression (Cambridge, Mass.: Harvard University Press, 1999), written by six French scholars, some of whom are former communists.
3. Frederic Bastiat, Selected Essays on Political Economy (Irvington-on-Hudson, N.Y.: Foundation for Economic Education, 1995 [1964]).
4. Peter F. Drucker, Toward the Next Economics, and Other Essays (New York: Harper & Rowe, 1981), pp. 1-21.