Will economic freedom continue to triumph?

 

As I was reading The Triumph of Economic Freedom, the recently published book by Phil Gramm and Donald J. Boudreaux, I wondered whether its title might be too optimistic. The book certainly supports its conclusion that “freedom has been the key to the great progress we have made in the past, and it the key to our progress in the future” (p. 197). However, the impression I was left with is that the authors are not overly optimistic that economic freedom will continue to triumph in America.

The subtitle of the book is Debunking the Seven Great Myths of American Capitalism. In the introduction the authors suggest that current “conventional wisdom” about the desirability of “expanding the government’s role” (i.e. reducing economic freedom) is supported by those myths (pp. xii-xiii). The ongoing triumph of economic freedom will depend importantly on whether enough people understand its merits and are willing to defend it.

Phil Gramm and Donald Boudreaux have both been staunch defenders of economic freedom over a long period. Phil Gramm is an economist and former politician. He represented Texas in both chambers of the U.S. Congress and, at different times, served as both a Democrat and a Republican. Donald Boudreaux is an economics professor at George Mason University and a senior fellow at Mercatus Center. He has vigorously sought to make economic issues, particularly issues surrounding international trade, understandable to a broad audience. He has used his Café Hayek blog for that purpose for over 20 years.

My aim in this essay is to draw on The Triumph of Economic Freedom to consider where anti- market myths come from and who defends them.

Myth 1: The industrial revolution caused a great deal of misery.

This bleak assessment dominates conventional wisdom and popular literature to this day, yet the authors point out that it is refuted by “every major measure of material well-being”.

The myth seems to have its origins in the fact that poor people become much more visible when they move from the countryside in search of a better life in factory work in urban areas. Victorian literature, particularly the novels of Charles Dickens, paint a “worst of times” portrait at the end of the Industrial Revolution.

There has been debate among economic historians about the point at which average real wages actually began to rise in England during the 19th century (even some discussion on this blog) but there can be no doubt that the industrial revolution was the beginning of a golden age of material well-being.

Why does the myth persist? Those who wish to question the merits of free markets still see it as a useful narrative for their purposes (which may include encouraging opposition to imports from “sweatshops” in developing countries).

Myth 2: Progressive era regulation in the U.S. was necessary to meet the threat posed by corporate monopolies.

This myth seems to have had its origins in the inability of many small, local firms to withstand the competition of economic giants serving the national market. These corporate giants contributed to widespread growth of economic opportunity, but their competition was portrayed as harmful by interest groups and politicians seeking greater control of the economy.

This myth is still to be found in leading history textbooks. It is still a useful narrative for those who promote a new progressive vision for regulation of tech giants.

Myth 3: The great depression was a failure of capitalism.

Gramm and Boudreaux suggest: 

“When failed government policies produce a crisis, government blames capitalism and then uses the crisis to expand the very powers that initially caused the crisis” (p. 193).

Some prominent economists who prefer market failure explanations to government failure explanations certainly helped governments to do this. Advocates of market failure put forward some explanations of the depression that appeared to be plausible e.g. the idea that free market capitalism has a tendency toward under-consumption. Gramm and Boudreaux point out, however, that the long period of economic growth after the end of World War II, following restoration of “a largely free market”, testifies against theories of underconsumption (p. 80).

Myth 4: The myth of trade hollowing out American manufacturing.

This myth has its origins in the decline in employment in manufacturing as a percentage of total employment. As Gramm and Boudreaux point out, as part of the economic growth process, advances in technology eliminate jobs in manufacturing (as in agriculture beginning at an earlier point) and create jobs in the service sector. This process enables wages and other incomes to rise.

Import competition is blamed because nationalism is “always a powerful force than can be tapped to stoke support for protectionism, and significant benefits can be granted to a small number of economic interests, with the costs spread almost imperceptibly across society as a whole” (p. 193).

Myths about international trade persist because the roles of economic freedom and technological progress in the economic growth process are poorly understood by most citizens. Few economists support protectionist policies.

Myth 5: The myth that deregulation caused the financial crisis of 2008.

The central element of the myth is that financial deregulation enabled banks to “recklessly gamble depositors’ funds in securities markets”.  Gramm and Boudreaux point out that government “regulatory policy pressured banks to make bad loans”, “forced government-sponsored enterprises to purchase and securitize those loans”, and “manipulated financial institutions’ capital standards to encourage banks to hold massive quantities of mortgage-backed securities” (p. 193).

As with the great depression, this is another example of government causing a crisis and then creating a myth to suggest that the crisis occurred because of insufficient government regulation.

Myth 6: The myth that income inequality in America is high and rising on a secular basis.

Gramm and Boudreaux point out that this myth has its origins in reliance on official Census Bureau data which fails to count two-thirds of transfer payments. When appropriate adjustments are made to the official figures, the ratio of average household income in the top quintile to average household income in the bottom quintile falls from 16.7 to 1 to 4 to 1, and the appearance of growth of inequality disappears.

The idea that income inequality is high and rising in America is so ingrained in conventional wisdom that I had some difficulty accepting that it is a myth. However, the authors have presented a persuasive argument based largely on research by John Early, who was formerly assistant commissioner at the Bureau of Labor Statistics.

The Census Bureau apparently includes footnotes in its publications to acknowledge the limitations of its measures of household income, but it is difficult to understand why it has not produced more accurate measures.

Myth 7: The myth that poverty is a failure of American capitalism.

The authors argue that poverty is a failure of U.S. government rather than free markets. The growth of welfare payments has diminished labor force participation to such an extent that it has largely delinked the bottom quintile of income earners from the economy. The authors suggest that by making the poor dependent on the government the welfare system has severed their “avenue for success and personal achievement”.

The authors suggest that the current welfare system might serve “the political interests of the government” rather than the interests of poor people.

Discussion

The common element in many of these myths is a lack of understanding of the spontaneous forces of a free market, in combination with a planning mentality, and a tendency to overlook the potential for deliberate government controls to have unintended adverse consequences. Another common element is the activity of interest groups that have an incentive to create and perpetuate myths that advance their interests at the expense of others.

Lack of understanding of spontaneous forces poses a particular problem in the context of economic change. As Friedrich Hayek noted, in the context of complex spontaneous orders, it is not possible “to predict the particular changes that any event in the environment will bring about”. He suggested that this “ignorance of how the mechanism of the spontaneous order will solve such a ‘problem’ … often produces a panic-like alarm and the demand for government action for the restoration of the disturbed balance” (LLL, v1, p. 63).

Hayek went on to note that when it is possible to foresee how market forces are likely to restore the disturbed balance, the situation can become even worse:

“The necessity of adaptation to unforeseen events will always mean that someone is going to be hurt, that someone’s expectations will be disappointed or his efforts frustrated. This leads to the demand that the required adjustment be brought about by deliberate guidance, which in practice must mean that authority is to decide who is to be hurt” (LLL, v1, p. 63).

How can anti-market myths be debunked? I can’t think of a better way than via publications such as this book by Phil Gramm and Donald J. Boudreaux, who are following in the footsteps of Frédéric Bastiat. I hope that their book will be widely read in the U.S. and in other countries (including Australia) where anti-market myths seem to be even more widely accepted.

It seems appropriate to end this essay by quoting in full the paragraph by Frédéric Bastiat from which the epigraph was extracted:

“By the dissemination of knowledge, by enlightened discussion of cause and effect, to bring public opinion back to the intelligent attitude that condemns bad tendencies and resists the adoption of harmful measures, is to render a great service to one's country. When misguided public opinion honors what is despicable and despises what is honorable, punishes virtue and rewards vice, encourages what is harmful and discourages what is useful, applauds falsehood and smothers truth under indifference or insult, a nation turns its back on progress and can be restored only by the terrible lessons of catastrophe” (Economic Harmonies, 1850).