Refuting Economic Sophistry – David Lewis Schaefer

While Americans are typically diligent in protecting their political and religious freedom, economists Phil Gramm and Donald Boudreaux observe in The Triumph of Economic Freedom that they often show less concern for defending their economic freedom—“control over their own livelihoods”—despite its essential role in securing their other rights. This is so, the authors maintain, because they “understand it the least.” Lack of appreciation for how the free-market system works leaves citizens vulnerable to misleading claims by politicians, interest groups, and ambitious intellectuals that induce them to accept restrictions on economic freedom that are detrimental to their welfare.

Gramm (who authored Ronald Reagan’s first budget and later chaired the Senate Banking Committee) and Boudreaux (who teaches at George Mason University) debunk seven “myths” about American economic history that have been used to support those false claims. These include, successively, the myths that the Industrial Revolution impoverished workers; that the growth of large corporations generated the need for Progressive Era regulations; that the Great Depression was caused by “a failure of capitalism”; that free international trade “hollowed out” American manufacturing; that the 2008 financial crisis was caused by deregulation; and that America’s free-market system causes both poverty and excessive income inequality.

The authors begin by exposing the mythical character of the claim, first adumbrated by socialists like Friedrich Engels (followed by a multitude of twentieth-century historians, but made most memorably by literary authors like Charles Dickens) that the industrial revolution had “catastrophic” consequences for working people. While mid-nineteenth-century factory working conditions undoubtedly looked unpleasant, the irony of the anti-industrial argument is that it was put forth at the beginning of “a golden age of material well-being—especially for workers.” What economic historian Deirdre McCloskey called “the Great Enrichment,” starting just over two centuries ago, ultimately raised living standards in industrializing countries including Britain, Japan, and the US, by anywhere from 3,000 to 10,000 percent. Those who lament the substitution of factory labor for the supposedly more pleasant life of farmers lack awareness of how impoverished human life, in terms of life expectancy, housing, nutrition, and health, really was in the countryside. (It was precisely the higher incomes that factories offered that lured workers from the countryside.)

In the United States, as the authors note, over just the three decades from 1870 to 1900, “inflation-adjusted gross national product tripled, [a]gricultural production more than doubled, and mining and manufacturing [output] grew eightfold and sixfold, respectively, rates of economic growth never before experienced in recorded history.” But the so-called Progressives, arising during this period, objected that the growth was achieved by large corporations or “trusts” whose owners retained most of the gains while “exploiting” workers. The consequence was antitrust legislation aimed at breaking up the trusts, while initiating a broad national regulatory system.

But while leading history textbooks still propagate the progressive myth that the trusts used monopoly power to restrict output and thus generate higher prices, the late nineteenth century was actually an era of price deflation, owing to rising production, particularly in the industries dominated by large corporations, thanks to the economies of scale they enjoyed, and the incentives they possessed to introduce innovative technology. Nor were trusts able to use their power to stifle competition: as historian Gabriel Kolko observed, the distribution of economic power was constantly being altered thanks to the introduction of new products, production methods, markets, and supply sources. Government intervention did not promote competition but rather impeded it, serving the interests of politically influential firms. Notably, when socialist Upton Sinclair publicized false claims about unhealthful practices in Chicago’s slaughterhouses, progressives in Congress passed the 1906 Meat Packing Act, which large meatpacking firms supported because they could afford the cost of government inspection more easily than their smaller rivals. Competition was similarly squelched by government tariffs on sugar, and by Interstate Commerce Commission regulations that fixed prices in rail transport, trucking, and shipping.

Gramm and Boudreaux refute the related myths that economic inequality in America is steadily growing, causing the impoverishment of millions.

Not until the 1970s, under the Carter administration, was this regulatory system partly disassembled, with the abandonment of anti-consumer federal price setting and the adoption of a new antitrust policy based on “consumer welfare.” Yet forty years later, the Biden administration sought to reimpose Progressive policies through executive orders and the appointment of regulators who were hostile to the free-market system.

The authors also tackle persistent myths about the causes of the Great Depression. According to “conventional wisdom,” it resulted from the stock-market “greed” that culminated in the Crash of 1929, combined with a supposed problem of “underconsumption” that Franklin Roosevelt endeavored to remedy through the “New Deal.” This myth begins with demonstrably false claims about the prosperity of the 1920s, to the effect that its benefits were (as Roosevelt hagiographer Arthur Schlesinger Jr. maintained) unequally distributed, owing to tax policies that favored millionaires, while businessmen refused to share profits with their workers, leading to a “relative decline of mass purchasing power.”

In reality, however, the 1920s witnessed an unprecedented gain in the average standard of living. (In his book Modern Times, historian Paul Johnson lists the widespread increase in the goods that ordinary people were suddenly able to enjoy, from automobiles and radios to life insurance policies.) Nor did the crash of 1929 have to produce anything like the lengthy depression that followed: it was preceded by what economist James Grant calls the “forgotten depression” of 1920–21, which lasted only some 18 months and ended without any application of the government spending policies adopted by Herbert Hoover and FDR starting in 1929.

As Gramm and Boudreaux observe, Roosevelt and his progressive advisers used the charges of underconsumption and maldistribution to justify policies they had favored long before the economic crisis: higher government spending and increased, more progressive taxation. Nor did Roosevelt’s policies do anything to curb the Depression; by 1939, his treasury secretary, Henry Morgenthau, admitted that the administration had “never made good” on its promises, with unemployment remaining as high as it had been six years earlier, even while incurring “an enormous debt.”

Gramm and Boudreaux join monetarist economists Milton Friedman and Anna Schwartz in blaming the Depression’s origins on the “blunders” of the Federal Reserve, which fueled a market “frenzy” in the late 1920s by keeping interest rates too low, then “overcompensated” by raising them too high, “making it harder for business people to borrow and invest” and thus add employees. But Roosevelt then prolonged the Depression, first by emulating his predecessor’s policies of increased (and more progressive) taxation, running large budget deficits, and trying to prevent prices and wages from falling; then by creating a hostile business environment, boasting of the enmity his policies had earned him; raising taxes still higher, and adopting wacky schemes like paying farmers to kill and bury their animals, at a time when the cities were filled with bread lines.

Contrary to the belief that the Depression ended only thanks to America’s entry into World War II (which solved the unemployment problem), leading economists like Paul Samuelson to urge the immediate restoration of “astronomical deficits” once peace returned (advice that was fortunately ignored), Gramm and Boudreaux attribute the country’s long postwar boom to “the restoration of a largely free market and an end to the extreme uncertainty regarding the sanctity of property and contract rights” that FDR’s policies had engendered. Though Harry Truman favored policies like national health insurance and opposed the Taft Hartley Act’s limitations on union power, polls showed that businessmen and professionals “felt much less threatened” by him than they had been by FDR.

Of more immediate relevance, given our current president’s professed “love” for tariffs, is that the authors also address the myth that international trade “hollow[s] out American manufacturing.” That myth rests on a longing (shared by presidents of both parties) to restore the “golden age” of the three decades following the end of World War II, when America ran a consistent trade surplus, unemployment stayed low, and wage growth was high. But the trade surplus was a product of the superior economic position with which the US emerged from the war, a position that was bound to end as Europe and Japan rebuilt and other countries like Taiwan and South Korea industrialized. Yet, the authors note, the end of the surplus did not entail any stagnation in the incomes of working Americans: “In real purchasing power dollars, 66.3 percent of all American households currently have incomes that would have put them in the top 20 percent of income recipients in 1967.” Nor has American manufacturing output declined, even as its share of global manufacturing decreased. But the recent slowing in the growth of industrial capacity is a worldwide phenomenon, which “coincided with the rise of the tech industry,” generating increased labor productivity.

Contrary to President Trump, the authors note, it isn’t true that when “foreigners are net investors” in the United States, causing us to have a trade deficit, they are draining our “lifeblood.” America “ran trade surpluses,” they point out, “in 102 of the 120 months of the 1930s,” the era of the Depression that began with the prohibitive Smoot-Hawley tariffs that devastated global commerce. By contrast, postwar America “has been a magnet for talent and capital,” fueling job creation and increases in household wealth. Raising tariffs can only damage our prosperity, even as it favors certain limited groups. One recent example: The tariffs Trump imposed on steel and aluminum in his first term “created” 1,000 and 1,200 jobs, respectively, while costing 75,000 manufacturing jobs overall because of the higher prices companies had to pay for the metals—and retaliatory tariffs imposed by other countries caused American farmers $22 billion in lost sales.

The authors go on to refute the myth, espoused by everyone from Barack Obama to Time magazine, that the 2008–09 recession was caused by the deregulation of mortgage bankers, who “concocted complex mortgage loans … to fool unsuspecting homebuyers” into borrowing more than they could afford to pay. In reality, it was the Clinton administration’s pressure on banks, under the 1977 Community Reinvestment Act, that compelled them steadily to lower their lending standards, in the name of promoting “affordable housing,” while pretending that subprime mortgage-based securities were “as creditworthy as US government debt,” that led to the market crash. (Clinton ally Barney Frank, then-chair of the House Banking Committee, openly professed his wish to “roll the dice” with the housing market. He got his wish, but the country lost his bet.)

Lack of appreciation for how the free-market system works leaves citizens vulnerable to misleading claims that induce them to accept restrictions of economic freedom.

Turning their attention to economic inequality, Gramm and Boudreaux refute the related myths, espoused by everyone from Pope Francis to French socialist economist Thomas Piketty to Disney heiress Abigail Disney, that economic inequality in America is steadily growing, causing the impoverishment of millions. The greatest flaw in these arguments (elaborated in Gramm’s previous co-authored book The Myth of American Inequality) is their reliance on Census Bureau figures that omit two-thirds of all transfer payments (e.g., food stamps, Medicaid, “tax credits”) from the definition of “income,” while also failing to adjust household income for the amount of taxes paid. When the necessary adjustments are made, the Bureau’s claim that members of the top income quintile receive on average 16.7 times as much as members of the bottom quintile is replaced by a ratio of 4 to 1. Additionally, so flat is the adjusted income distribution among the bottom three out of five quintiles that in 2017, those in the bottom quintile received an average of $49,613, compared to $53,924 for the second quintile and $65,631 for the middle. And after adjusting for household size, it turns out that “individuals living in the bottom 60 percent of American households all have roughly the same level of income … even though only 36 percent of prime working-age persons in the bottom quintile actually work, compared to 85 percent in the second quintile and 92 percent in the middle quintile.” In sum, the current combination of taxes and transfers serves to disincentivize work for many, leading to the social and moral problems documented by AEI economist Nicholas Eberstadt in his monograph Men Without Work.

While citing evidence of considerable economic mobility (that is, increases in income over time) among those born into the lowest quintile, the authors properly take collectivists such as Piketty to task for describing the incomes of higher earners as “what they ‘take,’ ‘claim,’ or ‘absorb’” from others rather than “what they earn or create.” While Bill Gates, for instance, “owns 0.53 percent of Microsoft,” they write, “his products enrich our lives, he created hundreds of thousands of jobs, and our pension funds are more valuable because we own many times more shares of Microsoft than he does.”

While Gramm and Boudreaux conclude that following proper adjustments to income, the rate of real poverty in America is only 2.5 percent, they add that far from that poverty being caused by “capitalism,” “poverty and dependence” are rather “the great failures” of federal policies, specifically the “War on Poverty” initiated by Lyndon Johnson—along with failing American public schools. Hence, they urge a reform of welfare programs to include “work incentives and mandatory work requirements for able-bodied working-age adults,” along with reform of our educational system, which might include adding charter schools, school choice, and—I add—breaking the power of teachers’ unions to block improvement.

As Gramm and Boudreaux remind us, although “in the richest countries in history’s most prosperous age, it is poverty, not affluence, that looks unnatural,” prosperity isn’t natural, but must be “continuously produced” by work, innovation, and investment. Yet currently, “the explosive growth of means-tested social welfare spending … absorbs 57.4 percent of general revenues in the U.S.,” putting at risk not only America’s fiscal soundness, but vital services such as defense, along with adequate capital investment in the nation’s future.

I wish that every American college and high school teacher of politics, economics, and history could be persuaded to read this invaluable book and to share its lessons with their students.