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The latter 1970s were dark days economically. Inflation was skyrocketing, growth had stalled, median income was falling...and the popular economic theory that had led to all that, Keynesianism, had no solution.

However, a group of economists and financial analysts were busy rediscovering supply-side economics. Ronald Reagan, who graduated with a degree in economics prior to the arrival of Keynes, believed in classical economics and what would become the Supply-Side theory: less government means a better economy.

As detailed in The Reagan Information Page, Reagan's limited implementation of supply-side (meaningful cuts in spending were never achieved) spurred the greatest peace-time expansion in history.

However, during the 1980 campaign primaries, Reagan's chief rival, George Bush, called supply-side economics "Voodoo Economics", and proclaimed his disbelief in the system. Apparently Bush was asleep during the 1980s, because when he became president, he turned away from lower income taxes and even increased spending and regulation. The result: a recession. Ironically, opponents of Reagan and supply-side try to pin the blame for the recession on Reaganomics!

In this article I will illustrate the difference between the policies of President Bush, and President Salinas, our supply-side believer to the south. In doing an about-face economically, Bush ironically puts the US on a path to arrive where our recently defeated rivals (the XSSR and it's satellites) are struggling to leave: the socialist quagmire.

"...it looks as if the East European countries are trying to move to where we were 50 years ago while we are trying to move to where they were 50 years ago." --Milton Friedman.

We are essentially emulating the losers: the US and emerging nations are swapping histories.

Note: except where noted, excerpts from FORBES are from the August 17th, 1992 edition.

FORBES: How's the economy?

Friedman: If you look closely, and pay attention to the short-term money supply movement, it looks very scary.

President Bush has a policy I've been calling reverse Reaganism. It promises slow growth in the 1990s. Now, on top of that, the short-term cycle came down sharply, then started to go up, but has been severely retarded by slow monetary growth. It may indeed turn into another recession.

[Federal Reserve Chairman Alan] Greenspan has ben more successful than Volcker in avoiding excessive volatility in the money supply. But while I share his objective of long-run zero inflation, in the short run the money supply has grown much too slowly....

Aren't markets now supposed to discipline central banks?

Oh, there's no doubt that the market has made inflation less profitable than it was before, first by forcing the government to move to short-term securities and second by reacting more rapidly to an inflationary monetary policy, so that the long-term rates go up more quickly. But as a technical matter, that wouldn't prevent an inflation. On the contrary, it means inflation would occur more rapidly. The Fed could flood the country with money and nominal rates would shoot up, just like the 1970s. Unlike the 1970s, the markets would be able to prevent real rates going negative. But then that just means nominal rates--and inflation--would be worse.

Note that what Mr. Friedman is describing has continued under President Clinton. The use of short-term securities while long term rates are increased quickly in response to inflationary signals. And that this will not prevent inflation if the Fed floods the country with money...what President Clinton's hand-picked Fed Chairman to be Alan Blinder wants to do!

Note also that President Bush and President Clinton are both slaves to the old-fashioned job creation methods: play the tunes big labor wants to hear and spend, spend, spend on government "solutions" to unemployment. This is exactly what got us into trouble in the 1970s, when government made it affordable to not work instead of working for entry-level wages. This only fuels inflation by driving up the cost of low-end labor.

Forbes: Four years ago, when we interviewed you, our cover line was "Why liberalism"--in the American sense of interventionist government--"is obsolete." Well, if liberalism is dead, why won't it lie down?

There are too many good jobs at stake. You have this enormous bureaucracy in Washington, and also in every city and state, all dependent upon the continuation of New Deal and Great Society kinds of programs.

Instead of Lincoln's government of the people, by the people, for the people, we have government of the people, by the bureaucrats, for the bureaucrats--including among the bureaucrats the elected bureaucrats.

If you're going to have term limits, they ought to apply to the bureaucrats as well as to elected officials....

See look at the reaction in the US to the collapse of the Berlin Wall. You'd think it would be: "Well, you see, that just shows what happens when government's too powerful." But instead I believe the reaction has been: "Hmm. You see, we must be doing everything right, because they're trying to imitate us."

There weren't any summit meetings in Washington about how to cut down the size of government. What was there a summit meeting about? How to increase government spending. What was the supposedly right-wing President, Mr. Bush, doing? Presiding over enormous increases in paternalism--the Clean Air Act and the the Americans with Disabilities Act, the so-called Civil Rights quota bill.

And (chillingly) this description fits the 1993 "budget summit" to a T also. President Clinton's own estimates show a return to 6% deficits. Yet he continues to claim that two years (1994 and 1995) of smaller deficits, combined with the last year of the Bush economics (1993) is a historic lowering of deficits. Yet Reagan did better! From 6.2% to 2.9% of GNP, including five straight years of declining deficits (1985-9). What we have here is a repeat of the Carter years.

(Friedman continues)

Indeed, right now it looks as if the East European countries are trying to move to where we were 50 years ago while we are trying to move to where they were 50 years ago.

And not only in Eastern European countries. Look at Latin American countries. Fifteen years ago or so I was being picketed and harassed for supposedly running Chile from my office at the Univ. of Chicago. Today Chile is a great success story. You've got a politically free country. Mexico is trying to follow. Argentina, too.

In the Far East you have four "Little Tigers." [Hong Kong, S. Korea, Singapore, Taiwan] Hong Kong is the purest case of free market approach. Taiwan, Singapore and South Korea have large elements of authoritarian paternalism. But all of them stress the market as opposed to central planning. The same thing is now happening in Indonesia. It's certainly happening in Malaysia. It's happening all over the place.

Does this mean that you're disappointed in Bush?

[Laughs.] Disappointed is putting it very mildly. I believe the Bush presidency has been very close to a disaster.

Reagan when he came into office had four basic points: one, reduce marginal taxes; two, reduce regulation; three, restrain government spending; four, have a stable and noninflationary monetary policy. And while he did not achieve them to the extent to which I would have liked, he did achieve a great many of them.

Now Mr. Bush comes into office, and what happens with respect to these four planks? He presided over the summit, which ended up with an increase in marginal tax rates. Not very large. But it's opening the door to future increases. As long as you had a firm policy, "Read my lips," that possibility was simply ruled out.

On regulation: an enormous increase in control over the citizens. The number of people employed by the regulatory agencies has now gone up under Bush more than it went down under Reagan. He reversed Reagan on policy number three as well, spending. Government spending has been going up more rapidly under Mr. Bush than--you have to go back a very long time to find a comparable period.

On inflation: He hasn't been able to dominate the Federal Reserve Board. However, he did try to interfere. He waited until the last minute to reappoint Alan Greenspan. He and Secretary of the Treasury Brady have been jawboning the Fed. I'm not going to defend the Fed's policy. I'm just contrasting the situation.

Spooky, he could have been talking about Clinton's past two years! This is why when discussing the recent economic history we should not speak of the "Reagan-Bush" years, but of the "Bush-Clinton" years.

Forbes: How do you explain Bush? Because it's not as if the Reagan policies were unsuccessful.

Friedman: They were successful. My answer to that is that principles matter a great deal even in politics. Mr. Reagan had very strong principles. Mr. Bush has some strong principles, but not about the domestic economy.

People don't change. What is Bush? He is a product of East Coast country club Republicanism. As such he views his role as administering a governmental system, not leading it....

In domestic policy, all of his natural instincts came to the fore, that what you try to do as a proper eastern Republican gentleman is conciliate, cooperate, compromise.

During the Reagan administration, I was a member of the President's Economic Policy Advisory Board, which was composed of people on the outside of the government who were willing to say "no". We met with Reagan, it must have been half a dozen times a year on average. Mr. Bush attended every such meeting. I never heard him say a word except "Hello," "Goodbye" or some pleasantry. At various times there were vigorous discussions. He never entered into any of them.

Was he awake?

Yes. I think it was just that he had decided his role as the Vice President was to listen and not speak.

Rather, President Bush didn't know thing 1 about economics, and like so many other opportunists at the end of the Reagan expansion, believed that President Reagan had just been lucky enough to be President at a time when the "business cycle" was on the upswing. Too bad that theory can't explain why that upswing lasted twice as long as the usual expansion.

(Friedman continues, now speaking of Clinton vs. Bush)

Forbes: But you don't expect much difference in economic policy?

No. In fact, in some ways I think you might have better economic policy with Clinton. If I look around the world and ask what characterizes the places where you have had free market reforms, most came from the left-wing governments. The exceptions are Britain and the US, Thatcher and Reagan, who were sports, very unusual people in politics.

That was true in Australia, it was true most extremely in New Zealand, in France where Mitterrand made a 180-degree U-turn, Spain.... On the other hand, in Germany, which is under supposedly right-wing control, the movement is toward more statism and a bigger role for government.

With a Democratic candidate, the people to the left of him have no place else to go. If he wants to broaden his appeal, he's got to move to the right.

It's too bad that this form of "only a Nixon could go to China" didn't pan out as a "only a Clinton could have dismantled the welfare state". President Clinton has proven to be a Carter in Reagan clothing.

(Friedman continues)

Unless there's a Great Society wave of legislation--the same faction will control both branches of government, as after the Goldwater debacle.

Forbes: With more than $300 billion deficit, it's not going to be easy to move in a Great Society direction.

See, you were able to get the Great Society because of the tax dividend that resulted from "bracket creep"--inflation was forcing people into higher tax brackets without increasing their spending power. Tax receipts were going up sharply without any increase in tax rates. Today the large-scale indexing of the tax system has taken that possibility away.

Forbes: But now Congress passes laws mandating benefits and compelling business to absorb the cost.

It's true. Yes. But business is starting to react. And it's much harder than to spend money directly.

Forbes: You finished your first degree in the Depression--

In 1932, when I was 19.

Forbes: Your life's work, to some extent, has been demonstrating that Roosevelt's economic policies were actually perverse in that they probably exacerbated the Depression. But politically, Roosevelt's policies were immensely successful.

I agree. The government's failure in managing the economy from 1929 to 1933 produced, ironically, the public perception that only the government could manage the economy. The long-run political effects of the Depression were far more severe than the economic effects.

Forbes: So could the Eighties go down as an era of failure despite its success?

In the public memory, there's no doubt [helped by a compliant media--Brett], it will be--unless Bob Bartley's new book, The Seven Fat Years (Free Press), is more successful than I expect. It's a very good book, although I don't agree with his support for fixed exchange rates.

It's a question of the perception of the economic facts. You've got a third party involved here that you didn't have at an earlier date: the media. I don't understand why media people were so universally adverse to Reagan.

The media hates Reagan because he took their power, so recently gained after Watergate, and gave it back to the people. Once people saw that they could control government, what need is there for worshiping the almighty press?

Friedman has pointed out that Bush has failed to continue the policies that Reagan used to bring about economic expansion in the Eighties. Far from doing his own version, Mr. Bush has acted as mere caretaker to the presidency, letting Congress set economic policy. More taxes are definitely not the answer, yet both parties seem to be indicating that they will be mandatory. Here's a peek at what we can expect in the next four years of higher taxes:

[Taken from "California's Experiment with the Laffer Curve", Wall Street Journal, Thursday, July 9th, 1992. By Arthur Laffer.]

Nothing seems able to make politicians understand that higher tax rates do not automatically translate into more money.

They do, however, translate into higher unemployment. Americans in the other 49 states owe California a bit of gratitude for its grim demonstration of this law.

"California Dreaming: General Fund Revenues"
(Projected and Actual, in Billions of Dollars)

$50    Projected Levels of Revenues:
         1 from 1990
         2 from 1991
         3 from 1992 (Jan)                       2
 45      4 from 1992 (May)                               3

                                         1       3
                                                 4
 40                              1       2               4
								
                                XXXX
                        XXXX    XXXX    XXXX
 35                     XXXX    XXXX    XXXX
                        XXXX    XXXX    XXXX
        XXXX    XXXX    XXXX    XXXX    XXXX
        XXXX    XXXX    XXXX    XXXX    XXXX
 30     XXXX    XXXX    XXXX    XXXX    XXXX
_____________________________________________________________

        1987    1988    1989    1990    1991    1992    1993
		

Since June 1990, California has imposed staggering tax increases. According to the Office of the Governor, California, the 21st-most heavily taxed state in 1990, will be the 12th-most heavily taxed in 1992. Even that does not tell the half of it. By the governor's own numbers, California would qualify as the seventh-most taxed state save for the assumption that other states are going to raise their taxes enough to leave California in 12th place....

But here's where the warning comes: Tax rate increases are a far cry from tax revenue increases, because people's actions can never be held constant. For some reason unknown to politicians, people don't work to pay taxes, and if necessary will stop working to avoid taxes....

[Or funnel more money into tax-free investments--Brett]

The situation isn't likely to improve any time soon. But perhaps after the 1994 elections, someone in Sacramento will figure out how to increase tax revenues--by cutting tax rates.

Note that since then, supply-side proponents have defeated their opponents in every major off-year election.

As Arthur Laffer demonstrates above, when you are near the peak of the Laffer curve, raising tax rates will cause revenues to decrease. We've seen it many times, and apparently elected officials need to see it many more times before they'll admit the truth.

It makes one yearn for the early Reagan years. When talk of not whether to cut taxes, but "how much" was rampant. As succeeding tax rate increases have shown, the economy likes tax cuts far more than tax hikes.

The US worker is not stupid. When faced with taxes that are too high, they will shunt money into tax free investments. They will work for cash and bypass the tax man. When rates are lowered, people pull their money out of the shelters and invest it in stocks and other taxed securities.

Indeed, as the chart for revenues from capital gains taxes shows, raising the capital gains tax caused revenues to decrease. Every preceding tax cut for capital gains had caused a rise in revenues. It makes you wonder about those opposing new cuts in the capital gains tax rate. Or any tax for that matter. It seems that their true goal is not to increase revenues (though they would love that) but to redistribute income (mainly to their voters).

"Congress should take a crash course in economics from Carlos Salinas. He talks--among other things--about how his administration's supply-side policies have gotten Mexico growing again." _Forbes_, August 17th, 1992. Page 64.

The following is largely taken from Forbes, August 17th, 1992.

We Had to Act Quickly

An Interview with President Carlos Salinas

George Bush apparently had no idea how supermarket checkout counters worked. The media had a good time with that one and Bush lost a few more votes. Mexican President Carlos Salinas de Gortari would never pull a boner like that.

Though he's a dapper, polished man with a Harvard Ph.D. in political economy and government, Salinas has worked hard at keeping in touch with ordinary Mexicans. Since he was inaugurated in 1988, Salinas has spent Thursday and Friday of nearly every week on helicopter visits to towns and villages in the remotest corners of his sprawling country....

FORBES: Mr. President, I can remember going to Mexico in the 1960s, and if I had pesos left over, they'd still be worth exactly 12.5 to the dollar if I went back a year later. You had 13 years of a rock-solid currency. Mexico was an economic miracle, year after year of 6% economic growth. And then everything fell apart; you had hyperinflation, negative growth, massive unemployment, and the peso is nearly 3,000 to the dollar. What went wrong?

President Salinas: The main lesson is that you cannot spend beyond your means, that the strengthening of internal savings is essential to sustain the process of growth; that those who live on debt must pay its consequences sooner rather than later.

With the process of privatization [in Mexico], we've raised almost $33 billion. Instead of spending that money, we used it to reduce the [domestic] national debt. The national debt in the US is 58% of GDP; in Japan, 63%; in Italy, 105%. But the national debt in Mexico is today only 13% of GDP. The savings from reduced debt service can now be channeled into social programs and still enable us to keep a tight fiscal policy.

FORBES: In the years that Mexico was piling up debt, wasn't the aim of the spending to redistribute income?

If that was the aim, it didn't work, because income distribution didn't improve. We are convinced today that the best way to make a proper income distribution is, first, through creating the conditions for a sustained economic recovery. And second, improved education. We are [also] restructuring the educational system.

FORBES: In addition to reducing domestic debt, you've also substantially reduced tax rates.

Oh, yes, we reduced tax rates and we increased the tax base. We know we have to be competitive [in tax rates] on an international level if we are to compete for capital, which in the Nineties will be the key question for economic success or failure. We've reduced tax rates and strengthened enforcement, and now are getting more revenue out of [lower] tax rates.

A pause while the Laffer proponents do a high-five. Yet another example that the Laffer curve holds true.

(Salinas continues)

Inflation had reached almost 200% three or four years ago; this year it's going toward 10%.

The main tool for reducing inflation is on the fiscal side. This year we're running a [budgetary] surplus for the first time in history.

FORBES: One thing about your economic program that has surprised the world is its speed and momentum.

We had to react quickly to the end of the Cold War. The transformation and change throughout Eastern Europe and the new developments in the Asian-Pacific countries, the unification of Europe. At the same time a clear message was coming from Mexicans to reform the country.

FORBES: What reassurances can you give that your liberalization process will continue this opening to foreign capital, privatization and fiscal discipline?

We have the political will to maintain the process of reform. As important as the will is that the population demands this process of reform to be permanent; and that you can find in Mexico today. There is very broad support for the process of reform....

FORBES: It has always been tough in Mexico to go into business without cutting in the old political bosses. Have you made it easier for people to start small businesses?

Oh, much, much easier. We have deregulated, and deregulation has opened the way for practically anyone who has the means, the desire, the resources to do so to open a business. We've established a program for small and medium-size enterprises. Last year we provided financial support for more than 100,000 new small and medium-size firms. Also training and technological packages and commercial education.

This small business program is separate from Solidarity. [A grass-roots economic program.--Brett] Solidarity works with the slums and the rural communities. The small and medium-size enterprises support is a program at the Nacional Financiera, the government development bank.

Makes you wish that Salinas was Reagan's successor here, eh? Salinas also is prophetic about another hot issue in the coming 1994 elections: immigration. Perhaps we can all learn a valuable lesson from what he has to say on the subject:

FORBES: Mr. President, when the people in the US think of Mexico, they think of immigration. It's an issue that almost dominates US-Mexican relations. You have said that our Simpson-Mazzoli immigration law ignored economic reality.

I said that in the sense that the American economy demands this type of labor. Mexicans are migrating, attracted by the demand pull from the American economy. But at the same time, the Mexicans who go north take many risks; they are very energetic risk-takers. That's precisely the kind of people I want here. That's why I am so committed to generate employment opportunities in Mexico, so that Mexicans will not go north, competing for with Americans for their own jobs in their own country. That's why we have to grow faster. That's why it's better to have a free trade agreement, and we would be able to export goods and not people. But migration will have to be talked about in the bilateral relations sooner or later....

Unfortunately, instead of talking about how to legally integrate the immigrants who will come, no matter what we do to stop them, we talk of simply ignoring the illness (illegal immigrants) and treating the symptoms (higher spending for people who don't pay into the system). Hey, people in CA, take note! Have a general amnesty and proclaim everyone now in the state as a legal citizen, give them the oath, and put them into the system! They are there anyway, so there will be no "sucking sound" as they take jobs and they will now be paying taxes and fees and all the other bothersome aspects of being a citizen...and that is the optimum solution, is it not?

Let us turn to another success story from Mexico's supply-side policies. In Mexico, the government recognizes that investments are not a cash cow, but a source of capital for future growth.

We Don't Tax Capital Gains

An Interview with Finance Minister Pedro Aspe

FORBES: ...Well, some people are pretty worried about your current account deficit--$11 billion is a lot of money in an economy like Mexico's.

There are four things that are important with respect to trade. The first thing is whether the country is capital intensive or labor-intensive.

FORBES: You're saying that a country where labor is cheap needs to import capital. That's common sense.

In the 1950s, when Japan was labor-intensive, it was good that Japan had a current account deficit. Then Japan became highly capital-intensive and now has a surplus of capital.

FORBES: This is getting complicated.

I'm sorry if I sound professorial.

FORBES: Don't apologize. It's a pleasure to meet someone running an economy who understands economics.

Okay, now be careful. I've said a current account deficit like Mexico's can be good. But you can also have a current account deficit for a bad reason. If the government has a balanced budget like in Mexico, it is obviously the private sector that is using the imported capital. The private sector is investing more than it is saving, and it needs net savings from the rest of the world. That's happening in Mexico.

FORBES: This is the reverse of the situation ten years ago, when you were borrowing abroad to finance government consumption.

Ten years ago it was 180 degrees the reverse. Which brings me to the third part of my argument: What is the private sector doing with the capital it imports?

FORBES: Well, if it is importing machinery and other capital goods, that must be good.

And it's exactly what Mexico is doing now. Our imports are growing at around 20%, but imports or capital goods and machinery are growing at 40%. That concludes my lecture on current account deficits....

An industrial country for a while can get by with a big fiscal deficit if the rest of the world is willing to finance you. But what you are really doing is building up debt, instead of building up factories. So you erode your competitiveness. When you lose control of the fiscal deficit, sooner or later you get into trouble.

FORBES: Stop, Mr. Aspe. You're hitting too close to home. Let's talk about a pleasanter subject. President Salinas has said that supply-side economics has worked very well in Mexico. Would you elaborate?

Only a few years back our maximum tax rate for individuals was 60.5%. Today it's 35%. For a corporation, it was 42%; now it's 35%. On value-added tax we had two rates, 20% and 15%; now we have just one, 10%. And we have made 13 federal taxes disappear. We have zero tax on dividends. Why should you tax corporations if they distribute the money?

FORBES: Come to Washington and convince our Congress.

You know, a government should not mess around with the decision of the corporation to distribute dividends or not. This is a typical entrepreneurial decision that the government should not mess around in....

FORBES: Do you have a capital gains tax in Mexico?

On all [publicly traded] firms the rate is zero.

Well, I think our friends down south have eloquently put down any supply-side nay-sayers. The proof is in the pudding, so to speak. We are today approaching the point Mexico was at last decade. They are using the same methods we used to boom in the 80s. Why have we turned away? Collective guilt at being wealthy? Tired of success? Willing to rest on our laurels?

Well, there is still a lot more to be done in America, and around the world. Please fax this article (heck, send the August 17th issue of FORBES!) to your congresspeople and/or favorite candidate.

If you are dissatisfied with the Dems and the Reps, take a look at the Libertarians, whose economic philosophy is based on free trade and no government intervention (like taxes), or groups within those parties like the Republican Liberty Caucus, who are dedicated to more freedom in all walks of life.

We've gotten derailed. But we know how to get back on track. The only question is: are we willing to try?

Reagan's limited implementation of supply-side (meaningful cuts in spending were never achieved) spurred the greatest peace-time expansion in history.

Forbes: How do you explain Bush? Because it's not as if the Reagan policies were unsuccessful.
Milton Friedman: They were successful.

President Clinton has proven to be a Carter in Reagan clothing.

It seems that their [the liberals] true goal is not to increase revenues (though they would love that) but to redistribute income (mainly to their voters).

"We have deregulated, and deregulation has opened the way for practically anyone who has the means, the desire, the resources to do so to open a business."--President Salinas

Oh, yes, we reduced tax rates and we increased the tax base.

We have zero tax on dividends. Why should you tax corporations if they distribute the money?