Something feels off in the timing of our debate over the economy. A loss of faith in free markets, among intellectuals and the public alike, was only natural in the 1930s. But today? Intellectuals on the left and the right are more convinced than ever that our economic policies are deeply misguided, at the same moment that unemployment rates and wage growth are the best they have been in decades. When Americans answer polls, they express less and less confidence in free-market capitalism — even as they express more and more satisfaction about economic conditions.
Perhaps people are evaluating these questions against different time horizons. They may, that is, think that the economy is performing well at the moment but has become less capable of delivering broad-based prosperity over the course of a generation. If today’s conditions persist long enough, then, the reputation of capitalism may recover.
Timing is relevant to our evaluation in another way. If our economy has gotten worse at generating sustained prosperity, worse enough to make a loss of faith in capitalism understandable if not justified, then it matters when this decline began.
In 2015, during the last presidential campaign, Hillary Clinton suggested that “for decades” the economy had been offering a worse deal for most people. Her explanation: “For 35 years, Republicans have argued that if we give more wealth to those at the top — by cutting their taxes and letting big corporations write their own rules — it will trickle down. It will trickle down to everyone else.” The election of Ronald Reagan, in other words, was the turning point. It followed that many of his policies should be reversed: The top tax rates should go back up and unions should be strengthened.
If economic conditions have been deteriorating for an even longer period, however, then merely reversing Reaganomics might not be enough. And it is common to run into claims, apparently backed by data, that suggest as much. The Pew Research Center notes that the average wage, adjusted for inflation, fell between 1973 and 2018. It had risen steeply from 1964 (when the data series began) through 1973. Then it dropped for roughly two decades, and over the next two recovered but did not get back to its peak.
If real wages have truly been stagnant for longer than most Americans have been alive, then the economy has not worked in anything resembling the fashion we expect. Economic growth has been mostly an illusion: We have more stuff only because more of us work, large numbers of women having joined the paid labor force. If this picture is accurate, we need to make radical changes either to the economy or to our expectations of ever-rising prosperity.
There are, however, two big reasons to doubt the stagnation thesis. The first is that non-wage benefits have become a larger and larger element of compensation. Perhaps they have become too large an element: The tax code encourages employees to get health insurance through their companies rather than take higher wages and buy coverage themselves, and there are reasons to think we would be better-off if the tax code did not do that. But non-wage benefits have economic value to employees, and so looking at wages alone will cause us to underestimate employees’ material welfare.
The second reason for doubt is that a common method of adjusting for inflation — the one used in the Pew numbers cited above — overdoes it. The center-right social scientist Scott Winship has been indefatigable in explaining why using the Consumer Price Index (specifically a measure called “CPI-U”) as the gauge of inflation is a mistake, and how it warps our understanding of economic trends. It overestimates housing inflation before 1983, and ignores how consumer behavior responds when prices change.
Since inflation compounds, small errors each year add up to major changes over decades. Use a better measure of inflation, one based on personal-consumption expenditures, and the average wage rose by 21 percent from 1973 to 2018. (Average compensation must have risen more.)
The data on median family income also show a reassuring amount of growth. The family in the middle of the pack in 2015 made 45 percent more, with the right inflation adjustment, than its counterpart in 1970.
But the same numbers may also explain some of the public’s dissatisfaction with the economy. Median family income grew by a spectacular 58 percent in the 15 years from 1955 to 1970, then grew another 11 percent from 1970 to 1985, and 24 percent from 1985 to 2000. But the median family income of 2014 was slightly lower than it was in 2000.
What happened is that after the turn of the millennium we went through an extended period of slow growth punctuated by one mild and one severe recession. Median family income dropped more than 7 percent from 2007 through 2011, the sharpest decline since this data series started in 1953. It did not recover completely until 2015.
We have had a few good years since then. But it is not surprising that during the last two decades many Americans came to feel that their economic circumstances were stagnant and insecure. It is not surprising, either, that many of them have the sense that things used to be better — or that a generation of young people who started their work lives in a slow-growth economy tend not to have positive attitudes toward capitalism.
Instead of five decades of economic stagnation, we have had two decades of weak growth. That record does not suggest that the pro-market policies of the 1980s and 1990s were fundamentally mistaken. It suggests, rather, that we have discrete problems that deserve to be tackled.
High on the list of needed changes should be a reform of our monetary regime. It failed badly over the last dozen years. In 2008, excessive fear of inflation led the Federal Reserve to signal that it was going to tighten monetary policy even as the economy was sinking into a recession. It kept monetary conditions too tight after the crisis hit, too, for example by encouraging banks to hold additional reserves. These policies made the recession more severe and the recovery weaker. That these failures are not more widely appreciated is symptomatic of the misguided thinking that continues to govern monetary policy.7
Reforms should be undertaken in other areas, too. Our higher-education system is not working for most young people. Our immense health sector includes immense inefficiency. Regions of the country with high economic growth have imposed regulations that make it prohibitively expensive for less fortunately situated Americans to move there.
So we are called to be ambitious, but not revolutionary. Capitalism does not need to be overthrown or even rethought. Rather, the principles that make markets work need to be applied to some areas where they have not been present. Our economic system does not need dismantling. But it does