October 14, 1999

Review & Outlook

A Supply-Side Nobel

For a generation now these columns have preached economics from the gospel by Robert Mundell. So it's gratifying to see the Royal Swedish Academy of Sciences recognize his eminence with the Nobel Prize for Economics.

The academy rightly cites his contributions to international economics-- academic papers from the 1960s with theoretical catchwords such as optimum currency areas and the monetary approach to the balance of payments. In more recent and more practical terms, he was the chief intellectual proponent of the euro, as readers of this page may remember from his three long articles here last year. He argued that the gains from a common currency, with accurate transmission of price signals throughout the economy, were of the same order as the gains from a free trade area.

The euro has recently strengthened against the dollar, after an initial slide following its inauguration in January. There seems little doubt that it is here to stay. There are even indications, with talk of tax cuts from the socialist governments of France and Germany, that the common currency is starting to exert discipline on the governmental bloat that has retarded the continental economies. In any event, the creation of a multi-national central bank is a historical landmark. It is also a profoundly Mundellian idea.

It is a large mistake, however, to try to shelve Bob Mundell in the pigeonhole of "international economics." One of his aphorisms is, "The only closed economy is the world economy." His courses at Columbia have carried ambitious titles such as "General Equilibrium." He repeatedly brings his awesome knowledge of economic history to bear on contemporary problems. He came to our attention in the mid-1970s, as senior partner with Arthur Laffer in the founding of "supply-side economics."

The 1970s were a decade of bewildering economic malaise. "Stagflation" confounded the prevailing Keynesian economic doctrines, which thought of recession and inflation as a trade-off, not a combination. Faddish ad hoc explanations revolved around OPEC and depletion of the earth's crust. Professor Mundell was one of the few who understood this as an issue of international economics--the source of the disturbance was the collapse of the Bretton Woods system in 1971. And the solution could be found in the policy mix--using monetary and fiscal policy for independent purposes, against the Keynesian doctrine that they are necessarily complementary.

The theory was propounded at the Michael 1 dinners, in a now departed restaurant in the canyons near Wall Street, hosted by financial maven Charles Parker and attended by Mundell, Laffer and Jude Wanniski and Robert Bartley of this newspaper. It is hard at this remove to recognize how radical these ideas were in the climate of the 1970s, before the Royal Academy stopped giving its awards to Keynesians. The problem was to get anyone to understand.

Yet the ideas became the intellectual foundation of the Reagan economic policies--actually the Reagan-Volcker economic policies. Paul Volcker waged tight money to curb the inflation. And to promote economic growth, as Mr. Mundell had long urged, Mr. Reagan promoted tax cuts, reducing incentive-killing high marginal tax rates. This engendered great sturm und drang intellectually, politically and economically, especially when the economy plunged into the 1982 recession. The tight money came immediately, while the tax cuts were staggered for fear of deficits. But when the cuts were fully effective Jan. 1, 1983, the economic recovery started on cue.

That recovery continues today. With only a nine-month recession associated with the Savings and Loan crisis, the U.S. economy has marched forward ever since stagflation was solved. And despite harmful tax increases in 1989 and 1991, no one proposes to take marginal tax rates back to pre-Reagan levels. No one disputes the need for a non-inflationary monetary policy. And with only moderate spending restraint, we've grown out of the deficits, as supply-siders originally predicted. The question of the day is whether the euro over time will promote a similar economic revolution in Europe.

The science of economics has by now left the era that started with "The General Theory" in 1936. Friederich von Hayek (Nobel 1974) was the great pioneer of the counterrevolution. Milton Friedman (Nobel 1976) has been its leading advocate. But who has been the intellectual champion of two such radical innovations as the Reagan tax cuts and the European currency? In terms of actual policy initiatives, Robert Mundell has been the most influential economist since John Maynard Keynes.

For information about subscribing, go to http://wsj.com