The Triumph of Economic Freedom

Freedom is only one generation away from extinction.

That includes economic freedom. But Phil Gramm and Donald Boudreaux have written an excellent book continuing the defense of capitalism and economic freedom for another generation. Their book tackles common myths about capitalism, such as that it impoverished workers in the industrial revolution or that it caused the Great Depression and the 2008 Financial Crisis. Gramm and Boudreaux also sort out what really drove Progressive-era regulation and whether freer trade really “hollowed out” American manufacturing while tackling concerns about income inequality and poverty.

These myths are not mere urban legends. They are held, and even defended, by many otherwise intelligent, educated people. Gramm and Boudreaux give their opponents their due before debunking each myth. 

Authors like Charles Dickens to William Wordsworth as well as writers like Karl Marx and Friedrich Engels describe the industrial revolution as masses of people moving from happy, healthy lives on farms in the country to dirty squalor and exploitation in urban factories—along with rampant child labor. Marx explicitly described the proletariat masses as being oppressed and impoverished by capitalists. 

Leaving aside the fact that, somehow, people today have become unbelievably wealthy and better off materially than they were two or three hundred years ago, what actually happened to workers during the industrial revolution? Well, wages and life expectancy rose dramatically throughout the industrial revolution. 

The poor crowded together in cities and became highly visible to the literati. However, the poor scattered in the countryside were much less visible but lived in equal, or often worse, squalor—leaky thatched roofs, cramped quarters with animals or vermin, etc. Yet industrialization led to rapid improvements in living standards. Skilled and unskilled builders in Britain saw their income more than double between 1840 and 1900. Similarly, life expectancy for men rose from 40.2 years to 48.5 years and for women from 42.2 years to 52.4 years.

Rather than a dark period of bleak prospects for average workers, the industrial revolution kick-started the greatest improvement in living standards for the greatest number of people in human history. And that trend continues today. 

Another entrenched myth holds that the capitalists and “robber barons” of the late 1800s ran roughshod over workers, customers, and competitors. Supposedly major industrial titans like John Rockefeller and J.P. Morgan, and important industries like meatpacking, railroads, oil, and steel, engaged in anticompetitive consolidation and reckless disregard for safety and decency. Muckraking journalists like Ida Tarbell and Upton Sinclair wrote fantastic (i.e., mostly fabricated) accounts of the oil and meatpacking industries, respectively.

Nevertheless, their Jeremiads contributed to the significant increase in regulation enacted by Progressive politicians on both sides of the political aisle. The Sherman Antitrust Act, the Pure Food and Drug Act, even the Federal Reserve Act, were all passed to regulate sectors of the economy that were seen as anticompetitive and abusive.

Ironically, these regulations made these industries less competitive and less beneficial for consumers. Many economists throughout the twentieth century spent large parts of their careers exposing the problems created by Progressive-era regulation and the incorrect criticisms of industry in the late nineteenth century. In fact, these major business titans lowered the costs of oil, steel, meat, transportation, and almost everything else.

The regulation of railroads led to higher, not lower, shipping rates. It also made the industry less competitive, less innovative, and less profitable. Furthermore, it protected incumbents from smaller competitors and new entrants. These effects were not limited to railroad regulation but occurred across the board with Progressive-style business regulations.

Historians in the 1950s and 1960s largely agreed the myth that the Great Depression was created by greed and stock market speculation turned panic. Weak unregulated banks, in turn, fell like dominos without any market mechanism to reverse the damage. It was only the bold action of FDR’s New Deal programs and, ultimately, World War II spending that brought an end to the Depression.

Nearly a century later, we know that this consensus lacked any economic or historical basis. The Depression was mostly created, and sustained, by poor government policy. This includes major errors by the central bank, pointed out by Milton Friedman and Anna Schwartz, that resulted in a severe contraction in currency and rampant bank failures. 

Other harmful policies include the Smoot-Hawley tariff which caused international trade to collapse, an increase in taxes under Herbert Hoover and Franklin Roosevelt, and massive government spending programs and regulations—including widespread implementation of price controls. Mancur Olson argued persuasively that the imposition of price controls were a major factor in how quickly or how slowly various industries in the US recovered from the Depression. 

Far from a failure of capitalism, the Great Depression was the result of the suppression of capitalism.

Although the idea that US manufacturing has declined over the past four decades primarily due to free trade has become accepted wisdom in the current administration, the story is far more complicated. Manufacturing output in the US is more than double today what it was in the 1990s. The productivity of manufacturing workers has also risen. What has declined is the number of workers in manufacturing.

Furthermore, there has been significant geographic change in where manufacturing takes place. The Midwest rust belt has seen thousands of factories close. But southern states have seen thousands of factories open. The decline in manufacturing in the rust belt began before China entered the World Trade Organization, and even before the North American Free Trade Agreement. Inefficiencies, burdensome regulations, and anti-competitive union labor drove factories out of Michigan and Ohio and Pennsylvania, not greater international trade.

Proponents of protectionism defend their narrative by raising poignant examples. Look at how much steel and concrete China produces! Look at how busy and advanced Chinese ports are! Look at how China has essentially cornered the market on rare-earth metal mining and processing! All these are well worth looking at, but they do not really support the narrative that free markets and free trade are the problem.

When it comes to steel and concrete, China produces a huge amount, but it also wastes a huge amount on ghost cities. Raw output alone does not signal wealth or value creation. When it comes to ports, the Chinese do have a decisive advantage—but that is almost entirely because US unions and regulators have stifled technical innovation and capital investment in US ports. Allowing greater market forces and competition will improve US ports, not some misguided tariff to “balance” trade. 

Finally, China has dominated rare-earth metal mining and processing because they have few environmental laws and regulations and thereby minimal compliance costs. US environmental agencies, on the other hand, have made it prohibitively expensive for US companies to mine and refine rare-earth metals (and many other things).

Free trade hasn’t hollowed out manufacturing; regulations and labor unions have.

Although many excellent articles and books have argued that the 2008 financial crisis was largely manufactured by misguided government policy, the colloquial view on the street still holds that the financial crisis was caused by greed and unregulated capitalism. Gramm and Boudreaux point out that government policy in the 1990s diluted underwriting standards. They explain how Fannie Mae and Freddie Mac further fueled bad underwriting with their Congressional mandates to buy affordable mortgages. 

Various capital requirements then encouraged banks to load up on opaque mortgage-backed securities built on increasingly poor-quality loans. Leverage was not the problem. The repeal of Glass-Steagall was not the problem. 

Misregulation and overregulation caused the Financial Crisis.

The authors draw on Gramm’s recent book (with Robert Ekelund and John Early) The Myth of American Inequality to reveal how misleading, even shoddy, research about income inequality is. It’s hard to believe, but most income inequality statistics only look at pre-tax monetary earnings and do not include government benefits. As a result, households in the highest quintile look like they have 16.7 times the income of households in the lowest quintile.

This, of course, is absurd.

Simply noting people’s after-tax revenue rather than their pre-tax revenue reduces the inequality between rich and poor dramatically. Once taxes and transfers are accounted for, the top quintile has income only 4 times greater than the lowest quintile—making the income inequality story laughable. In fact, those in the second and third quintiles are hardly any better off after taxes and transfers than those in the lowest quintile who receive free or heavily subsidized food, healthcare, and housing.

Many news headlines talk about “food insecurity” and “widespread poverty” in the United States. Pundits tout various surveys and reports that suggest tens of millions of Americans are barely surviving. It looks like poverty in the US is rampant—more than one in ten Americans—and severe. Pundits might also point to western Europe as a better model where there is less poverty and less income inequality. Yet, these headlines and statistics are highly misleading.

For one thing—poverty, like income inequality—tends to be measured without considering government transfers and benefits. Yes, a person earning no income looks like they could possibly starve, but with EBT cards and other food programs, they have no trouble at all getting enough calories. 

For another thing, poverty is a relative term. The “poor” in America are actually closer to middle income in European countries. As the authors point out, nearly a third of the population in Germany or in the United Kingdom would be classified as poor using US income metrics.

Gramm and Boudreaux conclude that economic freedom has radically improved people’s lives around the world. And the more economic freedom a country has, the more its people’s lives become richer and healthier. The myths that capitalism causes all kinds of economic problems are undercut by the simple fact that capitalism has generated the immense prosperity we all enjoy today.