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posted on 10 January 2017

Narrative Economics And The Laffer Curve

by Timothy Taylor, Conversable Economist

Robert Shiller delivered the Presidential Address for the American Economic Association on the subject of "Narrative Economics" in Chicago on January 7, 2017. A preliminary version of the underlying paper, together with slides from the presentation, is available here.

Shiller's broad point was that the key distinguishing trait of human beings may be that we organize what we know in the form of stories. He argues:

"Some have suggested that it is stories that most distinguish us from animals, and even that our species be called Homo narrans (Fisher 1984) or Homo narrator (Gould 1994) or Homo narrativus (Ferrand and Weil 2001) depending on whose Latin we use. Might this be a more accurate description than Homo sapiens, i.e., wise man? Or might we say "narrative is intelligence" (Lo, 2007), with all of its limitations? It is more flattering to think of ourselves as Homo sapiens, but not necessarily more accurate."

Shiller goes on to make a case that narratives play a role in economic activity: for example, the way people acted during the steep recession of 1920-21 and the Great Depression, as well as in the Great Recession and the most recent election. To me, one of his themes is that economist should seek to bring the narratives of these times that economic actors were telling themselves into their actual analysis by applying epidemiology models to examine actual spread of narratives, rather than bewailing narratives as a sort of unfair complication for the purity of our economic models.

Near the start, Shiller offers the Laffer Curve as an example of a narrative that had some lasting force. For those not familiar with the story, here's how Shiller tells it (footnotes omitted):

Let us consider as an example the narrative epidemic associated with the Laffer curve, a diagram created by economist Arthur Laffer ... The story of the Laffer curve did not go viral in 1974, the reputed date when Laffer first introduced it. Its contagion is explained by a literary innovation that was first published in a 1978 article in National Affairs by Jude Wanniski, an editorial writer for the Wall Street Journal. Wanniski wrote the colorful story about Laffer sharing a steak dinner at the Two Continents [restaurant] in Washington D.C. in 1974 with top White House powers Dick Cheney [at the time, a Deputy Assistant to President Ford, later to be Vice President] and Donald Rumsfeld (at the time Chief of Staff to President Ford, later to be Secretary of Defense]. Laffer drew his curve on a napkin at the restaurant table. When news about the "curve drawn on a napkin" came out, with Wanniski's help, the story surprisingly went viral, so much that it is now commemorated. A napkin with the Laffer curve can be seen at the National Museum of American History ...
Why did this story go viral? Laffer himself said after the Wanniski story exploded that he himself could not remember the event, which had taken place four years earlier. But Wanniski was a journalist who sensed that he had the elements of a good story. The key idea as Wanniski presented it is, indeed, punchy: At a zero-percent tax rate, the government collects no revenue. At a 100% tax rate the government would also collect no revenue, because people will not work if all the income is taken. Between the two extremes, the curve, relating tax revenue to tax rate, must have an inverted U shape. ...
Here is a notion of economic efficiency easy enough for anyone to understand. Wanniski suggested, without any data, that we are on the inefficient side of the Laffer curve. Laffer's genius was in narratives, not data collection. The drawing of the Laffer curve seems to suggest that cutting tax rates would produce a huge windfall in national income. To most quantitatively-inclined people unfamiliar with economics, this explanation of economic inefficiency was a striking concept, contagious enough to go viral, even though economists, even though economists protested that we are not actually on the inefficient side of the Laffer Curve (Mirowski 1982). It is apparently impossible to capture why it is doubtful that we are on the inefficient side of the Laffer curve in so punch a manner that it has the ability to stifle the epidemic. Years later Laffer did refer broadly to the apparent effects of historic tax cuts (Laffer 2004); but in 1978 the narrative dominated. To tell the story really well one must set the scene at the fancy restaurant, with powerful Washington people and the napkin.

Here an image of what must be one of history's best-known napkins from the National Museum of American History, which reports that the exhibit was "made" on September 14, 1974, and measures 38.1 cm x 38.1 cm x .3175 cm, and was a gift from Patricia Koyce Wanniski:

Did Laffer really pull out a pen and start writing on a cloth napkin at a fancy restaurant, so that Jude Wanniski could take the napkin away with him? The website of the Laffer Center at the Pacific Research Institute describes it this way:

"As to Wanniski's recollection of the story, Dr. Laffer has said that he cannot remember the details, but he does recall that the restaurant where they ate used cloth napkins and his mother had taught him not to desecrate nice things. He notes, however, that it could well be true because he used the so-called Laffer Curve all the time in classroom lectures and to anyone else who would listen."

In the mid-1980s, when I was working as an editorial writer for the San Jose Mercury News in California, I interviewed Laffer when he was running for a US Senate seat. He was energy personified and talked a blue streak, and I can easily imagine him writing on cloth napkins in a restaurant. When remembering the event 40 years later in 2014, Dick Cheney said:

It was late afternoon, sort of the-end-of-the-day kind of thing. As I recall, it was a round table. I remember a white tablecloth and white linen napkins because that's what [Laffer] drew the curve on. It was just one of those events that stuck in my mind, because it's not every day you see somebody whip out a Sharpie and mark up the cloth napkin at the dinner table. I remember it well, because I can't recall anybody else drawing on a cloth napkin.

The point of Shiller's talk is that while a homo sapiens discussion of the empirical evidence behind the Laffer curve can be interesting in its own way, understanding the political and cultural impulse behind tax-cutting from the late 1970s up to the present requires genuine intellectual opennees to a homo narrativus explanation--that is, an understanding of what narratives have force at certain times, how such narratives come into being, why the narratives are powerful, and how the narratives affect various forms of economic behavior.

My own sense is that homo sapiens can be a slippery character in drawing conclusions. Homo sapiens likes to protest that all conclusions come from a dispassionate consideration of the evidence. But again and again, you will observe that when a certain homo sapiens agrees with the main thrust of a certain narrative, the supposedly dispassionate consideration of evidence involves compiling every factoid and theory in support, as well as denigrating those who believe otherwise as liars and fools; conversely, when a different homo sapiens disagrees with the main thrust of certain narrative, the supposedly dispassionate consideration of the evidence involves compiling every factoid and theory in opposition, and again denigrating those who believe otherwise as liars and fools. Homo sapiens often brandishes facts and theories as a nearly transparent cover for the homo narrativus within.

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