Executive Summary:In the recent retrospectives on the Kennedy presidency, almost no attention was given to his economic policies, foreign and domestic. The major mistake of his tenure, in Vietnam, was his failure to apply the economic growth model he implemented at home. President Reagan, with policies similar to JFK, has made the same error thus far in foreign economic policy. But his second term will likely rectify the error, abandoning the postwar egalitarian model favored by the IMF in favor of supply-side democratic capitalism. Extending the Reagan Revolution internationally would have great impact on financial and commodity markets, patterns of production and trade, adding another trillion dollars of global output. Jamaica and Salvador are still on the margin. Possibilities in Haiti, Bangladesh as the World Bank shifts to the supply-side.
Reagan, JFK and the Third World
The 20th anniversary of President Kennedy's assassination has come and gone with hardly a whisper of the economic policies of those 1,000 days. JFK's old associates were provided a major opportunity to massage history to fit their current political agenda, and they reminded us of his compassion for the poor, his yearning for peace, and his "mistake" in getting us into Vietnam—which they say he would have gotten us out of had he lived. But the old gang doesn't remember Kennedy's plan to get the country moving again with sharp cuts in personal income-tax rates that would seem to benefit the richest the most. The JFK theory, also forgotten, is that increased incentives to work, produce and invest would expand the economy, and a bigger tax base would produce more, not less, revenue. The tax cuts, enacted soon after Kennedy's death, ushered in the great bull market and non-inflationary boom of the mid-Sixties. But the keepers of the Kennedy flame, including Teddy, don't remember.
It's not surprising. The egalitarian ideologues of the Kennedy Administration — people like John Kenneth Galbraith, Arthur Schlesinger, Jr., Stanley Surrey — were not happy with the capitalist flavor of the tax cuts at the time. And Teddy wasn't paying attention. Most of what Senator Edward M. Kennedy learned of his brother's tenure was learned after the fact, from the ideologues who shaped him, Teddy, into the most egalitarian of the Kennedys. Ronald Reagan has much more in common with John F. Kennedy than does Senator Kennedy. The President hasn't forgotten the Kennedy tax cuts or the growth model behind them. And it's not hard, in fact easy, to imagine JFK approving of Reagan's posture on foreign policy, including and perhaps especially Grenada.
Kennedy was in many ways an admirable President, and history no doubt will remember him as a good one. But he made two major mistakes, one that cost him his life and one that cost him a great presidency. The first was his covert attempt to assassinate Fidel Castro after failing to oust him at the Bay of Pigs. This led to an understandable Castro complaint, one that brought Lee Harvey Oswald out of the woodwork. World leaders just do not put out contracts on their political opponents.
Wall Street Journal Editor Robert Bartley believes the greatest JFK blunder was his compliance in toppling Vietnam's Ngo Dinh Diem, our ally, assassinated November 1, 1963 by our new allies. The act committed us morally and politically to the slippery slope that eventually cost 50,000 U.S. lives and military defeat.
But a much more fundamental error was made earlier in the Kennedy Administration, one that led inexorably to the Diem coup. This was Kennedy's acceptance of the idea that American-designed economic policies of an egalitarian bent had to be forced upon Diem for his own good, to enable him to win the minds and hearts of the people.1 The steady application of these policies in 1961 and 1962 had the opposite effect, contracting the economy and subtly destroying Diem's political base. The record is clear that Kennedy forced Diem to implement these economic policies or lose U.S. military aid, and Diem was not happy with the program. In the countryside, land reform: the government would expropriate "large" farms, those over 20 acres, and deal out small parcels to the peasants. Those expropriated would get bonds that would be paid off as the peasants paid off their state mortgages in monthly installments.
In the cities, a program announced January 5, 1962 involved a host of new taxes designed to finance government development projects and social spending. These included a foreign-exchange transaction tax and a 71 percent levy on "luxury goods," covering almost everything but basic staples. Diem resisted appeals that he devalue the piaster, but after he was gone the devaluationists had their way and the ensuing inflation pushed up personal tax rates via bracket creep; by the end of the war the 70 percent bracket was encountered at about $5,000.
The new tax rates of course produced no new revenues; they sent the economy into an immediate tailspin. By June 19, 1962, the New York Times was reporting South Vietnamese "government concern over business stagnation and the first budget deficit in the regime's history." By August 19 the government was forced into large-scale deficit financing and the Times reported from Saigon: "Americans here observed that economists generally agreed that a certain degree of inflation, if kept under control, was desirable for an underdeveloped country. It was termed a stimulant to business."
Diem had clearly been on top of the military situation in 1961, before these harebrained "development" schemes were pushed down his throat. When the economy unraveled, the military situation also deteriorated. Diem became increasingly authoritarian, trying to preserve order as social, cultural and religious tensions mounted both in the country and in the cities. Kennedy liberals enjoyed chastising Diem for his lack of understanding and compassion, criticisms taken up by the U.S. news media. Ironically, Diem's Catholicism in a country of Buddhists came to be seen as his major flaw, with his fellow Catholic in the White House having no choice but to pull the plug on him — three weeks before Dallas.
But it was the ruinous policies of Kennedy's economists, Keynesians all, that did in South Vietnam. In an historic sense, the United States was thereby punished for inflicting such destructive policies on a developing country. History expects the nation that claims global leadership to disseminate superior policies. The present poverty of the Third World, in Asia, Africa and South America, is due in large part to U.S. dissemination of that destructive egalitarian model in the years after World War II. It was a simple matter to push the poor countries, newly emerged from colonial status, in this direction, offering foreign-aid handouts as inducement.
In 1951, the United Nations Technical Assistance Administration commissioned a young Keynesian, Walter Heller, to write the gospel on fiscal policy for the underdeveloped nations:
In the underdeveloped economies, taxation is increasingly assigned a far more positive role in the process of capital formation. The reason for this is implicit in the extremely low levels of income and saving which serve as the course of capital formation.... Propensity to consume out of these incomes is understandably high. Little remains for saving after meeting the pressing demands of sheer subsistence in the lower income strata and of traditionally lavish living, forced by the "demonstration effect" of American consumption standards, in the higher income strata.... Even worse, a considerable part of the meager savings is diverted into real estate and inventory speculation and the holding of precious metals, currency, and foreign exchange....
These countries are caught in the vicious circle of extreme poverty, a circle proceeding from low incomes to high consumption propensities to low savings to low rates of capital formation to a continuation of lower levels of income. To break out of this circle, apart from foreign aid, calls for vigorous taxation and government development programmes; on this point, expert opinion is nearing a consensus. Fiscal policy is assigned the central task of wrestling from the pitifully low output of these countries sufficient savings to finance economic development programmes and to set the stage for more vigorous private investment activity.
This was the same Walter Heller who a decade later would become President Kennedy's chief economic advisor. Unlike Martin Feldstein, Heller supported the Kennedy tax cuts and even shared credit for their success. But he certainly wasn't responsible for designing them. Kennedy was pushed in that direction by West Germany's Finance Minister, Ludwig Erhard, when he visited Berlin in the spring of 1962. Years later, Wilbur Mills, who had been chairman of the House Ways and Means Committee in the Kennedy era, told me that he, Kennedy and Treasury Secretary Douglas Dillon were aware of the success of the Mellon tax cuts of the 1920s and that Heller had hoped for a "quickie" tax cut that could be phased out once the pump was primed.2
Mills' speech to the House that introduced the tax cuts in 1962 was written by Norman Ture, the supply-sider who in 1981 became Ronald Reagan's Treasury Undersecretary for Tax Policy. Walter Heller's model hadn't changed. He denounced the Reagan tax cuts of 1981 and to this day blames them for the "failure" of Reaganomics. The only confusion about the effectivenss of the Kennedy and Reagan tax cuts results from the fact that the Kennedy tax cuts could work their magic within the stable framework of a gold-based international monetary system. The Reagan tax cuts have had to work against a monetary non-system that permitted the monetarist-inspired deflation of 1981-82.
In other words, John Kennedy's instincts led him to apply a capitalist growth model at home even as he was forcing an egalitarian "development" model on Vietnam.
The development model the United States and developed nations continue to urge upon the Third World is essentially the same one designed at the UN with help from U.S. and British economists. One difference is that the United States no longer bears the direct onus of keeping much of the world impoverished with this model. Partly because of the Vietnam experience, the U.S. abandoned bilateral foreign-aid experiments and now hides behind the International Monetary Fund and the "multilateral" approach. The postwar development model remains deeply embedded at the IMF and continues as a source of global economic misery and political turmoil.
The chief difference between President Reagan and President Kennedy at this stage of their presidential terms is that Reagan survived the assassin's bullet. Which means he still has time, in this term and his second, to rectify the biggest error he's made thus far: failure to apply to foreign economic policy the growth model that is the foundation of his success at home. That is, where Reagan's first term centered on domestic policymaking and the building of a solid, non-inflationary economy at home that would protect U.S. strength abroad, the second term will likely focus on foreign policy, including a recasting of foreign economic policy. This would complete the Reagan Revolution and continue the supply-side revolution, with profound implications for the world economy and its political realignment. Anything less would flaw the Reagan presidency, as it did John Kennedy's. Because the stakes are so high when we talk of extending the growth model to the furthest corner of the globe, even partial success means a difference of perhaps another trillion dollars of global output in the course of the decade. The implications for financial markets, commodity markets and patterns of production and trade are, of course, enormous. And the process of getting from here to there would reveal the current bull market as the beginning of the bull market of the century.
This was the supply-side vision behind Reagan's 1980 election. But it wasn't in the cards that both the domestic and international initiatives would begin simultaneously. The entrenched forces of the American Establishment, wedded to the postwar model they had created, were determined to resist Reagan's domestic reforms—along with preventing the Reagan revolutionaries from overturning the existing international order by taking seriously the idea of exporting democratic capitalism around the world. The best that could be managed by the Reagan forces so far, no small feat, was to gain a foothold for the "Democracy Project," funding for which survived last month in Congress.
The postwar assumption of American foreign policy was that developing nations were not ready for democracy. The prerequisite for democratic institutions was said to be the existence of a broad, middle-class electorate. President Reagan, though, assumes democratic institutions are a prerequisite to the creation of a broad middle-class. The President may still be torn between economic development models, but he's certain of the benefits of the democratic political model. We have recent evidence: the Caribbean slide toward Castro's Marxism-Leninism was arrested with the election of Edward Seaga in Jamaica in October 1980; Central America's slide stopped with the Constituent Assembly elections in El Salvador in early 1982. Recent populist/conservative election victories in Argentina and Turkey are hopeful signs. Scheduled elections in Bangladesh next year could be key to putting the poorest of nations on a growth track. Nigeria's recent success with democracy should, with encouragement, fan out over black Africa. Even Nicaragua's oligarchs, cowed by U.S. assertiveness in Grenada, are finally mumbling about elections in 1985. But it's not enough that elections are held here and there. There must also be candidates who offer growth agendas, supply-side solutions that aim at the nurturing of indigenous capital and indigenous capitalism.
In 1980, it was the hope of supply-side strategists that this process could begin in our backyard, in Jamaica and in Central America. The hope was thwarted when the supply-side candidate for Secretary of State, Donald Rumsfeld, was passed over in favor of Alexander Haig, the Establishment entry. It took a fool not to see that Jamaica and El Salvador were "on the margin," and Haig's first initiatives were indeed in these two beleaguered spots. But he went with the same old development model. David Rockefeller was dispatched to Kingston to lend Seaga another $600 million (another $600 million of debt) in exchange for be-nice-to-American-businessmen promises. In Salvador, his effort was to push the ruling elite into fulfilling the land-reform program initiated at the behest of the Carter Administration and the AFL-CIO. (The University of Washington's Roy Prosterman, who designed the South Vietnam scheme, had been dispatched to do the same for Salvador.)
Jamaica's problem was, and is, its tax system, put into place by Socialist Michael Manley, a graduate of the London School of Economics. Jamaicans encounter the 57.5 percent tax bracket at $7,875, with no deductions permitted. The tax yields almost no revenue. Instead it blocks the development of indigenous enterprise and capital, fosters primitive barter and an exodus of talent, and keeps the leadership looking to corporate America for capital and jobs. In 1980, supply-siders met several times with Richard V. Allen before he was named National Security Advisor, urging a post-inaugural mission to Jamaica to counsel tax reform. But Allen, proving no match for Haig, retreated into minutiae. Jamaica's economy remains in the doldrums.
El Salvador's land reform is a source of its misery. The 30,000 civilian deaths at the hands of left-and right-wing death squads are linked to this foolish egalitarian scheme, as is the country's deepened agricultural poverty. In the 1982 elections, the only economic issue before the electorate was land reform, and the Arena Party of Roberto d'Aubuisson, which opposed the scheme, was swept into office, to Washington's surprise. Yet President Reagan, champion of democratic institutions, fell into step with those of his advisors and those in Congress who insisted that economic aid to Salvador be conditional on the government's rejection of its popular mandate. The death squads continue, as one might expect when democratic institutions are subverted.
The supply-side solution to the regional problem requires monetary and fiscal reforms. It also aims at a Central American Common Market that demolishes the barriers to commerce erected between the five countries a decade ago with the help and counsel of American economists. Rep. Jack Kemp, who with the late Sen. Henry Jackson was instrumental in calling for a Presidential Commission on Central America (the Kissinger Commission), has urged the Commission to embrace a "supply-side revolution" for the region. The Commission is to report to the President on January 10.
On the surface, it no doubt seems that this kind of international supply-side revolution is a pipedream. Nothing much seems to be happening. But that's because the national press corps, particularly the financial press, is off on a wild goose chase, trying to figure out how the U.S. economy could be booming, given the $200 billion deficits that are supposedly keeping the Third World impoverished by keeping up U.S. interest rates!!!
The success of the Establishment in winning the $8.4 billion IMF replenishment authorization in the closing days of Congress last month also suggests business as usual. But President Reagan had to win that fight with Democrats and without a majority of House Republicans. Of 150 Republicans, 90 voted against the President's position on the IMF, following Kemp's lead in insisting on IMF reforms as a prerequisite, along with a halt in the Fed's current deflationary monetary policy—which is aggravating Third World problems with low commodity prices and high interest rates. But in an important sense, Kemp got what he wanted. The White House not only learned a lot about the issues during the course of the struggle. It realizes that reforms have to be made or, the next time the IMF comes around, the President might find himself alone with the Democrats.
During the yearlong negotiations over the IMF in Congress, there were more palpable gains. At Kemp's urging, the Treasury Department ordered economic studies of 45 Third World countries, detailing monetary, fiscal and trade policies. To be sure, such studies are readily available in the private sector. But having government bureaucrats do the work produces an inevitable policy drift. It becomes difficult for the agencies and embassies involved in the project to ignore their own findings. They'll find a top marginal income-tax rate of 60 percent in Zaire, encountered at $10,582, 66 percent in Pakistan at $10,000, 85 percent in Portugal at $35,000, and everywhere in these nations a host of taxes and controls on business activity that strangle growth while producing pitifully small revenues.
In Bangladesh, for example, the 60 percent marginal tax rate on personal income is met at $7,200, and yields about $50 million from a population of 90 million. Total national revenues amount to only $1.5 billion. The U.S. Embassy in Dacca reports that at last the government, possibly contemplating next year's elections, is promising a reform of these confiscatory tax rates.
While the IMF is still mired in the past, pressing austerity measures everywhere it goes, the World Bank has finally turned toward growth, urging supply-side reforms at least in the most obvious cases. This is probably due in no small part to James Burnham, appointed executive director of the Bank 18 months ago at the nomination of Treasury Secretary Regan. Haiti, for example, the most impoverished nation in the Western Hemisphere, with tax rates rivaling Bangladesh and insanely high taxes on exports, is being pressed by the World Bank to lower rates in order to expand commercial activity and the tax base. And two months ago, Donald Regan put another Treasury supply-sider, Mary Bush, in a high post at the IMF, establishing a beachhead there.
At this point it would not take much to foster a worldwide, supply-side cascade of tax reforms. The whole world has been watching the Reagan tax-cut initiative at home. But there is hesitancy as long as Washington remains confused about the success of the initiative. Although the U.S. economic expansion is the most robust in the industrial world, and it's the only nation to have implemented major tax-rate reductions, Marty Feldstein still seems to dominate elite opinion with the view that we face recession in 1985 unless taxes are raised soon.
One of the great, hidden forces of reaction at work that must be overcome is the fear of economic growth in the Third World, the age-old mercantilist fear of competition. The imperialist powers, led by Britain, purposely kept tax rates high in their colonies to prevent them from competing with the mother country in manufacturing. But the empires were lost with this zero-sum thinking, history punishing these global leaders for keeping their colonies drawers of water and hewers of wood. The banner of leadership was passed to the United States, which as a developing nation 200 years ago broke with England for exactly this reason. Instead, we chose to embrace the failed British model after World War II and have ourselves been punished. If John Kennedy had it to do over again in Vietnam, who knows? He could have been a great President. But Ronald Reagan still has that opportunity, and 1984, Orwell's year, could see it grasped.
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1 For a more detailed exposition of this hypothesis, see pp. 279-286, The Way the World Works, Jude Wanniski, Touchstone, 2nd ed.
2 The success of reduced marginal tax rates has been documented by the Joint Economic Committee, 'The Mellon and Kennedy Tax Cuts: A Review and Analysis" (U.S. Gov't Printing Office, June 18, 1982).