Supply-Side University Summer School Economics Lesson #12
Memo To: Students of Supply-Side University
From: Jude Wanniski
Re: End of Summer-school questions
[The fall semester will begin next weekend with a general overview of Supply-Side economics. If you have registered previously you are still on the list for the new semester. You can still audit the course without registering, but will not get selected materials we will e-mail our students from time to time. The Q&A that follows ends the summer session.]
Q: (From Steve Piraino). There was a long expansion in the 1980's following the final phase-in of the Reagan tax cuts. For 8 years, GDP increased at over 2.5%, averaging about 3.7% per year. Unemployment dropped from 9.7% in 1982 to 5.3% in 1989. However, the data on wages I gathered from the Ronald Reagan Homepage show absolutely no correlation between wage growth and economic growth or wage growth and the amount of employment. Wages increase in 1982, '83, '84, and '86, and fall in '85, '87, '88, and '89, with a net fall in wages in the expansion as a whole. The funny thing is that wages take the biggest beating when unemployment is at its lowest. Wages also drop in three years, '85, '87, and '88, when growth tops 3%.
Are these statistics flawed, or do wages abide by laws I haven't taken into account? The statistics can be found on the Ronald Reagan Homepage in the subsection entitled "Living Standards." My assumption is that wages follow supply and demand, so wages should increase when unemployment is lowest. How does it really work?
A: When you add several million people to the workforce as happened in the Reagan years, average wages paid will decline, because most of the wages paid the entrants will be at entry levels. This is why the Democrats at the time complained that the jobs created by the Reagan tax cuts were not good jobs, but "hamburger flipper" jobs. Real wages for the country as a whole are now finally rising as additions to capital increase faster than additions to labor. Polyconomics did a paper on this during the Reagan years. If we can locate it in our dusty archives, we will share it with you. It was by Alan Reynolds, then our chief economist, now chief economist at the Hudson Institute in Washington. We asked Alan for his comments, which he offers here:
The correlation between annual changes in productivity gains and in real compensation (wages and benefits) was and still is quite close. Assertions to the contrary are usually based on bad data. There is no excuse for that, because the same tables that estimate output per hour also contain decent estimates of real compensation per hour.
GDP growth is always faster than real output per hour of work, because hours worked rose very fast in the eighties. Growth of output per hour plus growth of hours (more people with jobs and/or more part-timer going foil-time) equals growth of output.
The frequently cited "real wages" for "nonsupervisory" workers are probably the worst data ever published by a federal agency. If more teenage workers find work, that pushes the average down (because the previous zero wage was not in the average). If more workers get 40 IK plans and health insurance, that has no effect on "wages." If more fast food workers get jobs as assistant managers, or secretaries are called executive assistants, they are dropped out of the average because they are no longer "nonsupervisory." The CPI-W price index used to deflate nominal wages is based on how urban workers spent their money in 1982, when many of today's best bargains didn't even exist.
Alan also notes the following citations where you might get more on the issue: "One cite is 'Economic Foundations of the American Dream' in Lamar Alexander and Chester Finn, eds., The New Promise of American Life, Hudson Inst. 1995. Also, my Hudson briefing paper, 'Capital versus Labor: The Dubious Economics of Class Conflict.' Your students could get that by calling 317-545-1000, but there might be a modest charge."
Q: (From Jon Price). Does the U.S. profit by the dollar's role as the world reserve currency? It would seem to me that all those greenbacks in circulation around the world translate into an interest-free loan. We buy coffee from Brazil, send dollars, and to the degree that they remain in circulation and are not converted into treasury bonds, we have traded green pieces of paper for a tangible asset. As world dollar usage expands this float fee widens. Is this a correct assessment? We seem to have drifted into the role of world policeman. Is this our backdoor tax for services rendered?
A: Yes, we earn many billions of dollars a year by having the U.S. dollar the currency of choice in many parts of the world. There is roughly $350 billion in dollars outside the United States. If these dollars were cashed for local currency, the Federal Reserve would have to mop them up by selling bonds from its portfolio into the banking system. The government would incur the additional costs of debt service. If the US once again defined the dollar in terms of gold and maintained the dollar/gold exchange rate, other currencies would experience much less volatility, especially if they linked to us under our "dollar umbrella." There would be far less demand for the dollar as a circulating medium and the Fed would find itself gradually mopping them up. We would lose much of the several billion in tax revenues we collect as seignorage — the backdoor tax for services rendered, as you put it — but our banking system would once again become the most competitive in the world. The taxes we would get from having the center of capital formation here, in a thriving economy, would dwarf the seignorage losses.
Q: (From Scott Robinson) In a recent speech in San Francisco, Lester Thurow (one of the 10 Most Dangerous Men?) remarked that the Euro would become a rival to the dollar as a reserve currency. Do you have any thoughts on the effect of such an event? Also, how does the dollar's current status as a "reserve currency" affect the Fed's ability to control its value? Finally, if the economy becomes global (Thurow's contention) do you see a loss of U.S. sovereignty and with it the loss of the ability to control the value of the dollar?
A: Dr. Thurow, dean of the Sloan School of Management at MIT, was once dangerous, but only to the Democratic politicians who bought into his thesis of a Zero-Sum society. Nobody pays much attention to him anymore because his forecasts were always wrong, but he still shows up on the PBS Nightly Business Report about once a month, saying silly things about the world economy — such as the nonsense he reportedly said in San Francisco, about the Euro becoming a competitor to the dollar. The dollar is the world's key currency because the United States is the only commercial and military superpower on earth. The Europeans first have to figure out how to create a Euro before they can have it competing with the dollar. They have been doing it all wrong for the last 20 years, and show no signs of understanding how to create one that will work to serve continental interests, let alone global interests. Because Europe is so mired in socialism and its attendant burdens on the people of Europe, it will also have to persuade the United States how to pay all the costs of continuing our NATO presence in Europe and expanding it to Russia's borders. In other words, there is a lot of work for the Eurocrats to do before we need worry about the Euro. More likely, Beijing will get there first, with a currency that will be the envy of Europe, and a banking system that will rival ours — as Beijing gets the benefit of advice from entrepreneurial China. There is also a report that Beijing requires that all MIT economists be shot on sight, which would not be a very nice thing if it were true, a clear violation of human Rights, but at least it has so far kept Dr. Thurow from getting close enough to find out.
Q: (From Robert Sibi). I noticed not too long ago that the Laffer Curve can be applied to music. Music volume would go on the 'tax rate' axis, and music enjoyableness would be on the 'tax revenue' axis. When there is zero volume, there is no enjoyableness because you can't hear it. But as you keep turning the music up it keeps getting increasingly better until you reach point E. That is the desired point for the listener. Any increase in the volume above point E will cause the music to become less enjoyable all the way up to the point where you can't bear it any longer. Have you ever noticed this before?
A: The Laffer Curve represents a picture of an eternal verity that applies to all things — the law of diminishing returns. Applying it to the volume adjustment in listening to music is interesting because you do finally settle on exactly the point where you find greatest enjoyment. In The Way the World Works, I pointed out that as infants we learn the law of diminishing returns. When we cry all the time, mother pays us no attention. When we cry not at all, we get no attention. We learn to cry at the optimum level when we want attention.