A tariff is a tax a government imposes on imports. Since the end of World War II, high-income countries have only occasionally used tariffs as an important policy tool. The following figure shows how the average U.S. tariff rate, expressed as a percentage of the value of total imports, has changed in the years since 1790. The ups and downs in tariff rates reflect in part political disa-greements in Congress. Generally speaking, through the early twentieth century, members of Congress who represented areas in the Midwest and Northeast that were home to many manufacturing firms favored high tariffs to protect those industries from foreign competition. Members of Congress from rural areas opposed tariffs, because farmers were primarily exporters who feared that foreign governments would respond to U.S. tariffs by imposing tariffs on U.S. agricultural exports. From the pre-Civil War period until after World War II the Republicans Party generally favored high tariffs and the Democratic Party generally favored low tariffs, reflecting the economic interests of the areas the parties represented in Congress. (Note: Because the tariffs that the Trump Administration will end up imposing are still in flux, the value for 2025 in the figure is only a rough estimate.)
By the end of World War II in 1945, government officials in the United States and Europe were looking for a way to reduce tariffs and revive international trade. To help achieve this goal, they set up the General Agreement on Tariffs and Trade (GATT) in 1948. Countries that joined the GATT agreed not to impose new tariffs or import quotas. In addition, a series of multilateral negotiations, called trade rounds, took place, in which countries agreed to reduce tariffs from the very high levels of the 1930s. The GATT primarily covered trade in goods. A new agreement to cover services and intellectual property, as well as goods, was eventually negotiated, and in January 1995, the GATT was replaced by the World Trade Organization (WTO). In 2025, 166 countries are members of the WTO.
As a result of U.S. participation in the GATT and WTO, the average U.S. tariff rate declined from nearly 20% in the early 1930s to 1.8% in 2018. The first Trump Administration increased tariffs beginning in 2018, raising the average tariff rate to 2.5%. (The Biden Administration continued most of the increases.) In 2025, the second Trump Administration’s substantial increases in tariffs raised the average tariff rate to the highest level since the 1940s.
Until the enactment in 1913 of the 16th Amendment to the U.S. Constitution, which allowed for a federal income tax, tariffs were an important source of revenue to the federal government. As the following figure shows, in the early years of the United States, more than 90% of federal government revenues came from the tariff. As tariff rates declined and federal income and payroll taxes increased, tariffs declined to only 2% of federal government revenue. It’s unclear yet how much tariff’s share of federal government revenue will rise as a result of the Trump Administration’s tariff increases.
The effect of tariff increases on the U.S. economy are complex and depend on the details of which tariffs are increased, by how much they are increased, and whether foreign governments raise their tariffs on U.S. exports in response to U.S. tariff increases. We can analyze some of the effects of tariffs using the basic aggregate demand and aggregate supply model that we discuss in Macroeconomics, Chapter 13 (Economics, Chapter 23). We need to keep in mind in the following discussion that small increases in tariffs rates—such as those enacted in 2018—will likely have only small effects on the economy given that net exports are only about 3% or U.S. GDP.
An increase in tariffs intended to protect domestic industries can cause the aggregate demand curve to shift to the right if consumers switch spending from imports to domestically produced goods, thereby increasing net exports. But this effect can be partially or wholly offset if trading partners retaliate by increasing tariffs on U.S. exports. When Congress passed the Smoot-Hawley Tariff in 1930, which raised tariff rates to historically high levels, retaliation by U.S. trading partners contributed to a sharp decline in U.S. exports during the early 1930s.
International trade can increase a country’s production and income by allowing a country to specialize in the goods and services in which it has a comparative advantage. Tariffs shift a country’s allocation of labor, capital, and other resources away from producing the goods and services it can produce most efficiently and toward producing goods and services that other countries can produce more efficiently. The result of this misallocation of resources is to reduce the productive capacity of the country, shifting the long-run aggregate supply curve (LRAS) to the left.
Tariffs raise the prices of U.S. imports. This effect can be partially offset because tariffs increase the demand for U.S. dollars relative to trading partners’ currencies, increasing the dollar exchange rate. Because a tariff effectively acts as a tax on imports, like other taxes its incidence—the division of the burden of the tax between sellers and buyers—depends partly on the price elasticity of demand and the price elasticity of supply, which vary across the goods and services on which tariffs are imposed. (We discuss the effects of demand and supply elasticity on the incidence of a tax in Microeconomics, Chapter 17, Section 17.3.)
About two-thirds of U.S. imports are raw materials, intermediate goods, or capital goods, all of which are used as inputs by U.S. firms. For example, many cars assembled in the United States contain imported parts. The popular Ford F-Series pickup trucks are assembled in the United States, but more than two-thirds of the parts are imported from other countries. That fact indicates that the automobile industry is one of many U.S. industries that depend on global supply chains that can be disrupted by tariffs. Because tariffs on imported raw materials, parts and other intermediate goods, and capital goods increase the production costs of U.S. firms, tariffs reduce the quantity of goods these firms will produce at any given price. In terms of the aggregate demand and aggregate supply model , a large unexpected increase in tariffs results in an aggregate supply shock to the economy, shifting the short-run aggregate supply curve (SRAS) to the left.
Our thanks to Fernando Quijano for preparing the two figures.
Ninteenth century populist William Jennings Bryan delivering a campaign speech. (Photo from the AP via politico.com)
The following op-ed originally appeared in the Wall Street Journal.
The Economic Populists Have a Point
Many issues divide voters heading into the November election, but the economy may be the most crucial. Sound economic policy can foster prosperity and high living standards and affect income and opportunities. Economic resources can also enable society to fund defense or address social and environmental concerns.
Conservative economic policy traditionally has emphasized the openness of markets and growth. By contrast, the populist conservative ideas under discussion at the Republican National Convention focus on people and places hard hit by the disruption that accompanies openness and growth. While many commentators emphasize the differences between the two approaches, a modern conservative economic agenda should build on elements of both.
To begin, a conservative economic agenda should include policies that advance economic growth and living standards. That means supporting research and development, maintaining pro-investment business tax provisions in the Tax Cuts and Jobs Act of 2017, and making regulations that benefit everyone. Such an economy lets businesses and individuals get the most out of the opportunities they seize.
Populist conservatives argue that this traditional approach to policy misses an important objective: a disruptive, rough-and-tumble economy, guided by technological advances and globalization, one that brings everyone along. Populist conservatives want more emphasis on protecting jobs and communities.
There’s more to the populist conservatives’ skepticism than traditional conservatives acknowledge. But backward-looking protectionist measures such as inflationary tariffs or industrial policy aren’t the answer.
However, there is a conservative economic agenda that can unite these groups. The shortcomings of Bidenomics give conservatives an opening to push beyond both market-only neoliberalism and the statist tendencies of industrial policy and protectionism, with their attendant economic inefficiencies. To do so, conservative economic policy needs three ingredients.
The first is agreeing with populist conservatives that markets don’t always work perfectly and that a hands-off approach isn’t always the solution. The state can play a useful role in the market economy. Supply-chain restrictions and export controls can be tools to deny national-security-sensitive technologies to adversaries such as China. But an economic agenda requires more than a sound bite to avoid overreach—such as using “national security” as a pretext for slapping steel tariffs on Canada.
The second essential is competition—the linchpin of economic possibilities for classical economic thinkers from Adam Smith onward. While competition at home and abroad expands the economic pie, it says little about the relative sizes of the slices, a point noted by populist conservatives. A modern conservative economic approach would not only promote competition but also prepare more individuals to compete in a changing economy. One avenue could be supporting community colleges that understand local job needs rather than establishing more government training programs.
Third and most important, a conservative economic platform should recall why conservatives have stressed the benefits of markets. The goal, as my Columbia colleague and Nobel laureate Edmund Phelps puts it, is “mass flourishing.” That is why we want markets to work—to advance innovation and productivity and allow communities to make that flourishing possible.
As far as government’s role, a contemporary economic agenda should recognize a limited measure of successful industrial policy. Two roads should be on offer. The first is to provide more general support for basic and applied research, while letting market forces determine winners and losers. The second is to assign specific goals to particular interventions. The Apollo program’s goal was to put a man on the moon in a decade. The Trump administration’s Operation Warp Speed sought vaccines against Covid.
Populist conservatives are right that there is a role in a conservative economic agenda for helping areas hard hit by disruption. But that role isn’t a mercantilist blunderbuss of protectionism and industrial policy to turn back the economic clock. Rather, place-based aid could support business services for firms trying to create local jobs.
The economic ideas under discussion at the Republican National Convention have populist features that haven’t figured in earlier conservative economic agendas. Populists have some reasonable skepticism about excessive deference to markets. But avoiding excessive meddling from tempting protectionism and the mushy mercantilism of Bidenomics is important, too. Under a conservative economic agenda, growth can flourish.
Presidents Biden and Trump during one of their 2020 debates. (Photo from the Wall Street Journal)
On the eve of first debate between President Joe Biden and former President Donald Trump, Glenn reflects on the fundamentals of sound economic policy. This essay first appeared inNational Affairs.
The advent of “Bidenomics” has resurrected decades-old debates about the merits of markets versus industrial policy. When President Joe Biden announced his eponymous strategy in June 2023, he blasted what he described as “40 years of Republican trickle-down economics” and insisted that he would seek instead to build “an economy from the middle out and the bottom up, not the top down.” He would achieve this through “targeted investments” in technologies like semiconductors, batteries, and electric cars — all of which featured heavily in initiatives like the CHIPS and Science Act and the Inflation Reduction Act. Yet despite the president’s professed support for a “middle out” economics, Bidenomics has thus far proven to be less of an intellectual framework than a set of well-intended yet ill-fated industrial-policy interventions implemented from the top down.
Some conservatives have joined Biden in embracing industrial policy. Writing recently in these pages, Republican senator Marco Rubio of Florida asserted that while it is difficult to “get industrial policy right, conservatives can and must take ownership of this space to keep the American economy strong and free.” Former president Donald Trump, for his part, staunchly advocates heavy tariffs to promote domestic manufacturing.
Conservatives who adopt their own version of protectionist tinkering with markets are missing an important opportunity. As mercantilism’s decline did for classical liberalism in the 19th century and Keynesianism’s misadventures did for neoliberalism in the 20th, Bidenomics’ failures offer an opening for the right to champion a new type of economics — one that puts opportunity for the people ahead of the economic rules of the game.
Rapid globalization and technological change have left too many Americans behind. But the answer is not for the state to invest in costly projects with dubious prospects, nor is it to adopt a strictly laissez-faire approach to the economy. By reviving classically liberal ideas about competition and opportunity in the face of change, conservatives can promote an alternative economics that retains the enormous benefits of markets and openness while putting people first.
LIBERALISM’S RISE AND FALL
Before “Bidenomics” became a popular term, national-security advisor Jake Sullivan hinted at the president’s economic priorities in an April 2023 speech at the Brookings Institution. There, he declared that a “new Washington consensus” had formed around a “modern industrial and innovation strategy,” which would correct for the excesses of the free-market orthodoxy propagated by the likes of Adam Smith, Friedrich Hayek, and Milton Friedman.
This orthodoxy, according to Sullivan, “championed tax cutting and deregulation, privatization over public action, and trade liberalization as an end in itself,” all of which eroded the nation’s industrial and social foundations. Finally, after nearly three decades of such policies, two “shocks” — the global financial crisis of 2007-2009 and the Covid-19 pandemic — ”laid bare the limits” of liberalism. The time had come, Sullivan concluded, to dispense with decades of policies touting the benefits of markets and free trade — and economists would just have to get over it.
The Biden administration’s assault on open markets and free trade is odd in some respects. Scholars at the Peterson Institute for International Economics — located just across the street from Brookings — concluded in a 2022 report that, thanks to America’s openness to globalization, trillions of dollars in economic benefits have flowed to U.S. households. Moreover, the United Nations estimates that integrating China, India, and other economies into the world trading order has brought one billion individuals out of poverty since the 1980s. The impact of technological change as a driver of growth and incomes is larger still. Juxtaposing such outcomes with the administration’s grievances calls to mind the popular outcry in Monty Python’s Life of Brian: “What have the Romans ever done for us?” Quite a lot, in fact.
Proponents of free markets have clashed with advocates of government intervention before, most notably at the dawn of classical liberalism toward the end of the 18th century and the advent of neoliberalism during the first half of the 20th. These contests were not so much battles of ideas as they were intellectual critiques of real-life policy failures.
In 1776, Adam Smith’s Inquiry into the Nature and Causes of the Wealth of Nations threw down the gauntlet. The book was radical, offering a sharp rebuke of the economic-policy order of the day. Mercantilism — or the “mercantile system,” as Smith called it — assumed that the world’s wealth is fixed, and that a state wishing to improve its relative financial strength would have to do so at the expense of others by maintaining a favorable balance of trade — typically by restricting imports while encouraging exports. Recognizing merchants’ role in generating domestic wealth, mercantilist states also developed government-controlled monopolies that they protected from domestic and foreign competition through regulations, subsidies, and even military force.
Predictably, this system enriched the merchant class. But it did so at the expense of the poor, who were subject to trade restrictions and import taxes that drove up the price of goods. It also stunted business growth, expanded the slave trade, and triggered inflation in regions with little gold and silver bullion on hand.
Smith turned the mercantilist view on its head, insisting that the real touchstone of “the wealth of a nation” was not the amount of gold and silver held in its treasury, but the value of the goods and services it produced for its citizens to consume. To maximize a nation’s wealth, he argued that the state should unleash its population’s productive capacity by liberating markets and trade. Setting markets free, he observed, would enable firms to specialize in generating the goods they produced most efficiently, and to exchange surpluses of those goods for specialized goods produced by others. This approach would spread the benefits of free trade throughout the population.
While sometimes caricatured as a full-throated endorsement of laissez-faire economics, Wealth of Nations also recognized that government played an important role in sustaining an environment that would allow free markets to flourish. This included protecting property rights, building and maintaining infrastructure, upholding law and order, promoting education, providing for national security, and ensuring competition among firms. Smith cautioned, however, that government officials should be careful not to distort markets unnecessarily through such mechanisms as taxation and overregulation, and should avoid accumulating large public debts that would drain capital from future productive activities.
Mercantilism did not suddenly fall away after Smith’s critique; it continued to dominate much of the world’s economic order for another half-century. But eventually, Smith’s arguments in favor of market liberalization carried the day. For much of the 19th and early 20th centuries, free markets and free trade facilitated unprecedented prosperity in the West.
A parallel series of events occurred during the 1930s and ’40s, when Friedrich Hayek and John Maynard Keynes famously (and nastily) debated economic theory in the pages of the Economic Journal. That contest, too, revolved around what was happening on the ground: the Great Depression and increasing government investment in industry. Keynes contended that market economies experience booms and busts based on fluctuations in aggregate demand, and that the government could mitigate the harms of recessions by stimulating that demand through increased spending. Hayek disagreed, arguing that such large-scale public spending programs as those Keynes proposed would prompt not just market inefficiency and inflation, but tyranny.
During the 1950s and ’60s, Milton Friedman took on Keynes’s theories, asserting instead that the key to stimulating and maintaining economic growth was to control the money supply. He also expanded on Hayek’s case for free markets as necessary elements of free societies: As he wrote in Capitalism and Freedom, economic freedom serves as both “a component of freedom broadly understood” and “an indispensable means toward the achievement of political freedom.”
Of course Hayek and Friedman, like Smith before them, did not immediately win the debate; Keynesianism dominated America’s economic policy for decades after the Second World War. But by the mid-1970s, rising inflation and slowed economic growth pressured policymakers to consider a different approach. Hayek and Friedman’s arguments — now often referred to collectively as “neoliberalism” — ultimately won over important political figures like Ronald Reagan and Bill Clinton in the United States and Margaret Thatcher and Tony Blair in Britain. It had a major impact on each of their economic-policy initiatives, which typically combined tax cuts and deregulation with reduced government spending and liberalized international trade.
The upshot of that liberal market order is reflected in the 2022 findings of the Peterson Institute outlined above — namely the trillions of dollars in economic benefits that have flowed to American households. In a similar vein, the institute found in a 2017 report that between 1950 and 2016, trade liberalization combined with cheaper transportation and communication owing to technological change increased per-household GDP in the United States by about $18,000. The benefits of economic liberalism have thus been and continue to be massive.
NEOLIBERAL OVERCORRECTION
For all the prosperity it brought to the world, market-induced change in an era of globalization and rapid technological advance also entailed significant costs. Leaders across the political spectrum celebrated the former but paid little attention to the latter, which hit low- and medium-skilled American workers particularly hard. As global competition intensified and technological change mounted, tens of thousands of Americans in the manufacturing industry lost their jobs. Meanwhile, state benefits programs and occupational-licensing requirements made it difficult, if not impossible, for these individuals to move in search of better opportunities.
Neoliberal economic logic asserts that maintaining the labor market’s dynamism will right the ship in response to economic change — that new jobs will be created to replace the old. While true in most respects, for individuals and communities buffeted by structural market forces beyond their control, “just let the market work” is neither an economically correct answer nor a response likely to win political favor.
Proponents of neoliberalism tend to overlook the politically salient pressures generated by the speed, irreversibility, and geographic concentration of market-induced changes. Their lack of empathy for working-class communities hollowed out by the competitive and technological disruption that took place between the 1980s and the early 2010s ceded the political lane to proponents of industrial policy, enabling Trump to ride the wave of working-class grievances to the White House in 2016.
The ensuing tariffs, along with President Biden’s protectionist activity, invited retaliation from America’s trading partners. A Federal Reserve study by economists Aaron Flaaen and Justin Pierce concluded that, contrary to protectionists’ claims, employment losses triggered by trade retaliation were significantly greater than the number of jobs garnered through protectionism. The subsidy game tells a similar story: The Inflation Reduction Act’s large incentives for domestic clean-energy projects put America’s trading partners engaged in battery and electric-vehicle manufacturing at a disadvantage, which in turn pushed greater subsidization efforts overseas and prompted political grumbling among our trading partners.
It is policy failure, not a grand new economic strategy, that the Biden and Trump administrations’ industrial policies have teed up. Market liberalism must rise once again to counter the muddled mercantilism of both. But instead of repeating the cycle of neoliberalism overcorrecting for central planning and vice versa, today’s free-market and free-trade proponents will need to update their theories to address the challenges of our contemporary economy. By recovering insights from classical liberalism while keeping people in mind, economic policymakers can once again facilitate an open economy that ensures mass opportunity and flourishing.
MUDDLED MERCANTILISM
An intellectual path forward for today’s economic liberals must begin by highlighting the practical failures of Sullivan’s “new Washington consensus.” To that end, it will be useful to revisit the lack of intellectual foundation in today’s mercantilist industrial policy.
Skepticism of industrial policy revolves around two major challenges inherent to the strategy. The first is ensuring that capital is allocated to “winners” and not “losers.” The second is protecting industrial policy from mission creep and rent seeking.
Hayek addressed the first problem in his classic 1945 article, “The Use of Knowledge in Society.” As he observed there, “the knowledge of the particular circumstances of time and place” necessary to rationally plan an economy is distributed among innumerable individuals. No single person has access to all of this localized knowledge, which is not only infinite, but also constantly in flux. Statistical aggregates cannot account for it all, either. Thus, even the most earnest and sophisticated government planners could not amass the knowledge required to allocate capital to the right firms based on ever-changing circumstances on the ground. Recent examples of the government’s misfires — from the bankruptcy of the federally subsidized solar-panel startup Solyndra to the billions in Covid-19 relief aid lost to fraud and waste — speak to the truth of Hayek’s argument.
The free market, by contrast, transmits relevant information — that “knowledge of the particular circumstances of time and place” — in real time to everyone who needs it. It does so in large part via the price system. Friedman famously illustrated this process using the humble No. 2 pencil:
Suppose that, for whatever reason, there is an increased demand for lead pencils — perhaps because a baby boom increases school enrollment. Retail stores will find that they are selling more pencils. They will order more pencils from their wholesalers. The wholesalers will order more pencils from the manufacturers. The manufacturers will order more wood, more brass, more graphite — all the varied products used to make a pencil. In order to induce their suppliers to produce more of these items, they will have to offer higher prices for them. The higher prices will induce the suppliers to increase their work force to be able to meet the higher demand. To get more workers they will have to offer higher wages or better working conditions. In this way ripples spread out over ever widening circles, transmitting the information to people all over the world that there is a greater demand for pencils — or, to be more precise, for some product they are engaged in producing, for reasons they may not and need not know.
In this way, free markets ensure that capital is allocated to the right place at the right time based on the laws of supply and demand.
The second problem that plagues industrial policy arises when policies that are nominally targeted at a single goal end up serving the interests of government actors and individual firms. This problem comes in two flavors: mission creep and rent seeking.
Mission creep is the tendency of government actors to gradually expand the goal of a given policy beyond its original scope. One illustrative example comes from the CHIPS and Science Act, a bill designed to encourage semiconductor manufacturing in the United States. The act tasked the Commerce Department with drafting the conditions that manufacturers must meet to qualify for the program’s $39 billion in subsidies. In addition to manufacturing semiconductors domestically, those rules now require subsidy recipients to offer workers affordable housing and child care, develop plans for hiring disadvantaged workers, and encourage mass-transit use among their workforces. While arguably laudable (and certainly attractive to various interest groups), these goals distract from the original purpose of the law and may even detract from it.
Rent seeking — another problem characteristic of industrial policy — is a strategy that firms employ to increase their profits without creating anything of value. They do so by attempting to influence public policy or manipulate economic conditions in their favor.
Rent seeking often arises when firms devote lobbying resources to garnering funds from new government largesse. For the CHIPS and Science Act, firms’ scramble for subsidies replaces a focus on basic research. For the Inflation Reduction Act, firms’ hiring consultants to help them gain access to agricultural-conservation spending and technical assistance replaces a focus on researching market trends.
Industrial unions — whose goals might not be consistent with market outcomes or the new industrial policy — are a second source of rent seeking. Today, both the left and right have slouched away from liberalism’s emphasis on maintaining an open and dynamic labor market, pledging instead to create and protect “good jobs” — primarily in the manufacturing sector. This new thrust is yet another example of Washington picking “winners” and “losers” among industries and firms.
Concerns about this new approach to labor policy extend well beyond neoliberal critiques of limiting labor-market dynamism. Practically speaking, who decides what a “good job” is, or that manufacturing jobs are the ones to be prized and protected? Many of today’s most desired jobs for labor-market entrants did not exist decades ago when manufacturing employment was at its peak. Why should industrial policy’s goal be to cement the past as opposed to preparing individuals and locales for the work of the future?
A PATH FORWARD
Bidenomics’ policy failures offer an opening for leaders on the right to champion a new type of liberal economics that avoids the pitfalls of both markets-only neoliberalism and industrial policy’s central planning. In doing so, they will need to keep three things in mind.
The first is obvious but bears repeating: Markets don’t always work well, and calls for intervention are not necessarily calls for industrial policy.
Critiques of neoliberalism often focus on the stark observation from Friedman’s famous 1970 New York Times piece on the purpose of the corporation, which he asserted is to maximize its profits — full stop. While the article has now generated more than five decades of criticism, Friedman’s argument is quite sensible as a starting point under the assumptions he had in mind: perfect competition in product and labor markets, and a government that does its job well — namely by providing public goods like education and defense, and correcting for externalities.
Put this way, the problem with neoliberalism is less that it is laissez-faire and more that it assumes away important questions about the state’s role in the market economy. As a prominent example, national-security concerns raise questions about the boundaries between markets and the state. Export controls and certain supply-chain restrictions can be a legitimate way to deny sensitive technologies to adversaries (principally China in the present context). But they also raise several thorny questions. For instance, which technologies should be subject to controls and restrictions? What if those technologies are also employed for non-sensitive purposes? How do we defend sensitive technologies while avoiding blatant protectionism? (The Trump administration’s invocation of “national security” in levying steel tariffs against Canada was less than convincing.) Economists should invite scientists and technology experts into these discussions rather than ceding all ground to politicians and Commerce Department officials.
A second lesson relates to competition — the linchpin of both neoliberalism and classical-liberal economics dating back to Adam Smith. Is the pursuit of competition, though a worthy goal, sufficient to ensure widespread flourishing?
Contemporary economic models assign value to economic growth, openness to globalization, and technological advance. But as noted above, with that growth, openness, and advance comes disruption, often in the form of a diminished ability to compete for new jobs and business opportunities. It’s not a stretch to argue that a classical-liberal focus on free markets should also recognize the ability to compete as an important component to advancing competition. Competition might increase the size of the economic pie, but some will have easier access to a larger slice than others. Thus, in addition to promoting competition, today’s free-market advocates need to focus on preparing individuals to reconnect to opportunity in a changing economy.
To that end, neoliberals would do well to increase public investment in education and skill training. This includes greater support for community colleges — the loci of much of the training and retraining efforts required to reconnect workers to the job market. The demand for such training is rising among young workers skeptical of the value of a four-year college degree: The Wall Street Journal recently reported that the “number of students enrolled in vocational-focused community colleges rose 16% last year to its highest level since the National Student Clearinghouse began tracking such data in 2018.” Returning to Hayek’s “Use of Knowledge” essay, these interventions are likely to be successful because they decentralize training programs, divvying them up to the educational institutions that are in the best position to prepare workers for the jobs of today and tomorrow.
A third lesson for today’s neoliberals relates to the goals of the market. Smith, the father of modern economics, was also a student of moral philosophy — a discipline studiously avoided by most contemporary economists. To win the war of policy ideas, Smith understood that the goal could not simply be for the market to function. Today, demands to “let the market work” clearly do not meet the moment.
Market and trade liberalization are not ends in themselves; they are tools for organizing and promoting economic activity. Channeling Smith’s thoughts in his other classic work emphasizing shared purpose, The Theory of Moral Sentiments, Columbia professor and Nobel laureate Edmund Phelps argued that economic policies should pursue freedom not for its own sake, but to facilitate “mass flourishing.” In this vein, markets should promote, not prevent, innovation and productivity. They should aid, not hinder, the formation of strong families, communities, and religious and civic institutions.
Just as neoliberals need to be more cognizant of the human element in economics, proponents of industrial policy need to rethink the mercantilist strand present in their proposals.
To minimize the problems endemic to industrial policy — mission creep, rent seeking, and the risk of backing the wrong firms and industries — policy architects need to be both more general and more specific in their proposed interventions. By more general, I mean they must emphasize broad mechanisms to counter market failures. In the technology industry, for instance, expanding federal funding for basic scientific research can lead to useful applications for technologies and industries without picking winners and losers. Likewise, adopting a carbon tax would provide more neutral incentives for firms to develop low-carbon fuels and technologies without the need to pick winners and spend taxpayer dollars on costly subsidies. And again, as workers’ skills are an important policy concern, increases in general public investment in education and training should be front and center in any industrial policy.
By more specific, I mean the proposed policy interventions must have more specific goals. The Trump administration’s Operation Warp Speed succeeded without picking winners or over-relying on bureaucracy largely because its goals — developing and deploying a vaccine against Covid-19 as quickly as possible — were narrowly defined. Similarly, the Apollo program — which Senator Rubio rightly pointed to as an effective example of industrial policy — succeeded in part because it focused on a single, concrete, time-bound goal: putting a man on the moon within the decade.
Targeting and customizing aid is another way of making industrial-policy goals more specific. Economist Timothy Bartik has pushed for reforms to current place-based jobs policies, which typically consist of business-related tax and cash incentives. Such incentives, he argues, should be “more geographically targeted to distressed places,” “more targeted at high-multiplier industries” like technology, more favorable to small businesses, and more “attuned to local conditions.” Different local economies have different needs, from infrastructure to land development to job training. Funding customized services and inputs is more cost effective, more directly targeted at local shortcomings, and more likely to raise employment and productivity than one-size-fits-all tax and cash incentives.
While much of this analysis has been applied to the manufacturing context, such approaches can also be applied to the services sector. Customized input support would focus on developing partnerships between businesses and local educational institutions to develop job-specific training. Public support for applied research centers could help disseminate technological and organizational improvements to firms across the country. As with the general improvements to current industrial policy outlined above, these methods harness market mechanisms while recognizing and responding to underlying market failures.
A RIGHT TO OPPORTUNITY
The neoliberal notion that markets should focus on allocation and growth alone cannot be an endpoint; updating classical-liberal ideas with a deliberate focus on adaptation and the ability to compete is the place to start. Recognizing a right to opportunity in addition to property rights could provide a liberal counterweight to the temptation to reach for industrial policy to help distressed communities.
This right to opportunity — for today and tomorrow — should lead a conservative pushback to Bidenomics. Voters might not have much of a choice between Biden and Trump’s economic populism in the election this fall, but economists and policymakers can begin to advance a new market economics that leaves no Americans behind in the hope that future administrations will take notice.
Join authors Glenn Hubbard & Tony O’Brien as they discuss the economic landscape of inflation, soft-landings, and the green economy. This conversation occurred on Saturday, 9/16/23, prior to the FOMC meeting on September 19th-20th.
Join authors Glenn Hubbard & Tony O’Brien as they discuss the state of the landing the economy will achieve – hard vs. soft – or “no landing”. Also, they address the debt ceiling and the barriers it might present to a recovery. We also delve into the Chips Act and what economics has to say about the subsidy of a particular industry. Gain insights into today’s economy through our final podcast of the 2022-2023 academic year! Our discussion covers these points but you can also check for updates on our blog post that can be found HERE .
Adam Smith bronze statue on Royal Mile Market square in front of Saint Gilles Cathedral in Edinburgh, Scotland.
Growth matters. A lot. A slightly higher rate of economic growth, sustained over time, can make the difference between a big increase in living standards and relative stagnation. Whether we can still generate strong and steady growth is a “$64,000 question” for the economy — the question. Nobel Prize–winning economist Robert Lucas famously observed that once economists think of long-term growth, it is hard to think of anything else. A pro-growth policy agenda is a good idea because growth is a good idea.
But a deeper question remains: Is public support for growth guaranteed? Oren Cass of American Compass refers to growth and economists’ fealty to economic participation for all as “economic piety.” This critique resonates for a simple reason: Forces that propel growth invariably leave a wake of economic disruption for people in many places and political disruption for the nation. A serious discussion of pro-growth policy must account for that disruption.
A conventional pro-growth policy agenda can be enhanced by support for openness to markets, ideas, and new ways of doing things, and for the ability of firms to adapt to change. Such an enhanced agenda would center on infrastructure broadly defined, development and dissemination of better management practices, and reduced barriers to competition.
Yet the political process, and even many a conservative, is openly skeptical of such an agenda. This skepticism is rooted not in disagreement over the future of scientific advances or of organizational adaptation — but in a concern that growth’s benefits be shared broadly. Addressing this skepticism head-on is essential for rebuilding social support for growth and for countering well-meaning but potentially harmful policies.
The system that needs defending is a mature and successful one. Adam Smith, the great proponent of the “invisible hand” (not the visible hand of a state-directed economy), saw openness and competition as worth the candle. His 1776 publication of The Wealth of Nations came before what we would recognize today as industrial capitalism, though technological change and globalization were features of economic debates in the aftermath of Smith’s ideas.
Smith’s radical insight is central to economic policy today: National prosperity (the “wealth of a nation”) is represented by consumption of goods and services by its people — i.e., their living standards. The goal of the economy in Smith’s telling was to make the economic pie as large as possible. His advocacy of free markets and competition rested on their ability to boost consumption possibilities.
Two centuries later, Nobel laureates Kenneth Arrow and Gérard Debreu added the jargon and mathematics of contemporary economics to formalize Smith’s intuition. While individuals and firms act independently, competitive markets lead to an efficient allocation of resources and a maximized economic pie. Friedrich Hayek, another Nobel laureate, hailed the virtue of a decentralized competitive price system in maximizing economic activity.
Smith’s radicalism draws from his attack on mercantilism—the economic orthodoxy of the day—which stressed a zero-sum view of trade and state intervention to promote and protect certain firms and industries. (Sound familiar?) His second radical insight was that the “nation” did not mean the sovereign and the well-connected. In Smith’s view, individuals as consumers—all people—were kings. Finally, channeling the sympathetic concern espoused in his earlier classic, The Theory of Moral Sentiments, Smith championed mass participation in the productive economy as a precondition for human flourishing.
It is fair to say that Smith lacked a theory of per capita growth in the economy over time; indeed, he wrote before the massive increase in living standards attendant upon the Industrial Revolution. After 1800, per capita income in the United Kingdom — and the United States — witnessed a 30-fold increase. There have also been major improvements in the quality of goods and services that such a statistic doesn’t quite capture. And, of course, many of today’s offerings — from smartphones to computers to air-conditioning — were not available even in 1900, let alone 1800.
That lacuna in Smith’s theory partly reflects technical difficulties in modeling growth. Higher output can come from growth in inputs such as labor and capital, but what determines their growth? Today’s economists highlight population growth and society’s willingness to work, save, and invest. Still more important is growth in productivity, or the efficiency with which inputs are used to produce goods and services.
Smith’s pin-factory example — in which output rose with the specialization of tasks — links how things are done with the level of productivity. But what factors determine productivity growth over time? Today’s economic analysis focuses on technology and the process of generating ideas. Since economic growth is still crucial for people seemingly marginalized by capitalism, it’s worth asking whether the economic foundations expressed in The Wealth of Nations are still relevant today. Where does growth come from now? And do those sources still require openness and competition?
The short answer is that they do, but to see why, we need to focus on the ideas of two prominent economists after 1800: Edmund Phelps and Deirdre Nansen McCloskey.
Phelps, a Nobel laureate, has done much to connect growth to Smith’s foundational ideas. He starts with Smith’s emphasis on a great many individuals (not the state or privileged firms) searching for new and better ways of doing things. This relentless search produces innovative ideas, processes, and goods that drive growth — but only if the political economy allows openness. Smith’s messy, “bottom up” version of the market therefore puts mass innovation at the heart of economic growth. Phelps’s argument reflects how Smithian societies committed to openness are best able to prosper and promote growth.
This argument has two important applications. The first is to debunk the sometimes fashionable view of secular productivity decline — that we have run short of new things to discover and exploit. The second is to give an answer to economies struggling with growth in a period of structural changes from technology and globalization. Slowdowns in innovation are likely not due to scientific barrenness but to walls against openness and change — that is, fears of disruption.
Phelps’s concern with economic dynamism draws him to Smith’s arguments against mercantilist tinkering in the economy. Like Smith, he worries about the hidden costs of tinkering with competition by blocking change from the outside and by enabling rent-seeking on the inside. These “corporatist” policies — fashionable among some conservatives at present — inevitably embolden vested interests and cronyism, slowing change and growth. Even seemingly small interventions can subtly diminish innovation, a point to which I’ll return.
Yet such a critique must acknowledge the political consequences of disruption. Dynamism is messy. It creates growth in the aggregate, but with many individual losers as well as individual gainers.
McCloskey, an economic historian, has similarly identified the continuous, large-scale, voluntary, and unfocused search for betterment as the source of new ideas that can produce economic growth. She sees this “innovism” as primarily a cultural force, preferring the term to the more familiar “capitalism,” and connects innovism to economic liberalism. Echoing Smith, she emphasizes how an open economy allows individuals—from the moderately to the spectacularly talented—to “have a go.” This economic liberalism allows competition to enshrine liberty and mass flourishing.
In McCloskey’s telling, growth depends on a liberal tolerance and openness to change, which encourage many people to be alert to opportunity. Sustaining that tolerance as structural shifts bring economic misfortune to many individuals, however, requires more than devotion to Smith.
Therein lies the current economic-policy rub. Economists’ theories of growth bring to mind a coin: Sunny descriptions of growth and dynamism are “heads,” and hand-wringing over disruption is “tails.” As I observed earlier, growth is messy. It can push some individuals, firms, and even industries off well-worn and comfortable paths.
But Smith offers more in defense of growth than paeans to laissez-faire. Though he is sometimes caricatured as being anti-government in all cases, Smith was principally opposed to mercantilist privileges for specific businesses and industries and to the governmentalization of social affairs. He wanted government to provide what economists today call “public goods,” such as national defense, the criminal-justice system, and enforcement of property rights and contracts the institutional underpinnings of commerce and trade. He also favored support for infrastructure to keep commerce flowing freely.
But Smith went further: To prepare workers and enrich their lives, he called for government to provide universal education, and he drew a connection between education and liberty as well as work in a free society. But boosting participation in today’s economy—participation that provides support for growth—will require a bit more.
Not surprisingly, political reaction to economic disruption brings about — pardon the econ-speak—a “demand” for and “supply” of policy actions. Job losses, firm failures, and diminished industry fortunes bring about a demand for help, for adaptation. The political process responds with a supply of ideas in one of two forms: walls or bridges. Walls are protections against disruption or change. Bridges, ways to get somewhere or back, prepare individuals for the changed economy and help those whose economic participation has been disrupted reenter the workforce.
Proposals for walls are familiar. They can be physical, of course, but they needn’t be. Conservative populists advocate limits on trade and technology, in order to advance industrial policy. Some progressives advocate universal basic income. All these policies would diminish the prospects for economic advances.
The most prominent sort of wall today is what I call “modern corporatism.” It assumes that Smith was wrong: The “wealth of a nation” lies not in consumption or living standards (and so ultimately in growth) but in jobs, good jobs, even particular good jobs, with good manufacturing jobs the very paradigm. The sort of tinkering with the market that drew Smith’s ire may actually be a necessary way of recentering economic policy on jobs, so the theory goes. Opportunities for work, and for the dignity it can bring, are surely important.
A gentle industrial policy devised by social scientists who are worried about jobs is not the answer. It results in state tinkering for special interests, precisely the kind of thing that prompted Smith’s criticism of mercantilism. Moreover, as University of Chicago economist Luigi Zingales argues in A Capitalism for the People, it risks a vicious cycle: A little bit of tinkering becomes a lot of tinkering—and anyone who cannot justify special privileges is left out, calling into question social support for growth. Nevertheless, industrial policy has caught the attention of elected officials on the right, from Donald Trump to Josh Hawley to Marco Rubio. While national security and the border can be exceptions as concerns, advice from Milton Friedman to the party of Ronald Reagan this is not.
That said, economists’ invocation of Smith as a proponent of let-’er-rip laissez-faire is neither faithful to Smith nor particularly helpful to individuals and communities buffeted by disruption. With today’s rapid and long-lasting technological change and globalization, “having a go” requires support for acquiring new skills when they are needed.
That is why we need more bridges. Bridges take us somewhere and bring us back. The journey to somewhere is about preparation for new opportunities. The journey back is about reconnecting to the productive economy when economic forces beyond our control have knocked us away.
Economic bridges have three features. The first is that they help people overcome a specific challenge on their way to economic flourishing — they don’t provide that outcome directly. The second is that wider society builds the bridge, through private organizations, governments, or public–private partnerships, as globalization and technological change have introduced significant risks that individuals by themselves cannot avoid. The third feature is that they avoid restraints on openness to changes in markets and ideas.
We once did better, much better. During the Civil War, President Abraham Lincoln worked with Congress to pass the Morrill Act, directing resources to the development of land-grant colleges around the country, extending higher education to citizens of modest means, and enabling workers to develop skills for new industries, particularly in manufacturing. As World War II drew to a close, President Franklin D. Roosevelt and Congress came together to enact the G.I. Bill, helping to educate returning troops for a changing economy.
Supporting economic growth and undergirding broad participation in the economy require similarly bold ideas. To begin, community colleges are the logical workhorses of skill development and retraining, and their presence in regional economies makes them attractive partners for employers. Yet community colleges have seen their state-level public support wither. The Biden administration calls for free tuition, which would boost demand but provide no support for community college to offer a practical education and an emphasis on completion. Amy Ganz, Austan Goolsbee, Melissa Kearney, and I proposed an alternative approach based on the land-grant-college model. We proposed a supply-side program of federal grants to strengthen community colleges — contingent on improved degree-completion rates and labor-market outcomes. To further encourage training, the federal government could offer a tax credit to compensate firms for the risk of losing trained workers. It could also increase the earned-income tax credit for workers with or without children.
New ideas are also needed to promote workers’ reentry into the workforce. Personal reemployment accounts, for example, would support dislocated workers and offer them a reemployment bonus if they found a new job within a certain period of time. The “personal” refers to individuals’ choosing from a range of training and support services. Another idea is to beef up support for place-based assistance to areas with stubbornly high rates of long-term nonemployment. Such support could be integrated with an increase in the earned-income tax credit and the supply-side investment in community colleges. Building on the decentralized approach in the land-grant colleges and grants to community colleges, expanded place-based aid would be delivered via flexible block grants encouraging business and employment.
Broad public support required for growth and dynamism requires both bridge-building and a political language that frames it. Growth, opportunity, and participation are good, and we do not need a new economics. But phrases like “transition cost” and “inevitable economic forces” must give way to bridges of preparation and reconnection.
‘Why did nobody see it coming?” a quizzical Queen of England questioned a quorum of economists at the London School of Economics about the global financial crisis as it emerged in late 2008. How could major disruptive forces build up over time and yet escape the attention of experts and leaders?
Of the disruptive structural changes accompanying economic dynamism, one might ask a similar question. Growth matters. But that growth is one side of a coin whose flip side is disruption is known, certainly to economists. Why has our political discourse not emphasized this basic point?
Why did we not see fatigue with change coming among the people who most had to bear its ill effects?
However foolishly, we did not. Some so-called conservatives today have responded by saying that we should limit change. Surely a better response is that we should seek ever more growth by allowing unfettered change, but also facilitate the establishing of ever more connections in a growing economy. That classical-liberal answer has the better place in American conservatism — and in American economic life.
— This essay is sponsored by National Review Institute.Originally published here.
Glenn published the following opinion column in the Wall Street Journal. Link here and full text below.
NATO Needs More Guns and Less Butter
Russia’s unprovoked invasion of Ukraine has challenged Western assumptions about security, economics and the postwar world order. In Europe and the U.S., public finances have long favored social spending over public goods such as defense. While President Biden doubled down on his proposal to increase social spending during his State of the Union address, Russia’s aggression highlights the shortcomings of this model. Western democracies now face a more uncertain and dangerous world than they did two weeks ago. Navigating it will require significantly higher levels of defense and security spending.
But change will be difficult, and the magnitude of what needs to be done is sobering. The U.S. currently spends 3.2% of gross domestic product on defense—roughly half of Cold War spending levels relative to GDP. An increase in spending of even 1% of GDP would amount to about $210 billion. That’s about 5% of the total federal spending level using a 2019 pre-Covid baseline. While Covid spending was large, it was transitory. Defense outlays would be much longer-lasting, an insurance premium or transaction cost for dealing with a more dangerous world.
The U.S. is not alone. Germany’s announcement of €100 billion in additional defense spending this year represents an increase of just over 0.25% of GDP, leaving Berlin still under the 2% commitment agreed to by North Atlantic Treaty Organization allies. Increasing Europe’s defense spending merely to the agreed-on level would require significant outlays. Such spending increases would occur against the backdrop of elevated public debt relative to GDP, brought on in part by heightened borrowing during the Covid pandemic and the earlier global financial crisis. High levels of public debt make it unlikely that countries will want to pay to increase their defense spending with new borrowing.
Paying for higher levels of defense spending will force most governments either to raise taxes or cut spending. Tax increases raise risks to growth. The larger non-U.S. NATO economies are already taxed to the hilt. Tax revenue relative to the size of the economy in France (45%), Germany (38%), Canada (34%) and the U.K. (32%) doesn’t leave much room to tax more without depressing economic activity. The U.S. has a lower tax share of GDP—about 17.5% at the federal level and 25.5% in total—but its patchwork quilt of income and payroll taxes makes tax increases more costly by distorting household and business decisions about consumption and investment.
A significant tax increase in the U.S. would need to be accompanied by fundamental tax reform, dialing back income taxes (as with the 2017 reduction in corporate tax rates) and increasing reliance on consumption taxes. A broad-based consumption tax could be implemented by imposing a tax at the business level on revenue minus purchases from other firms (a “subtraction method” value-added tax). Alternatively, the tax system could impose a broad-based wage and business cash-flow tax, with a progressive wage surtax on high earners. These consumption-tax alternatives would be efficient and equitable in a revenue-neutral tax reform. And they are crucial in avoiding decreases in savings, investment and entrepreneurship that accompany a tax increase.
Since the 1960s, spending on Social Security, Medicare and Medicaid has come to dominate the federal budget. Outlays for these programs have almost doubled since then as a share of GDP to 10.2% today, and the Congressional Budget Office projects they will consume about another 5% of GDP annually by 2040. Spending offsets to accommodate higher defense spending would surely require slowing the growth in social-insurance spending. As with tax increases, there are trade-offs. It is possible to slow the growth of this spending while preserving access to such support for lower-income Americans. Accomplishing that will require focusing net taxpayer subsidies on lower-income Americans, along with undertaking market-oriented health reforms. Such changes require serious attention.
The U.S. and its NATO allies will face a challenging set of economic trade-offs and political realities in achieving higher defense spending. The challenge will be exacerbated by additional private investment needs in a more dangerous world of investment risks, skepticism about globalization, and cybersecurity threats.
In the U.S., the failure of the 2010 Simpson-Bowles Commission’s proposed spending and tax reforms to spark a serious discussion is a warning sign. So, too, is the antipathy of Democratic and Republican officials alike toward creating the fiscal space necessary to accommodate greater defense spending. Such challenges don’t cause threats to vanish. They require leadership—now.
Authors Glenn Hubbard & Tony O’Brien reflect on the global economic effects of Russia’s invasion of Ukraine last week. They consider the impact on the global commodity market, US monetary policy, and the impact on the financial markets in the US. Impact touches Introductory Economics, Money & Banking, International Economics, and Intermediate Macroeconomics as the effects of Russia’s aggression moves into its second week.
A map of Europe with Ukraine in the middle right below Belarus and to the east of Poland.
During a lecture in my Modern Political Economy class this fall, I explained—as I have to many students over the course of four decades in academia—that capitalism’s adaptation to globalization and technological change had produced gains for all of society. I went on to say that capitalism has been an engine of wealth creation and that corporations seeking to maximize their long-term shareholder value had made the whole economy more efficient. But several students in the crowded classroom pushed back. “Capitalism leaves many people and communities behind,” one student said. “Adam Smith’s invisible hand seems invisible because it’s not there,” declared another.
I know what you’re thinking: For undergraduates to express such ideas is hardly news. But these were M.B.A. students in a class that I teach at Columbia Business School. For me, those reactions took some getting used to. Over the years, most of my students have eagerly embraced the creative destruction that capitalism inevitably brings. Innovation and openness to new technologies and global markets have brought new goods and services, new firms, new wealth—and a lot of prosperity on average. Many master’s students come to Columbia after working in tech, finance, and other exemplars of American capitalism. If past statistics are any guide, most of our M.B.A. students will end up back in the business world in leadership roles.
The more I thought about it, the more I could see where my students were coming from. Their formative years were shaped by the turbulence after 9/11, the global financial crisis, the Great Recession, and years of debate about the unevenness of capitalism’s benefits across individuals. They are now witnessing a pandemic that caused mass unemployment and a breakdown in global supply chains. Corporate recruiters are trying to win over hesitant students by talking up their company’s “mission” or “purpose”—such as bringing people together or meeting one of society’s big needs. But these gauzy assertions that companies care about more than their own bottom line are not easing students’ discontent.
Over the past four decades, many economists—certainly including me—have championed capitalism’s openness to change, stressed the importance of economic efficiency, and urged the government to regulate the private sector with a light touch. This economic vision has yielded gains in corporate efficiency and profitability and lifted average American incomes as well. That’s why American presidents from Ronald Reagan to Barack Obama have mostly embraced it.
Yet even they have made exceptions. Early in George W. Bush’s presidency, when I chaired his Council of Economic Advisers, he summoned me and other advisers to discuss whether the federal government should place tariffs on steel imports. My recommendation against tariffs was a no-brainer for an economist. I reminded the president of the value of openness and trade; the tariffs would hurt the economy as a whole. But I lost the argument. My wife had previously joked that individuals fall into two groups—economists and real people. Real people are in charge. Bush proudly defined himself as a real person. This was the political point that he understood: Disruptive forces of technological change and globalization have left many individuals and some entire geographical areas adrift.
In the years since, the political consequences of that disruption have become all the more striking—in the form of disaffection, populism, and calls to protect individuals and industries from change. Both President Donald Trump and President Joe Biden have moved away from what had been mainstream economists’ preferred approach to trade, budget deficits, and other issues.
Economic ideas do not arise in a vacuum; they are influenced by the times in which they are conceived. The “let it rip” model, in which the private sector has the leeway to advance disruptive change, whatever the consequences, drew strong support from such economists as Friedrich Hayek and Milton Friedman, whose influential writings showed a deep antipathy to big government, which had grown enormously during World War II and the ensuing decades. Hayek and Friedman were deep thinkers and Nobel laureates who believed that a government large enough for top-down economic direction can and inevitably will limit individual liberty. Instead, they and their intellectual allies argued, government should step back and accommodate the dynamism of global markets and advancing technologies.
But that does not require society to ignore the trouble that befalls individuals as the economy changes around them. In 1776, Adam Smith, the prophet of classical liberalism, famously praised open competition in his book The Wealth of Nations. But there was more to Smith’s economic and moral thinking. An earlier treatise, The Theory of Moral Sentiments, called for “mutual sympathy”—what we today would describe as empathy. A modern version of Smith’s ideas would suggest that government should play a specific role in a capitalist society—a role centered on boosting America’s productive potential(by building and maintaining broad infrastructure to support an open economy) and on advancing opportunity (by pushing not just competition but also the ability of individual citizens and communities to compete as change occurs).
The U.S. government’s failure to play such a role is one thing some M.B.A. students cite when I press them on their misgivings about capitalism. Promoting higher average incomes alone isn’t enough. A lack of “mutual sympathy” for people whose career and community have been disrupted undermines social support for economic openness, innovation, and even the capitalist economic system itself.
The United States need not look back as far as Smith for models of what to do. Visionary leaders have taken action at major economic turning points; Abraham Lincoln’s land-grant colleges and Franklin Roosevelt’s G.I. Bill, for example, both had salutary economic and political effects. The global financial crisis and the coronavirus pandemic alike deepen the need for the U.S. government to play a more constructive role in the modern economy. In my experience, business leaders do not necessarily oppose government efforts to give individual Americans more skills and opportunities. But business groups generally are wary of expanding government too far—and of the higher tax levels that doing so would likely produce.
My students’ concern is that business leaders, like many economists, are too removed from the lives of people and communities affected by forces of change and companies’ actions. That executives would focus on general business and economic concerns is neither surprising nor bad. But some business leaders come across as proverbial “anywheres”—geographically mobile economic actors untethered to actual people and places—rather than “somewheres,” who are rooted in real communities.
This charge is not completely fair. But it raises concerns that broad social support for business may not be as firm as it once was. That is a problem if you believe, as I do, in the centrality of businesses in delivering innovation and prosperity in a capitalist system. Business leaders wanting to secure society’s continuing support for enterprise don’t need to walk away from Hayek’s and Friedman’s recounting of the benefits of openness, competition, and markets. But they do need to remember more of what Adam Smith said.
As my Columbia economics colleague Edmund Phelps, another Nobel laureate, has emphasized, the goal of the economic system Smith described is not just higher incomes on average, but mass flourishing. Raising the economy’s potential should be a much higher priority for business leaders and the organizations that represent them. The Business Roundtable and the Chamber of Commerce should strongly support federally funded basic research that shifts the scientific and technological frontier and applied-research centers that spread the benefits of those advances throughout the economy. Land-grant colleges do just that, as do agricultural-extension services and defense-research applications. Promoting more such initiatives is good for business—and will generate public support for business. After World War II, American business groups understood that the Marshall Plan to rebuild Europe would benefit the United States diplomatically and commercially. They should similarly champion high-impact investment at home now.
To address individual opportunity, companies could work with local educational institutions and commit their own funds for job-training initiatives. But the U.S. as a whole should do more to help people compete in the changing economy—by offering block grants to community colleges, creating individualized reemployment accounts to support reentry into work, and enhancing support for lower-wage, entry-level work more generally through an expanded version of the earned-income tax credit. These proposals are not cheap, but they are much less costly and more tightly focused on helping individuals adapt than the social-spending increases being championed in Biden’s Build Back Better legislation are. The steps I’m describing could be financed by a modestly higher corporate tax rate if necessary.
My M.B.A. students who doubt the benefits of capitalism see the various ways in which government policy has ensured the system’s survival. For instance, limits on monopoly power have preserved competition, they argue, and government spending during economic crises has forestalled greater catastrophe.
They also see that something is missing. These young people, who have grown up amid considerable pessimism, are looking for evidence that the system can do more than generate prosperity in the aggregate. They need proof that it can work without leaving people and communities to their fate. Businesses will—I hope—keep pushing for greater globalization and promoting openness to technological change. But if they want even M.B.A. students to go along, they’ll also need to embrace a much bolder agenda that maximizes opportunities for everyone in the economy.
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