Economic Growth
Jude Wanniski
March 29, 1996


Executive Summary: The political establishment has decided that for the moment we have reached the practical limits of a sustainable economic growth rate. With the work force stretched to its limit and real wages continuing to decline, we clearly have a crisis in capitalism marked by mass underemployment, as opposed to the mass unemployment of the Great Depression. The people work harder and harder to accomplish less and less. The parallels are clear in capitalism's failure in both crises to optimize its technological possibilities, while our ruling class is in denial about its failures. We being with the proposition that capitalism is a cold and mechanical economic system, not a political system, and that it is the capitalist qua political leader who fails us. Good socialism is then superior to bad capitalism. The capitalist marketplace is capable of achieving optimum use of the nation's capital its surplus of time, energy and talent by assessing the risks and rewards of financial intermediation. As political error in monetary and fiscal policies adds risk, capital becomes underutilized, putting added burdens on labor. The prescriptions on how to alleviate or end the capitalist crisis flow obviously from the analysis, but prospects for fundamental change seem remote. A consensus among the diffuse populist forces in a third party movement could break the status quo political equilibrium at the top. More likely, continued contraction of living standards and income divergence will increase social strife that would force incremental change.

Economic Growth

You may have noticed, all of a sudden, everyone is talking about economic growth and how fast the United States can and cannot grow. All the political talk shows have discovered the topic and are chattering about real wages, income inequality, and middle-class anxiety. The New York Times recently ran a seven-part series on America's downsizing, inferring that we must become accustomed to a new era of slow growth. In the NY Times Sunday "Week in Review" of March 17, the lead article by Louis Uchitelle is given over to the dismal news that the U.S. economy absolutely cannot grow faster than 2 1/2 %, and that everyone in the know realizes this harsh fact, but they are all afraid to say so publicly. Lawrence Mayer, a distinguished professor of economics nominated to the Federal Reserve, advised the Senate Banking Committee in his confirmation hearings that the U.S. is now at full employment, and the committee unanimously approved his nomination. Various Establishment spokesmen, such as Robert Samuelson of Newsweek, are out and about spreading the news that things are better than ever, even though people do not realize how good they have it.

The chatter is being driven by the presidential election year, of course, with the Ruling Class being forced to contend with the fact that the voters are unhappy with the state of the economy. There is irritation in the Establishment with the ideas of Steve Forbes and Pat Buchanan, each of whom tapped into the economic anxieties of ordinary people. A meager 2 1/2% growth rate leaves those people at the bottom half of the socio-economic pyramid on the knife edge of desperation. Alas, the Ruling Class insists this is about as good as it is likely to get, whether Democrats or Republicans are in power. Here is what Uchitelle found after surveying the movers and shakers:

The candidates challenge each other with conflicting nostrums for generating growth. Push the right buttons, they say, and presto, the economy will boom. What they don't debate is whether strong growth the sort that will raise living standards and make layoffs less frequent is in fact possible.

Such growth is not possible, according to the great majority of American economists. No campaign formula, whether from Republicans or Democrats, Steve Forbes, or Patrick J. Buchanan, will change that stark reality for the rest of this century. 'The candidates are promising what no President can deliver," said Robert M. Solow of the Massachusetts Institute of Technology, a Nobel laureate in economics.

History and circumstance, in sum, have locked the United States into a level of economic growth that, measured against expectations raised by the 1996 Presidential campaign, is politically unacceptable. "It might be good for our politics if some candidates acknowledged this," said William Kristol, editor of the Weekly Standard and a Republican strategist, addressing an issue that most politicians don't, in public.

How depressing. Here is America's democratic capitalism finally triumphant after a century of wars against absolutist monarchy, fascism and communism, yet the best it can do is sputter along indefinitely at growth rates that trap most of our citizens on a treadmill without hope. Thirty years ago, academic economists accepted the rule of thumb that the economy had to grow at a 3% annual rate just to break even on job creation, given population growth and technological advance. Even a 2 1/2% growth rate is measured by the national income accounts in a way that masks a continuing decline in real wages and national living standards. Gross National Product numbers are swollen by an ever-increasing fraction of the work force that is required to deal with social pathologies and economic volatility - lawyers and accountants, welfare caseworkers and corrections officers, financial service personnel, a fast-food industry and child-care industry that are necessary in a world of single-parent or two-breadwinner families.

What is especially distressing about the current national discussion regarding this pitiful level of economic growth is that the two major political parties seem to have decided that nothing much can be done about it. The Clinton administration and Democratic congressional leaders are so bereft of ideas that they can only propose an increase in the minimum wage! (Because California is so important in the Electoral College, the President does make repeated trips there to promise more construction of military aircraft.) The Republican leadership, Bob Dole in the Senate and Newt Gingrich in the House, has shamefully given up again on even a minor adjustment in the capital gains tax -- the one growth ingredient of their 1994 mandate. Instead, the GOP has painted itself into a balanced-budget corner, promising "middle-class" voters it has targeted a $500 cash handout for each kiddie in the family. They will do this as soon as they can persuade the Democrats to cut enough spending out of other social programs to finance those Santa Claus handouts. We find ourselves despairing along with Ralph Nader, a fellow populist of a different stripe, who told the Times on March 26: "Every four years the choice between the bad and the worst gets worse....There comes a time when civic society doesn't have a chance, when government is dominated by one major corporate party with two heads, Democratic and Republican."

While pondering this state of affairs, by sheer coincidence I recently read James Burnham's 1941 treatise, The Managerial Revolution, written after a decade of mass unemployment. Our problem today is not quite the same. We have plenty of jobs, but a capitalist crisis of mass underemployment of our work force. Too many people have to labor longer and harder in order to get the nation's daily work done, which is reflected in the decline in real wages for the past 30 years. In the capitalist welfare states of Europe, things are even worse, with both massive unemployment and massive underemployment. Still, a capitalist crisis is a capitalist crisis, and we surely are having one now.

Burnham, who had been a Trotskyist and later a conservative social philosopher identified with National Review, looked over the landscape of the 1930s - when unemployment at one point exceeded 20% and boldly predicted the imminent end of capitalism. What would replace it? Not socialism or communism, but something similar to the ism identified with Nazi Germany. If we put aside the negatives about Adolf Hitler, he suggested, we can note that in the first two years of his regime, he ended mass unemployment. And he did so in a way that produced a dynamic, non-inflationary economy. How? By putting smart managers in charge of the entire economy in order to overcome the inadequacies of the free market. "Capitalism is no longer able to use its own technological possibilities. One side of this is shown by such facts as the inability of the United States to carry out a housing program, when the houses are needed and wanted and the technical means to produce them in abundance are on hand. (This is the case with almost all goods.)"

The regulation of production in Germany is no longer left to the market. What is to be produced, and how much, is decided, deliberately, by groups of men, by the state boards, and bureaus and commissions. It is they that decide whether a new plant shall be built or an old plant retired, how raw materials shall be allotted and orders distributed, what quotas must be fulfilled by various branches of industry, what goods shall be put aside for export, how prices shall be fixed and credit and exchange extended. There is no requirement that these decisions of the bureaus must be based on any profit aim in the capitalist sense. If it is thought expedient, for whatever reason, to produce, for example, an ersatz rubber or wool or food, this will be done even if the production entails, from a capitalist point of view, a heavy loss. Similarly, in order to accumulate foreign exchange or to stimulate some political effect in a foreign nation, goods will be exported regardless of loss. A factory may be compelled to shut down, even though it could operate at a high profit. Banks and individuals are forced to invest their funds with no reference to their private and voluntary opinions about "risks" from a profit standpoint. It is literally true to say that the Nazi economy, already, is not a "profit economy."

Irving Kristol, 15 years younger, made the same traversal, from Leon Trotsky to conservative social philosopher, and knew Burnham well. He tells me Burnham's views in 1941 were hardly unusual, and were commonplace especially in Europe. A great many people had come to the conclusion that capitalism had been a stage of historical development, one that could no longer deal with its own technological inventiveness. The mass unemployment of the Great Depression had persisted for so long that it would have been surprising if the intelligentsia had not questioned the continued relevance of the capitalist idea. The depression continued until WWII, despite (or because of) the best co-operative efforts of President Roosevelt and the capitalist Ruling Class to put America back to work. Try as they might to get things going by devaluing the dollar or by raising taxes to balance the budget, stagnation persisted. Burnham was, of course, wrong about the death of capitalism, but he was prescient at least in seeing the arrival of the managed economy. In the paragraph quoted above, we can see the foreshadowing of the government's management of our national economy during the last 30 years.

For another real time perspective on the crisis in capitalism of that era, among the best I've read is the 1939 two-volume journal, America at Midpassage, by Charles and Mary Beard. In it, the distinguished historians take a first cut at history in a way that recreates the anxiety of the moment the events that would transform the "Golden Glow" of the 1920s into grave doubts about the reliability of capitalism and the free market. The work opens with this giddy picture:

After the long and toilsome rise, American civilization reached, at the summer solstice of Normalcy, the high plateau of permanent peace and prosperity in the general opinion of business organizers, bankers, guardians of the National Shrine in Wall Street, bond salesmen, grateful holders of stocks, lawyers, doctors, editors, writers, columnists, artists, architects, actors, philosophers, economists, scientists, engineers, teachers, professors, women of the leisure class, the aristocracy of labor, and the politicians of the right direction. Notes of jubilee drowned the plaintive cries of the farmers and the queasy doubts of querulous critics. According to the golden appearance of things, ingenuity would create novelty upon novelty, gadget upon gadget, to keep the nation's machines whirling; inevitably, outlets would be found for the accumulations of capital and the torrents of commodities; and employment would be afforded for laborers befitting their merits and diligence. Articles for comfort and convenience, devices for diversion and amusement were multiplying with sensational rapidity, giving promise of a satisfaction even more gratifying. Corporations were swelling in size, holding companies were rising to dizzy heights, the tide of liquid claims to wealth was flooding in. Since, it was thought, the morale of the nation was grounded in ineradicable virtues and sustained by a beneficent religion, American civilization was well fortified against all varieties of untoward experience.

Fast forward in the book to p. 107 and we find the Beards quoting from a report of the U.S. Chamber of Commerce of December 1931, when there were already 5 million unemployed:

"To an onlooker from another world, our situation must seem as stupid and anomalous as it seems painful to us. We are in want because we have too much. People go hungry while our farmers cannot dispose of their surpluses of food; unemployed are anxious to work, while there is machinery idle with which they could make the things they need. Capital and labor, facilities for production and transportation, raw materials and food, all these essential things we have in seeming superabundance. We lack only applied intelligence to bring them fruitfully into employment. This condition has led to a host of suggestions for national planning."

The simple sentence, written 65 years ago, is still relevant today: "We lack only applied intelligence to bring them fruitfully into employment." Why is there so much want when we have so much? How have we come to accept the idea of a high level of structural unemployment! Why does it take two breadwinners to do the job that one did prior to the last 30 years of decline in real wages? Must our children and grandchildren anticipate a perpetual decline in national living standards, even as the best educated grow wealthier in the new Information Age? Must we conclude there has been yet another failure of capitalism at just that moment we should be rejoicing in the defeat of communism? Must we think anew about national industrial planning that might include elements of trade protectionism? What do we know and what do we lack in our applied intelligence about the nature of economic growth? Let's ruminate on the state of the art.


What we should admit to begin with, if we can, is that good socialism is better than bad capitalism. The logic of the statement is really inescapable. It is only when capitalism fails that people and nations resort to alternative forms of political economy. A socialist system that is working well is one that is fully deploying the nation's resources through a central plan that has the approval of the people. It would be superior to a capitalist system that is working so poorly that its adherents must find excuses for mass unemployment, widely diverging income classes, and deepening social pathologies. The price paid for any form of socialism is the loss of some degree of individual freedom, but when the only alternative is bad capitalism of the type described, a people willingly pay that price. In that sense, the capitalism that defeated Soviet socialism in the Cold War did not necessarily end the competition between systems. At least theoretically, we might imagine a new outbreak of stagflation here that causes an explosion of social pathologies and a sharp decline in living standards. At the same time, we can imagine a reconstituted Russian socialism, one that permits more market signals and more personal freedoms than the variety that collapsed. This could bring about a new competition having a different outcome. Good capitalism, though, is superior to socialism at its best. I think we know enough to make capitalism function the way it should, with an economy of labor, ever-increasing living standards for ordinary people, and increased personal freedom as well. The crisis in capitalism exists because the Ruling Class does not like or want the changes that we have proposed for the past 20 years, and has no alternative solution -other than a managed economy. What is it that capitalism must do to perform to its ideal?

What must any system accomplish? At the core, it must provide a method by which its smallest constituent unit, a household, can save the surplus of its day's work for the day when it cannot work. This is because the highest priority of any unit of political economy is self-survival. The risks to survival are reduced by agreements among separate units to pool their resources. This enables those with a temporary surplus to share with those in temporary deficit. The family unit itself is such a system, which enables the young to draw upon the productive resources of their parents, returning the resources when their parents are too old to be productive. Civilization began with speech that enabled neighboring families and neighboring clans to contract with each other through verbal lOUs. "Money," as a palpable medium of exchange, soon followed as an extended form of commercial speech.

It is only in the last four centuries, though, that money began to overtake verbal transactions or the bartering of goods as the primary means of exchange. In earlier epochs, through the Middle Ages, only a minority of people ever saw money. And then, it was employed almost exclusively as a means of exchanging one set of goods for another not for developing longer-term contracts between people who normally would not come into physical contact with one another. In these earlier epochs, such "bond transactions" were generally limited to government finance of war or public works or church finance of cathedrals. Capitalism is a system by which ordinary people can exchange their daily surplus time, energy or talent (their capital) for claims on the future production of others. Its viability rests on its internal mechanisms for assessing the risks attendant to such exchanges of goods for promises. Even in the most primitive forms of political economy at the dawn of civilization, a family that pooled its resources with its neighbors had to be adept at assessing the reliability of its neighbors in holding up their end.

Modern capitalism has evolved to a level of sophistication that permits the largest and most liquid pools of capital. It is held together by a vast and elaborate mechanism for assessing risks and creditworthiness - a mechanism that is known as the free market. The modern mechanism is so close to perfection that it is a waste of time for any of us to devote resources to getting it closer to perfection. That is, the broad U.S. marketplace itself is 99% as good as it can possibly get, in terms of pricing goods and assets and assessing risks and return on investment. Information on every industry and enterprise is readily available and already flows at lightning speed. The financial service industry will continue to evolve in one direction or another, but it will have to do that just to stay at 99% efficiency. Its limits are not in its structure, but in the quality of analysts available to correctly assess and price information. At the other extreme, as Professor Reuven Brenner of McGill University points out, are the new financial markets in China, which must traffic in information about industry and enterprise that is always suspect - there being no tradition of open communication of bad news and good. It is, after all, the political marketplace that is still far short of its optimum levels of efficiency, in China at a maximum, or in the United States, at a minimum. As just one example, the U.S. economy would perform better if the regular meetings of the Federal Reserve Board were open to the public.

Capitalism, we must always remind ourselves, is not a political system, but an economic one. The distinction is extremely important, for it frees supporters of capitalism from having to defend it as a caring or compassionate institution, which it is not. It is coldly mechanical. Capitalism in and of itself functions according to the law of the jungle, as amended by the laws of man. At the margin, capitalists will do anything the law allows in seeking profit. If 999,999 capitalists leave something on the table, at its legal and moral edge, there will be one to take it up, especially if it means survival. And why not? A letter to The New York Times on this subject caught my eye on March 14, "What Capitalism Means," by Eli Zaretsky, a visiting professor at New York's New School: "Capitalism by itself produces only greed and exploitation. The great successes of the modern epoch are due to social movements like populism, progressivism, new deal liberalism, socialism, feminism, movements for racial equality and even communism, that have insisted that profit be tempered with social concerns." This sounds harsh, but it is not an unreasonable position. By itself, capitalism could be as savage and Darwinian as Karl Marx supposed it would become.

In this country, however, capitalism is not by itself, but is twinned with the kind of active democracy that even Marx allowed could save it from extinction. Democracy does so by tempering profit with social concerns, although Prof. Zaretsky would have to agree that profit can be tempered to death, and that profit occurs only by putting capital at risk. Marx himself understood that it would be silly for a capitalist to buy "C" commodities for an "M" amount of money, as he put it in Capital, with the object of then selling them for the same "M" amount. The capitalist buys "C" commodities -- including labor as a commodity -- hoping to sell the new product for "M + 20%," Marx suggested. If he has guessed wrong or the market has shifted, the capitalist may be forced to sell at "M -50%." There is no doubt that Marx, as a classical economist, understood that the capitalist must be rewarded for putting capital at risk. Unless there is risk-taking, there can be no growth. "M" will remain "M."

Now carry the impressions forward to the modern mechanisms of the market- the banks, credit unions, insurance companies, stock and bond markets, and all other market elements that can extend or withhold capital. They absorb the total mass of capital, assess myriad demands upon it and dispense it in little bits and pieces according to a schedule of likely returns on investment. In aggregate, the mechanisms are necessarily cold and mechanical, though within the mechanism there are kindly and generous country bankers making bets on unlikely credit applicants. The mechanism of the market, of course, sorts out those kindly and generous country bankers who make bad bets, for the highest priority of an institution is self-survival. In the same way, the mechanism of the market will reward those icy, gimlet-eyed investment bankers who bet on only sure things that turn out to be sure things. In between, there is a Bell Curve of some incompetents and many competents who comprise the market mechanisms, reckoning with varying degrees of precision the return-on-in vestment (ROI) for the organic mass of a nation's capital.

This mechanism will calculate ROI just as precisely when the central government imposes confiscatory taxes on capital at risk as it does when it absolves it of any tax. The market does not care. It is cold and mechanical, in the end as automatic as the tote board at a race track. It grinds out its dispensation of the bits and pieces of capital it absorbs as long as it calculates positive odds for ROI. When the odds turn negative, it stops accepting capital that it cannot dispense. Even kind and gentle country bankers will hesitate and retreat when they confront an obvious bad credit. We frequently encounter kind and gentle investors who tell us they do not care that their investment income is heavily taxed. They will invest anyway. We are sure they are telling us the honest truth, but they are not on the margin. The cold and mechanical market is absorbing their gifts of capital along with all others who casually contribute capital. The greater returns go to those who are not so casual, just as serious horseplayers over time will outperform the casual bettor. The nation as a whole benefits by having its capital -- the surplus time, energy and talent of all its members wisely invested.

It is when a nation's political system fails its economic system - when the market mechanism must refuse to finance unemployed resources because of a persistent negative ROI - that the masses have little choice but to turn to socialism. The body politic will permit the capitalist ruling class some reasonable margin for error, but it cannot permit either mass unemployment or a persistent decline in living standards that threaten the basic family unit. As they did in the 1930s, ordinary people will use the democratic political system to force socialist policies into play when capitalism fails. The social safety net we now have is the refined product of the American electorate of the 1930s. Without having the benefit of a democratic political system, the people of Russia in 1917 produced a much less refined safety net.

Capitalism did not fail in the Great Depression because profit was burdened with social concerns. It failed because the capitalist ruling class saw an opportunity to increase its profits by an increase in the protective tariff using its political muscle to push Smoot-Hawley through the Republican Congress and persuade President Hoover to sign the legislation. This was a blatant intervention in the market, not for the usual purpose of increasing government revenues, but to engineer a social outcome desired by Big Business. Instead of producing the desired effect, the big tote board on Wall Street crashed as ROI suddenly went negative on a host of capital investment dependent upon international trade. Capitalists had only themselves to blame for the New Deal that followed, with its myriad market interventions on behalf of the working class the labor legislation, minimum-wage mandates, farm programs, social security and public power programs that offended the sensibilities of laissez-faire advocates. Once the capitalist Ruling Class uses the tax system to redistribute income instead of raising revenues, how can it complain when populists appear with demands that the tax system be used simply to soak the rich? Because they had no better choice, the masses accepted the diminution of personal freedoms that government market intervention inevitably entails.

Survival requires risk-taking. If the capitalist market mechanism will not accept the risks of financing enterprise that will enable ordinary people to exchange with each other the fruits of their labor, it makes perfect sense to have government take on those risks. Conceptually, an elite socialist team at the center replaces the capitalist financial services industry. The private market mechanism essentially buys up all the nation's productive output and then sells it according to market pricing signals taking a cut to cover its work and its risk. The public mechanism also buys up all the nation's production, but redistributes it according to a plan. The difference is that a socialist system must ignore most of the signals that bear on ROI, taking all the risks inherent in putting everyone to work and absorbing losses that result from errors in the plan. Socialist systems that retain broad elements of market price signals can mitigate such errors, as Sweden has for many years. The experiments in total planning broke down in the USSR and Communist China as planning errors usually the result of clogged communication channels - came to dominate the economies. This meant less and less freedom for the work force. In the end, interlocking state monopolies came to operate at a fraction of planned capacity because of persistent interruptions in the supplies of one critical part or another. Mass unemployment had been eliminated, but production of goods and services was imploding.

Since 1978, China has been gradually restoring market mechanisms capable of better allocating the nation's enormous pool of unutilized capital. Its ruling class remains understandably wary of headlong experiments in laissez-faire capitalism or popular democracy, instead moving incrementally on both political and economic fronts. The former Soviet Union, persuaded by the West to throw itself headlong into capitalism via "shock therapy," has quickly produced the rudimentary market mechanisms for assessing ROI. The confiscatory tax and unpredictable monetary systems adopted by Moscow, though, guarantee that almost all private initiatives face a negative after-tax return on invested capital. The nation's social fabric continues to disintegrate as only an underground Mafia of privileged entrepreneurs amasses great wealth, paying modest bribes instead of murderous taxes. It is in the interest of this privileged class to maintain this corrupt status quo, which is why the masses once again are tempted to turn to the state and the Communist Party for relief. Unhappily, the western economists who advise the democratic government of Boris Yeltsin have little appreciation for the role the market plays in assessing macroeconomic tax and monetary risks to capital investment.

As evidence of this statement, we need only understand that one of the favorite nostrums of economists who advise socialist countries is privatization of state enterprise. The reason that a nation socializes an enterprise or an industry in the first place is that it is unable to produce profitable returns to capital in the private sector. Through much of Latin America during the past several decades, the banks themselves have been socialized and privatized and socialized again. When the tax and monetary authorities are working reasonably, banking can be profitable. When tax rates become confiscatory and currencies become unpredictable, the owners of private banks suddenly see merit in selling their assets (non-performing loans) to the state for prices that appear to be bargains, but which in fact represent taxpayer bailouts of the capitalist class.

In England after World War II, the electorate replaced the Conservative Party and Winston Churchill with the Labor Party and Clement Atlee. Had the Tories pledged to scale back the confiscatory wartime tax rates, which reached 96% at the highest marginal rate, the voters would have had a better choice than socialization of industry. Not until Margaret Thatcher in 1979 did the Tories run on a platform of tax reduction to expand the economy. Prime Minister Thatcher was forced to resign in 1991 when the Tories became unpopular. This followed the Thatcher government's sharp increase in the tax on capital gains. PM Thatcher made the mistake of following the lead of the United States in the 1986 Tax Act, which lowered the tax rate on ordinary income, but raised the capital gains tax to 28% from 20%. The Canadian Tory government made the same error, following Washington's lead, and neither the Conservative Party nor Canada has recovered as yet from the mistake.

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The capital gains tax is not the only tax that bears upon the market's assessment of ROI, but it is by far the most important. Even in Nazi Germany, Hitler's Finance Minister Hjalmar Schacht was careful to exempt capital gains on corporate shares from taxation. No historian of whom I am aware has noted the importance of this policy as the Third Reich's way of rewarding the capitalist class. Ordinary tax rates remained extremely high during the 1930s, but as long as the state rewarded industrial monopolies with government contracts, their shares climbed in value. The Ruling Class could not live on its after-tax income, but could live well by liquidating tax-exempt capital gains. In the United States in the same period, President Roosevelt was persuaded to "soak the rich" with an increase in the capital gains tax in 1937, in the midst of the Great Depression. The higher rate produced a further economic contraction, "a depression within the Depression," and in 1938 the Democratic Congress took it upon itself to roll back the tax increase. In the British Commonwealth countries, even when tax rates on dividends and interest "unearned income" approached 100%, their governments prior to 1988 carefully exempted capital gains.

As the only explicit tax on successful risk-taking, any capital gains tax is counter-productive. When the market mechanism sees a capital gains tax of 100%, it stops cold. The market will continue to accept capital from individuals who face a lower rate, either on the scale of progressive rates or through loopholes. If the capital gains rate is 100% for everyone in the system, though, all legal enterprise will eventually stop in its tracks. One way or another, all paper assets promises and claims are underpinned by human toil and initiative. When there is no possibility of gain through risk-taking, there might still be people willing to convert surplus time, energy or talent into paper promises that might at least hold their own debt over equity. But over time, economic implosion is as inevitable as it was in the USSR, when elitist plans were overwhelmed by error. Telescoped down to the family unit, a 100% tax on capital gains is the equivalent of parents being prevented from educating their children. (Education is a critical form of capital; what an individual or a family or a nation state learns today, it can use tomorrow.)

A 28% tax on capital gains that have not been indexed against inflation can be almost as bad as a 100% rate, depending upon the expected rate of inflation. This is because almost any new enterprise must have sufficient capital to see it through at least five years of market demands and struggle before it can feel a bit secure. The market mechanisms that absorb and dispense capital must cope with the monetary variable in reckoning the true after-tax ROI. Riskier enterprises cannot hope to find capital and credit in an inflationary environment, even without the compounding effect via capital gains taxation, because sources of capital simply disappear. Sources of capital become more plentiful in a deflationary environment, but those who might otherwise employ that capital are discouraged by its high real interest costs in a world of falling nominal prices. As a matter of simple arithmetic, the risks to capital in a combination of inflation and unindexed capital gains are at a maximum. It makes little difference that most market allocation of capital does not directly consider the capital gains tax, only risk-taking that cannot be insured. But as Chicago economist Frank Knight postulated almost 80 years ago, uninsurable risk-taking is the ultimate source of all economic growth.

In a U.S. economy that would suddenly shift to a gold-standard with no tax on capital gains, untapped capital would rapidly flow into the marketplace and be dispensed according to a steepening schedule of risks. We could not predict how the market's "invisible hand" would allocate the capital. It may even be that fewer enterprises would be initiated, while those already in existence would take on added capital and grow faster. It follows from this hypothesis that any marginal increase in the volatility of the dollar price of gold will cause less capital to flow into the market, with less available for deployment on any schedule of risks.

A mature enterprise that has all or most of its capital gains behind it does not need a gold standard or zero capital gains taxation in order to coax working capital out of those who have it, promising to repay it with interest or dividends. Big Business is generally risk averse, which puts it at the lower end of the schedule of risks when capital is available. There actually are complications which arise for Corporate America out of a surplus of capital. This tends to restrain the capitalist class's support for genuine capital formation ~ an observation of Ludwig von Mises on the right as well as Marx on the left. The most worrisome complication for Big Business is that policy changes that enhance the flow of capital to the market put upward pressure on the price of labor. The American Council for Capital Formation, for example, is a Big Business Washington lobby, which technically supports a lower tax on capital gains, but which spends little of its time or resources toward that end. Instead it pushes and shoves on Capitol Hill for tax breaks that fall into the category of corporate socialism, which do nothing to draw capital to fledgling enterprise. Given the choice of ending the capital gains tax or ending the double taxation of dividends, it would of course choose the latter. Oddly, the Council in 1977-78 was the driving force behind the capital gains tax cut that passed at the time, but that was when its members were still the fledgling enterprises of Silicon Valley. It has since matured along with its members.

A dramatic increase in the flow of capital to the market would have the unusual effect of eliminating jobs over time. Where it now takes two breadwinners to earn what one did formerly, an infusion of capital would enable one to do the work of two. The composition of the work force would also change, of course, as there would be a dramatic decline in the number of Americans needed to tend to social pathologies and economic volatility. In many cases, employees would not have to leave their desks to switch jobs, however. Lawyers and accountants, bankers and bond salesmen would shift mental gears to serve an economy in expansion instead of retreat. The global demand for U.S. white-collar expertise in a Pax Americana would swell college ranks again. Corporate America would be forced to automate faster, as blue-collar workers would be bid up in wages or move back to their higher-paid one-breadwinner families.

It is, after all, not enough to focus only on capital formation from the investment side, merely because that happens to be the current crisis of capitalism. Recall that England got the "British disease" of stagflation in the years following World War II. Yet at the time it was part of the Bretton Woods gold standard and there was no tax on capital gains. The problem then was that labor was still being taxed at the very high rates that remained in place from World War I, and interest and dividend income was being jobs. When capitalism was working well, the 40,000 displaced blacksmiths or buggy whip workers were being snapped up by Henry Ford at wages they had not even dreamed about. The crux of the problem is not a surplus or dearth of technology. It is a breakdown in financial intermediation the ability of the market to finance the exchange of relatively simple tasks, because of the risks attached to a floating currency and almost confiscatory taxation of capital. (Even putting aside the tax on capital gains, Gary and Aldona Robbins of Fiscal Associates in Arlington, Va., reckon the marginal tax on business capital at 66.3%, an all-time peacetime high.)

If the United States were to adopt optimum monetary, tax, and regulatory policies, it would certainly have to encourage the rest of the world to follow its example. If we are now among the most efficient of capitalist economies in the world, and are struggling at half our capacity, think of how far behind we would leave the rest of the world if we were operating at optimum speed. Our growth would be a great problem for the Establishment, which now encourages open immigration in order to attract more cheap labor. Our capitalist Ruling Class normally does not encourage other countries to grow rapidly, instead dispatching the International Monetary Fund to discourage emerging markets from emerging. Explosive growth in the United States would pull the work force out of Mexico even faster than the present rates. As we did observe in the Reagan years, though, our supply-side successes were quickly copied by much of the developed world.

At the moment, prospects for this kind of fundamental change seem remote. Not only are the two major political parties moving away from plans for basic reform, they are also persuading themselves that the nation is in an economic equilibrium that is about as good as we can expect. Ross Perot and Pat Buchanan and Steve Forbes and Ralph Nader the four political populists who in different ways have identified the anxieties at the bottom of the socio-economic pyramid are each moving in different directions. The know that the folks at the bottom sense they are at a knife edge of desperation. They don't seem to agree upon any formula that could force change at the top and thus appear to be dissipating as a political force that could threaten those at the top. The only possible solution may be a third party that unites the populists around central views upon which they could agree, which would force the two major parties controlled at the top to compete for their votes. Without this kind of dynamic, the status quo of continued contraction could tip anxieties over the knife edge, and political change could result from social strife. The Million Man March may have been the last peaceful one. Then again, perhaps we can avoid such unhappy options through incremental change. We would then simply have to wait another four years for the kind of necessary economic growth we have described here.