Adam Smith In 2016 Presidential Politics
The Wealth of Nations by Adam Smith is the accepted rationale for a free-market economy. Smith’s key insight was that individuals working in their own interests are led by “an invisible hand to serve public interest” benefiting the broader society. As a liberal-progressive capitalist, I believe that while on the whole this is true, government must step in to aid the invisible hand when one’s self-interest is not serving, or in some cases actually a detriment to, the public’s interest.
Per the Constitution, approving and enacting trade laws are exclusively the responsibility of the Congress; however, protectionist anti-trade measures and expanded entitlement spending are making a roaring comeback in presidential primary politics. Centuries of economic research have demonstrated that Adam Smith was right. Economic policy that fosters free markets is critical to economic growth.
Jon Hartley and Glenn Hubbard opine on the domestic economic benefits of free trade, particularly those that come from prospective trade agreements with European and Asian nations. The Peterson Institute for International Economics finds that a bilateral free-trade agreement with China would increase U.S. exports by almost $400 billion annually, increase U.S. national income by more than $100 billion annually, and add 1.7 million jobs to the U.S. economy over ten years. By contrast, Donald Trump’s proposal to exorbitantly raise tariffs on China ultimately would raise the prices of consumer goods for all Americans, raising the cost of living especially for the poor.
Lowering tax burdens helps low-income individuals access opportunity and work. Under the adage that “a rising tide lifts all boats,” President John F. Kennedy championed across-the-board tax cuts and their distributional benefits. The Kennedy tax cuts, enacted under President Johnson in 1964, were followed by falling unemployment and the second-longest period without recession in U.S. history.
Expansion of the earned-income tax credit (EITC), first introduced by President Gerald Ford in 1975, could help strengthen labor-force participation. This is one action Bill Clinton took during his presidency.
Lower corporate taxes could help stem the tide of tax inversions whereby companies reincorporate abroad through acquisition because of America’s 35 percent corporate rate, currently the highest rate among member countries of the Organization for Economic Co-operation and Development. Failure to reduce the tax burden on corporations and individuals will continue to drive them out of the U.S. and reduce the number of private-sector jobs for all Americans, particularly the poor.
In new estimates, the Congressional Budget Office projects that if current laws remain in place, internal federal debt will reach 86 percent of GDP in ten years and 155 percent of GDP in 30 years. These figures are not far from the debt-to-GDP ratios of Italy and Spain.
Perennial deficit spending is the largest contributor to rising federal debt. Our government’s increasing the budget deficit to 2.9 percent of GDP in 2016 marks the first time that the deficit has risen in relation to the size of the economy since peaking at 9.8 percent of GDP in 2009. The CBO expects that, In the absence of a policy change, the government will reach a budget deficit of 5 percent of GDP in 2026, putting the country on an even more unsustainable fiscal path, an issue that our next president must address.
The CBO projects entitlements will claim an increasingly higher share of national spending at the expense of other budget items, including education and infrastructure. Trump and Sanders are promoting even larger entitlement programs. They miss an important point: Their proposals would all eventually come back to haunt Americans in the form of higher taxation, and not just for wealthier individuals, given the sheer magnitude of their proposed expansion of government spending and the deficit.
Trump’s and Sanders’ rise mirrors the recent trends, in wealth and income inequality, documented by economists such as Thomas Piketty. However, there is growing evidence that trends in wealth inequality are in fact closely related to strict land-use regulations (zoning laws). Those are structural problems that can be corrected without having to raise taxes. A look at trends in consumption shows that now is the greatest time in human history to be a consumer, given rapid advances in technology and declining consumption inequality, as demonstrated in recent research by Alan Auerbach and Kevin Hassett. Adam Smith would be pleased with what he saw today.
The Blue Model
According to Walter Russell Mead, for much of the twentieth century, the United States was a stable and heavily regulated economic system with a few large companies controlling various sectors of the economy. Government heavily regulated these companies to ensure an adequate profit. There was very little competition, and most people had jobs for life. Educated and progressive administrators managed this social system, and strove to replace politics in the economic system with objective social scientific standards.
In the years after the New Deal, the makers of this “blue model” assumed that Americans would live a life of incremental improvements. Ultimately, America was what a “developed” human society looked like. Policymakers saw a future full of prosperity towards which America steadily marched.
Unfortunately, this optimism was founded in a world where the U.S. reigned as the unchallenged industrial leader and the government efficiently regulated the market. The thorough oversight was to guide the U.S. on one set of universally acknowledged best practices. The model guaranteed security for consumers and profits for producers.
The success of the blue model relied on predictability. In the aftermath of the second world war, there was virtually no foreign competition. This stable economic structure allowed a consistent division of the pie. But as Europe and Japan recovered, they proved more than a match for a less-than-dynamic U.S. economy. Retirement also began to take its toll; concurrent with the formerly monolithic economy’s decline, many Social Security and Medicare beneficiaries reached retirement age.
The blue model created a divide between production and consumption, which had previously been one and the same. The family enterprise (like a farm or a blacksmith’s forge) had no rigid divisions of leisure and work. In today’s arrangement, however, people are drawn outside of the family by other interests.
Populism Is Misguided In 2016
Unlike Adam Smith, Trump and Sanders both assume that the market can be predicted and controlled. This works only in the absence of international competition. The emergence of foreign industrial powers in the post-World War 2 economy was classic tortoise and hare, and the world caught us napping.
The New Deal “worked” in its time and place, but the same economy that made us comfortable in the short term sowed the seeds for its own eventual breakdown. Our planning, to some degree, led to the problem. The blue model insulated the U.S. from competition so that our economy could not adapt to the evolving world market. A permanent and dynamic policy that is compatible with the ever changing world is what is needed. Breaking up institutions solely because they are big, and enormous tariffs on imports, should not be a part of that policy according to Adam Smith.
The Postwar and Cold War years did not adhere to the rules of normal economics. Expectations were set in an era where the labor pool was artificially limited by destroyed infrastructure with puppets and insurgencies keeping the third world at one anothers’ throats.
That limited labor pool was able to leverage their privileged position to extract a lot of “cushiness” in their compensation packages. After the fall of the Berlin Wall, insurgencies and hostile governments began their own declines in the land of cheap labor, accelerating the decline, and ultimately ending the limits on the labor pool American workers had counted on to keep their little pieces of the “blue model” going.
Donald Trump and Bernie Sanders implicitly promise to bring back the heyday of the “blue model,” and it has been the key to their success in the primaries. Promises are not lies, but the blue model is dead. The promise to renew it is a lie. Hillary, Ted Cruz, nor John Kasich would be foolish enough to make outlandish promises through a primary like that, which is why they haven’t focused on it.
In April 2013, President Obama angered his base by offering to cut Social Security benefits through changes in the way cost of living benefits are calculated (Chained CPI). Republicans balked at the proposal.
Many of the carrots Obama dangled out there in an attempt to “change Washington” are the same carrots Donald Trump is using as policy ideas for his own campaign. The level of dysfunction in the Republican party is why there has not been the level of change we all want to see. Obama could not strike a deal with the very people who are now campaigning on his ideas.
Adam Smith would most likely view means testing as the best way to undermine support for these programs. It would reveal entitlements, even popular ones, as redistribution. Right now, they redistribute from the working age to the old as well as by income. Means testing helps working-age people realize that if they make too much money, they will never see any entitlements.
Social Security are payments to the elderly partially funded by dedicated taxes. The term “insurance” doesn’t apply, though that was the original intent of the program. Instead of accumulating nongovernment assets, the excess of dedicated taxes over benefits paid was taken to reduce the deficit each year.
Social Security is income for income tax purposes. Someone with other income is likely to pay income taxes on Social Security even though Social Security payments may be reduced when other income is earned until the recipient reaches a certain age.
Adam Smith and Presidential Politics
Free market economics, both domestically and internationally, is the best rout for the world to take. Unfortunately for fans of Adam Smith’s free markets and the “invisible hand,” there are a couple of political problems which allow the economically illiterate Trumps and Sanderses of the world to thrive.
First, the “invisible hand” is, well, invisible. For those who don’t have a rudimentary understanding of economics (which based on its lack of teaching in high school and college is likely over half of America), the benefits are not readily seen. Likewise, the detrimental effects of protectionism are not associated with the cause. Thus, when a 45% protective tariff is imposed to “protect American jobs,” the benefits it provides to certain groups are readily apparent, but the far greater negative effects (higher prices, less export jobs, lower GDP etc…) are not associated with it.
Second, once a government decides to shy away from a free market economy by providing a tax break here, a subsidy there, etc… people (with some justification) start to clamor for their own set of handouts, i.e. “where’s my bailout.” Their anger is understandable, although their solution isn’t. The answer to imperfect free markets is not to restrict them. Nevertheless, once a government breaks from free market orthodoxy, it sets off a wave of everyone wanting to get their own exemption from market forces. Thus, we have Sanders promising increased government services with increased taxes while decreasing government spending somehow, while Trump will wall us off from the world and have them pay us for the privilege to do so. Free market capitalism this is not.
The relevant question is between the result of the policy and the absence of the policy. Absent NAFTA, was GDP growth going to be higher or lower than that 4.33% growth rate in the ’90s? Adam Smith would would say lower and many would agree with him. Free trade opponents argue about the jobs in Michigan and Ohio, but the connection between wins and losses in trade is what they fail to make.
Still, the concerns over Adam Smith’s model are understandable. If the labor prices in Vietnam and Bangladesh are 29 and 23 cents an hour, respectively, how does a free market work in a global economy? The answer is buoyancy. Like water, it eventually finds its rest level, which is always far below its high point. That’s bad news for some people in developed nations; however, in a nation like ours, people have the opportunity to educate themselves and retrain for a different job. There have been displaced employees programs for some time. Some even include retraining and university scholarships. Of course, since there are many applicants for fewer job openings in the field for which they’ve been retrained, the effect hasn’t been all that was hoped. People are often tied to their current locations by underwater mortgages on unsellable houses as well as exhausted credit used during the training process. The problem can’t be easily resolved. A government relocation program might help, but that’s not a full solution.
Suspicion will arise when you call something a free trade agreement and it takes thousands of pages, is kept secret and results in large imbalances between nations. Skepticism that free trade is not “fair trade” plays into the hands of Trump and Sanders. This where they differ though. Sanders is an idealist who believes what he preaches in spite of the fact it’s mistaken. Trump knows full well the benefits of free markets and takes advantage of them. He is simply exploiting an opportunity.
Trump Is Particularly Odious
To say Trump is ignorant about Adam Smith or economics is wrong. He’s an economically educated man. He wants tariffs and protectionist policies anyway. Of course a tariff war will lead to economic collapse, but you have to realize the benefit to Trump if that happens.
If a tariff war is enacted, the price of all assets with value go up, including real estate holdings. Once prices skyrocket, you sell the real estate holdings or a portion of them for billions of dollars, and when the crash inevitably comes, you are sitting on a boatload of cash to pick up the pieces.
Its a sound business plan for Trump that his family and the people who work for him can carry out while he is president, And Trump gets to blame China. I’m sure that there are a lot of people who will believe him, just like they believe that trade deals lose jobs.
Trump points to the trade deficits we have with various countries as proof that we are “losing”. Trade deficits do not mention the benefits of trade deals. Contrary to popular belief, we are the leading manufacturer in the world. When consumers buy cheaper products made in China, they have more money to buy American products. When American businesses import foreign products and materials to make and sell their own products, they are able to offer their goods and services at reduced prices, growing their businesses and hiring people to work for them. Successful companies from overseas open offices and factories here. When these factors are considered, America has a net gain. In addition, Americans export agricultural products, machinery and industrial products to China, which is beneficial to those sectors of our economy.
Trump puts China, Mexico and Japan in the same box, which is ridiculous. Mexico is our neighbor, Japan is our ally in the far east, and China, is our adversary in the far east. The trade relationship with China has always been troubling. China is a militaristic aggressive dictatorship currently in the process of building military bases throughout the world. Whoever controls the seas leads the economy.
Trump does not have the knowledge, experience and vision to deal with the bigger picture. All he sees is the business deal of a lifetime. Trump loves America, just like he loved the Plaza hotel. He bankrupted the Plaza Hotel from which it has never recovered.
Trump has captured the anger of a huge swath of the American people, but I would remind Trump supporters to remember that no good can come from acting on your anger. You have a temporary emotional release, then you have to deal with the wreckage.
Adam Smith did not bank on China’s acceptance into the World Trade Organization (WTO) under President Clinton. China was also given preferred status. The problem is expecting a militaristic aggressive dictatorship to engage fairly in free trade practices when it is bent on undermining and replacing America as leader of the world. In other words, we don’t need a Carl Icahn to do a business deal, we need a Jeanne Kirkpatrick to do a diplomatic deal along with a strong military.
You really think China will be intimidated by a threat of tariffs? You’re talking about a country that is used to being impoverished. We’re not. We shouldn’t unilaterally threaten a tariff. That’s what the WTO was created to police. It’s politically seductive to promise tariffs for domestic votes regardless of the real world economic consequences.
The truth is that those good jobs in manufacturing would have ended anyway. Maybe they would have relocated within the US without trade agreements. But they would have left individual towns and states. Off-shoring and relocation are simply stopgaps. When automation is ready to take over jobs or at least reduce the wages of the machine operators because tasks have been simplified, then production can return to the US.
China is automating to compete with even lower wage countries. But at least they’re buying US capital machinery to make the tools. The same machines which reduce labor costs in China can be used in the US. Here, companies don’t have to deal with the Chinese government, nor with shipping costs. This is why more production is likely to return, even if better-paying jobs don’t. It’s limited because the Chinese government wants goods sold in China to be made in China. Stacked deck.
Companies go to the trouble of setting up shop in China for no reason other than profit. If companies make goods for the Chinese market in China and goods for the US in (low-wage areas of) the US, what’s the problem?
If a trade representative negotiated with the goal of preserving jobs above all, there wouldn’t be a trade deal. Unless there are known ways to increase exports in a way that maintains jobs and wages, losses have to be expected.
When a more-developed economy makes a deal with a less-developed economy, the more-developed economy will almost necessarily lose jobs and wages in return for cheaper goods. Which companies expect to find profitable, or they wouldn’t take advantage of the deal.
Corporations As Nations
By 1946 we had given France about a billion dollars to reconstruct, and they had little to show for it. A lot of money “disappeared” into French bureaucratic pockets. Enter The Marshall Plan. The Marshall Plan was implemented by a Conservative and a Liberal, and they agreed on one thing: Countries agreeing to accept had to show tangible proof that they were actually rebuilding factories, infrastructure, etc… After they finished a job, they got the credits. The country that was held to the toughest standards under this plan? Germany. She did more “proper” reconstruction than any country, with little spent on social nonsense. Result? She reemerged out of the Second World War stronger than any European nation.
China does buy products from US. They pretty much single-handedly support American soy bean exports and are big importers of other agricultural products. India buys products from us, Mexico buys from us. As their middle classes grow, the more American products they buy. China buying our debt wouldn’t be as much of an issue if we would just quit deficit spending. This is Adam Smith’s theory in action.
In the 21st century, corporations are not people, corporations are nations. The largest corporations have operating costs and profits greater than the GDP of many of the world’s nations. A corporation’s shareholders span the globe and as a result the largest corporations do not act as corporate citizens of the nation (certainly not in America) but rather act as a nation unto themselves for maximum profit. Under this scenario, whereby corporations operate on a scale bigger than many nations, an argument can be made that the free markets of Adam Smith are nonexistent because business is no longer operating within a market bur rather defining the market itself.
Adam Smith and free markets promote economic growth. Finding major industries that operate within relatively “free market” environments is the key.
It must be understood that, even under favorable conditions, free markets do not approximate perfect efficiency and maximize happiness. Rather, as Adam Smith understood, they’re less inefficient than the alternatives and, still messy as they are, more conducive to prosperity than the alternatives.
Creating fortress America when it comes to free trade is self-defeating. Reducing trade to protect jobs is bad. It cuts off access to foreign markets for our exporters, and it supports inefficient use of capital to support jobs that the market would have eliminated here if not for government support.
How does protectionism defend the economy exactly? How does picking winners and losers, which inevitably happens with protectionism, jive with the Constitution? Gaming international trade to our strategic advantage increases the size and scope of government.
Adam Smith demonstrates that free trade is not the problem, illegal immigration is not the problem, spending is not the problem. Those are all symptoms of the problem being government has grown too large and powerful and is no longer as constrained as it should be by our founding document and the principles upon which that document was based. Until we fix that, everything else is tinkering around the edges as we slide down the slippery slope.