October 15, 1999

Commentary

Economist of the Century

By Arthur B. Laffer, chairman of Laffer Associates, financial consultants in San Diego.

The first word that came to mind when I heard that Robert A. Mundell had just won the Nobel Prize in economics was vindication. Back in the 1960s Mr. Mundell, who then taught at the University of Chicago, was considered beyond the fringes of mainstream economics. He was the leader of a small group of economists--most of the time I thought it was just the two of us--who advocated fixed exchange rates, warned of impending inflation if the U.S. went off gold and called for tax cuts to spur economic growth. Many in the profession called him a kook. Today they call him a Nobel laureate.

More important than this personal recognition, Mr. Mundell has reshaped the world in the image of his vibrant new paradigm, which journalist Jude Wanniski called "The Way the World Works." Mr. Mundell has been as influential as John Maynard Keynes, the difference being that Mr. Mundell got it right.

I remember my first encounter with him, at a University of Chicago workshop. It was winter 1967 in the Windy City, and I was visiting from sunny California. To me, the university workshop looked like a set from "The Addams Family"--a stark, dimly lit room, sparsely furnished with a dusty oak table and chairs, soot-covered windows and a clanging steam radiator. In walked a sallow, tousle-headed, pipe-smoking figure wearing a faded trenchcoat belted with a clothesline cord. Bob Mundell's odd appearance was exacerbated by his painfully slurred speech. After the workshop we went to the Quad Club for martinis, whereupon his speech went from bad to worse. But however slurred the delivery, his economics had never been sharper or more lucid. Bob quickly made a convert of me--and, before long, of a few others, including the editor of this editorial page.

In the late 1960s and early 1970s the editorial page of The Wall Street Journal was downright old-fashioned. It was the bastion of monetarism, partial-equilibrium price theory, budget-balancing drum-thumpers, worshippers at the altar of trade surpluses, and holier-than-thou finger-waggers. Mr. Mundell's profound logic would have had little impact had it not been for a grand alliance with this editorial page.

Robert Bartley was advanced beyond his years when, at 34, he was named editor of the Journal's editorial page in 1972. He was a young man with an awesome mission of searching for a radically new paradigm. The resultant explosive combination of the two Bobs--Mundell and Bartley--has changed the face of the earth. Much of the history of these early years is chronicled in detail in Mr. Bartley's 1992 book, "The Seven Fat Years."

Mr. Mundell's classic dichotomy between the appropriate use of monetary and fiscal policies lies at the crux of his new paradigm. Living in a world that was being brought to its knees by hyperinflation, hyperunemployment and hyperactive do-gooders, Mr. Mundell provided the cure: tight money and tax-rate cuts. As simple as this policy mix is to all of us today, it sure wasn't obvious back then.

Mr. Mundell and his closest compatriot at the University of Chicago suffered at the hands of their academic colleagues. The press and the political establishment of that time and place were anything but open-minded about tight money reining in inflation and the incentive effects of tax-rate cuts spurring economic growth and employment. Economists back then actually had the chutzpah to say that inflation was caused by low unemployment, and high unemployment in turn was caused by tight money and insufficient government spending.

While other scholars have long recognized the importance of the global economy, it is Bob Mundell who put the individual economy into proper perspective in the world economy. Goods, labor, money, technology and bonds flow almost as freely across national boundaries as they do within an economy, Mr. Mundell explains. The porous nature of national boundaries throws into question the preponderance of macroeconomic models that postulate independent national monetary policies, fiscal policies or national policies of any other sort. To Mr. Mundell, the only closed economy is the world itself. The only meaningful monetary policy is global monetarism. National economics can be understood only in the context of the world economy. No longer was international economics an embarrassing adjunct to domestic macroeconomics. International economics was the core discipline of macroeconomics.

His 1973 article "Uncommon Arguments for Common Currencies," along with his keen sense of cultural diversity and politics, formed the basis of what now is known as the euro. Bob took the academic community head-on both by showing the fatal flaws in the logic of floating exchange rates and by elucidating the impeccable logic of the gains from trading money across national boundaries.

I have always been especially enamored of Bob's idea of "menu costs." In the context of inflation, menu costs derive from the need of a restaurant to change menus as prices rise. The higher the inflation, the greater the menu costs. If the menu example doesn't strike your fancy, try regrinding parking meters or taxi meters, or training businesspeople in the use of log tables. Inflation confers very real costs on doing business.

Menu costs are not only a problem in a world of changing prices over time; they are just as real when there are two or more moneys in different locations at any one moment. Who hasn't felt the bite of these menu costs when traveling through Europe with their pesetas, guilders, francs, marks, pounds, kroner, shillings, lire, drachmas, etc.? Floating exchange rates in such a world are patently absurd. Mr. Mundell's euro is the obvious solution. His cross to bear, however, is the vast cadre of incompetent bureaucrats scurrying back and forth in the porticos of Europe's capitals whose job is to implement his vision. Talk about casting pearls before swine.

Bob Mundell's impact on the practical world of real politics can be seen in Reagan's America, in Thatcher's Britain, in the renaissance of Chile and Argentina, and in Jakob Frankel's monetary policy in Israel. The most recent testament to the success of Mr. Mundell's version of economics has taken place in Keizo Obuchi's Japan. Mr. Mundell has transformed every aspect of the political economy.

Receiving the Nobel Prize in economics is a great honor. But Mr. Mundell deserves an even higher honor--to be recognized as the best economist of the century.

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