Glenn on Economic Growth and Its Social Consequences

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.

What’s Next for China?

Xi Jinping

When Deng Xiaoping assumed control of China following the death of Mao Zedong in 1976, he was in charge of one of the poorest countries in the world. The average person in China survived on the equivalent of $3 per day and the bulk of the population worked on government-run collective farms. Deng’s response to this dismal situation was a series of economic reforms that led China away from Mao’s socialist regime toward a free market economy. The results have been spectacular.

Since 1978, when Deng’s reforms began, real GDP per capita in China has increased from $381 (in 2010 prices) to $10,431 in 2020. Today, China is a solidly middle-income country on a par with Mexico or Indonesia. According to World Bank data, in 1981 more than 875 million people in China lived in extreme poverty. By 2019, fewer than 1 million did. The world has never seen such a high economic growth rate sustained over such a long period or as dramatic a reduction in poverty in such a short period. Deng brought about an increase in the material well-being of his people unrivaled in history.

But, as we discuss in the Apply the Concept in Section 11.5 of Chapter 11 in Macroeconomics (Section 21.5 in Chapter 21 of Economics), despite Deng’s success he failed to resolve a conflict at the heart of the Chinese system:  Deng and the other party leaders saw their economic reforms as strengthening socialism and not as replacing socialism with capitalism. They had no intention of undermining the role of the Communist Party in Chinese society or of introducing democracy. The result is the peculiar situation China now finds itself in under current leader Xi Jinping: A country that extensively relies on free markets ruled by an autocratic regime that justifies its dictatorship as necessary for the preservation of socialism.

In 2022, at the 20th Congress of the Chinese Communist Party, Xi seems likely to be elected to a third term as leader of the Communist Party, breaking with the tradition since Deng of leaders serving only two terms. Like Mao, Xi’s apparent intention is to retain his office indefinitely. Xi’s speeches indicate that he believes that China is following a path like the one that Karl Marx, writing in the 1800s, believed countries would follow, which would culminate in a socialist economy. He sees Mao as having reasserted China’s independence from Europe and the United States, although at his death China remained largely rural and agricultural with very little scope for market activity. Deng continued the evolution of the economy by establishing a market system that raised incomes and allowed for industrial development. Xi sees himself as finishing the process by leading China to become a “modern socialist nation” by 2035.

As we discuss in the Apply the Concept, there are a number of obstacles to China’s continued economic growth, obstacles that appear to have increased during 2021 as Xi’s plans have become clearer.

  1. As part of his plan to transition China to being a socialist nation, Xi has increased government regulation of China’s economy. He has imposed large fines on technology firms such as Alibaba and Tencent and on the ride-hailing firm Didi. A government proclamation effectively ended the for-profit school tutoring industry, which seven of ten Chinese students had been using. This government action raised concern among the owners of some small and medium-sized businesses that their investments in their firms could be wiped out arbitrarily without notice. Wealthy Chinese entrepreneurs were also being pressured to devote more funds to charity. Whether increased government regulation will result in entrepreneurs pulling back from the investment needed to sustain economic growth remains to be seen. 
  2. Over the decades since market reforms began, the Chinese economy had been cutting reliance on production by state-owned enterprises (SOEs) in favor of production by private firms. Recently, some observers have concluded that Xi plans to increase the share of the economy controlled by SOEs, although his public statements have emphasized the need for SOEs to become more efficient and for the government to reduce its subsidies to these firms. Many of China’s trading partners, including the United States, have objected to these subsidies. If the importance of SOEs in the Chinese economy should increase, it would likely further slow economic growth and increase the frictions between China and its trading partners. 
  3. Economic growth has been slowing down. Between 1978 and 2011, per capita real GDP grew at an annual average rate of 8.9 percent. Between 2012 and 2020 that growth rate slowed to 6.0 percent. Although compared with most other countries, a 6 percent growth rate is quite high, some economists believe that the Chinese government has been overstating the true growth rate. As an article in the Wall Street Journal put it, “real growth has long been one of the ways officials are evaluated in China, and so there is a strong incentive to inflate it—and substantial evidence that has happened.”
  4. China’s population is rapidly aging. Its birthrate of 1.3 children born per woman during her lifetime is well below the rate of 2.1 needed to maintain the population. The working age population has been declining since 2011, as the fraction of the population over 65 has been increasing. Although the populations of Europe, the United States, and other high-income countries have also been aging, those countries have more resources than does China to provide support to retired people, as with the Social Security and Medicare programs in the United States. Because China’s average retirement age is only 54, while its average life expectancy is 77 years, an increasing number of retirees is being supported by a decreasing number of workers. The Chinese government has announced plans to raise the official retirement age but the government has abandoned past attempts to do so in the face of public protests.
  5. The economy’s excessive reliance on investment in real estate. Particularly during the past five years, real estate investment has been an important contributor to the growth of the Chinese economy, accounting for as much as 25 percent of GDP (as opposed to only about 7 percent in the United States). But the difficulties that the Evergrande real estate development firm encountered during 2021 seemed to be an indication that what has been the largest real estate boom in history may be ending. In some cities as many as 40 percent of apartments are empty, making it difficult for Evergrande and other developers to make the interest payments on their loans and bonds. The Chinese government has issued regulations that limit borrowing by real estate developers in an attempt to reduce what the government sees as speculative building of apartments. Whether the government can reduce the importance of real investment in the economy without causing a significant reduction in the economy’s growth rate is uncertain. 
  6. Increasing political problems with other countries. The Chinese government has drawn sharp international criticism for a number of actions: Its repression of the more than one million members of a Muslim minority in western China; its ending the political independence of Hong Kong; the expansion of its military and its threatening actions towards Taiwan (which the Chinese government believes is part of China); and its failure to be forthcoming with information about the origins of the Covid-19 virus. An additional source of disagreements with other governments has been disputes over international trade. Both the Trump and Biden administrations, as well as governments in Europe, have been critical of the Chinese government forcing foreign firms that operate in China to transfer intellectual property to Chinese firms, an action that is in violation of the World Trade Organization’s (WTO) rules. The growth of Chinese exports has been greatly helped by China’s membership in the WTO, which may be threatened by what other governments see as China’s violations of WTO rules.

The actions that Xi Jinping takes in the coming years are likely to have a large effect on not just the Chinese economy, but on the world economy. 

Sources: Stella Yifan Xie, “China’s Economy Faces Risk of Yearslong Real-Estate Hangover,” wsj.com, November 8, 2021; “Xi Jinping Is Rewriting History to Justify His Rule for Years to Come,” economist.com, November 6, 2021; Sofia Horta e Costa, “Chinese Developer Controlled by Government Is Latest to Plunge,” bloomberg.com, November 8, 2021; Kevin Rudd, “What Explains Xi’s Pivot to the State?” wsj.com, September 19, 2021; “At 54, China’s Average Retirement Age Is Too Low,” economist.com, June 26, 2021; Nathaniel Taplin, “China’s Economic Data: A Guide for the Dazed and Confused,” wsj.com, January 4, 2021; Stella Yifan Xie and Mike Bird, “The $52 Trillion Bubble: China Grapples With Epic Property Boom,” wsj.com, July 16, 2020; the World Bank; and the Federal Reserve Bank of St. Louis.