Tuesday, June 17, 2014

Reaganomics as Keynesianism.


Or, a Two-Edged Sword Cuts Both Ways.

Beheading. Shahname. Isfahan (?), 1st quarter of 14th century. [A]

In all likelihood readers interested in economics have heard about the Laffer curve and supply-side economics. Applied during the Ronald Reagan presidency, Reaganomics has been singled-out as cause of the increase in inequality in the U.S.

Ronald Reagan gives a televised address from
the Oval Office, outlining his plan for Tax Reduction
Legislation in July 1981. [B]
I am unsure, however, whether readers understand what Reaganomics was and where it came from?

Arthur Laffer, one of its chief promoters, is in an exceptional position to answer. In 2004, in a report published by the American ultra-conservative Heritage Foundation, Laffer did just that.

Laffer starts by dispelling a myth: he did not invent the Laffer curve. He traces his ideas back to the 14th century Muslim philosopher Ibn Khaldun. But he acknowledged a more recent muse.

Laffer quotes:
"When, on the contrary, I show, a little elaborately, as in the ensuing chapter, that to create wealth will increase the national income and that a large proportion of any increase in the national income will accrue to an Exchequer, amongst whose largest outgoings is the payment of incomes to those who are unemployed and whose receipts are a proportion of the incomes of those who are occupied...
"Nor should the argument seem strange that taxation may be so high as to defeat its object, and that, given sufficient time to gather the fruits, a reduction of taxation will run a better chance than an increase of balancing the budget. For to take the opposite view today is to resemble a manufacturer who, running at a loss, decides to raise his price, and when his declining sales increase the loss, wrapping himself in the rectitude of plain arithmetic, decides that prudence requires him to raise the price still more--and who, when at last his account is balanced with nought on both sides, is still found righteously declaring that it would have been the act of a gambler to reduce the price when you were already making a loss."
(Emphasis added)
The quote is from Keynes' "The Means to Prosperity" (1933), which predates "The General Theory" by 3 years only and largely anticipates it.

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There is more of His Lordship in Laffer's tax cuts than a quote, however.

Those who were around at the time may remember the Republican sales pitch: "tax cuts pay for themselves". The idea was that balanced budgets would be achieved, because (paradoxically enough) of lower tax rates; in Keynes' words: "a reduction of taxation will run a better chance than an increase of balancing the budget".

Laffer's argument:
"Because tax cuts create an incentive to increase output, employment, and production, they also help balance the budget by reducing means-tested government expenditures. A faster-growing economy means lower unemployment and higher incomes, resulting in reduced unemployment benefits and other social welfare programs." (Emphasis added)
It doesn't get much more Keynesian than that: Laffer was talking, of course, about the very Keynesian automatic stabilizers!

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Did it work? A quick look at the data below would suggests otherwise.

(source)

However, in fairness, Reaganomics was more than tax cuts and what we have above is the effect of all those things combined. So, perhaps a fairer answer would be (inverting the ordinary usage) that the evidence failed to confirm the hypothesis.

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Some years ago, John Cassidy mentioned the above and concluded very aptly:
"Reaganomics, too, was a species of Keynesianism.
"But any attempt to categorize Keynes along traditional left-right lines is apt to founder. In his life and in his theorizing, he delighted in paradox".
Indeed.

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Perhaps due to Keynes' usefulness as justification to opposed political objectives -- to cut both ways, as it were -- Lord Skidelsky has proposed a Keynes/Hayek reconciliation; others have gone as far as arguing that conservatives should embrace Keynesianism.

Lefties should heed that: it sounds ominous to me. But that's me.

Image Credits.
[A] Execution, 14th century. Shahname illustrations from the Diez Albums. This is a faithful photographic reproduction of a two-dimensional, public domain work of art. Source: Wikipedia.
[B] Ronald Reagan gives a televised address from the Oval Office, outlining his plan for Tax Reduction Legislation in July 1981. Public domain, author: White House Photo Office. Courtesy of the Reagan Library. Source: Wikipedia

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