We hear frequent knocks on American capitalism that seem to gain credibility by simple repetition. But how many of these criticisms hold water? In their recent book, The Triumph of Economic Freedom: Debunking the Seven Great Myths of American Capitalism, former US senator Phil Gramm and George Mason University economist Donald J. Boudreaux single out what they see as the major myths that need to be refuted. And they refute them admirably.
The seven myths are:
(1) The Industrial Revolution made workers poorer;
(2) Progressive Era regulation made things better;
(3) The Great Depression was a failure of capitalism;
(4) Free trade hollowed out US manufacturing;
(5) Deregulation caused the financial crisis;
(6) Income inequality in America has grown; and
(7) Poverty in America is high and represents a failure of capitalism.
In each case, the authors start by quoting extensively from prominent proponents of the myth and then use copious data to show that they really are myths. I already knew much of the evidence that refutes these myths. But on each of the seven, Gramm and Boudreaux report evidence that I had not known. The book is a tour de force.
A detailed look at their evidence of each myth would make for an overly long article, so I’ll focus instead on their most important evidence.
The Industrial Revolution
While economic historians have known for many decades that the Industrial Revolution improved the lives of workers, that information still has not become widely known. One reason is that many people today still take their cues from novelist Charles Dickens and British Fabian socialists Sidney and Beatrice Webb. These critics often cite the squalor that existed in the cities to which workers had moved from the countryside. But they rarely point out the even greater squalor they left behind. That’s because, note Gramm and Boudreaux, these authors themselves lived in cities and were simply unaware of rural poverty.
Economists know that when you see people voluntarily leaving area A to move to area B, these people must see themselves as being better off in area B. But many of the critics failed to ask, “If life was so much better in the country, why did millions of workers choose to move to the cities?” That is the question to ask.
The hard data back the idea that the choice was an improvement. Between 1841 and 1901, life expectancy for British males rose from 40.2 years to 48.5 years and for females from 42.2 years to 52.4 years. And the literacy rate rose sharply, hitting 97 percent for adults by 1900. In the United States, between 1865 and 1900, real annual earnings for nonfarm workers rose by 62 percent.
Progressive Era regulation was unnecessary
Many Americans get their views on the need for regulation of industry by reading Upton Sinclair’s 1906 novel, The Jungle. Sinclair claimed that piles of meat were coated with “the dry dung of rats.” Yet a report published at the time by the US Department of Agriculture claimed that the novel contained “willful and deliberate misrepresentations of fact.”
Moreover, Gramm and Boudreaux quote economic journalist Lawrence Reed noting that two million visitors toured the Chicago stockyards and packinghouses every year. Is it really plausible, ask the authors, that some of these visitors would not have noticed the allegedly horrible conditions?
One of the most famous “robber barons” of the nineteenth century, whose success was a factor in the late nineteenth-century antitrust laws, was John D. Rockefeller and his Standard Oil of New Jersey. The authors note that whomever Rockefeller hurt, it wasn’t consumers. From 1870, when Standard Oil was founded, to 1885, when it served about 90 percent of the market for kerosene, the nominal price of kerosene fell by 69 percent. There was some deflation during those years, but the price of kerosene fell “60 percent faster than the general level of prices.”
They also cite some path-breaking work by economist Thomas DiLorenzo that showed that output in the industries accused of monopolizing their markets grew by 175 percent between 1880 and 1890. What makes this so striking? Companies that monopolize restrain output rather than expanding it, and in this case, they expanded it by six times as much as real GDP over that same period.
Fortunately, economists led the way from the 1960s to the 1980s in showing that some Progressive Era legislation, such as federal regulation of railroads and trucking, led to higher prices. These economists, and some cooperating politicians, including Jimmy Carter, substantially reduced federal regulation of railroads and trucking, giving a boon to shippers. Unfortunately, current progressives are pushing to use antitrust against tech companies, using the same arguments that were used to impose so much damaging regulation on railroads and trucking.
Great Depression
Those who are familiar with the path-breaking work of Milton Friedman and Anna J. Schwartz will not be surprised by one of the main findings of the chapter on the Great Depression: the Federal Reserve helped cause the Depression by failing to do its job as lender of last resort. People panicked in 1929 and 1930, trying to convert their checking accounts into currency. Doing so put pressure on the banks because each dollar of currency backed multiple dollars of demand deposits. The Fed could have stepped in and provided more currency. Instead, it stood by, letting thousands of banks fail and letting the money supply fall by over 30 percent between 1929 and 1933.
The authors point out one reason the Fed failed during the Great Depression even though the regional Federal Reserve branches had succeeded during the 1920-21 depression. During that depression, the regional branches were free to act as lenders of last resort. But in 1923, the Federal Reserve had concentrated the power to conduct monetary policy in Washington. No longer could the regional branches respond to local conditions.
The authors take on several other important myths about the Great Depression. One is that the stock market had overheated in the late 1920s because margin requirements for stock purchases were unusually low. They quote economist Gene Smiley’s finding that “margin requirements through most of the Twenties were essentially the same as in previous decades.” Indeed, noted Smiley, by the fall of 1929, "margin requirements were the highest in the history of the New York Stock Exchange.”
Another common myth is that Herbert Hoover, the president during the worst part of the Great Depression, practiced laissez-faire. Actually, he was an early New Dealer who persuaded businessmen to keep wages high, a measure that caused businesses to lay off workers. Hoover also doubled income tax rates and signed the notorious Smoot-Hawley tariff bill, which spurred a global trade war.
Did free trade hollow out US manufacturing?
One of the myths commonplace in the past few years is that free trade, especially free trade with China, has “hollowed out” out US manufacturing. Proponents of that view are numerous on the left and on the right. What these proponents often point to is the substantial decline in the number of jobs in manufacturing. Between June 1979, when the number of manufacturing workers reached its peak, and October 2024, the number of workers employed in manufacturing fell by 34 percent. But, note Gramm and Boudreaux, that doesn't mean that we lost manufacturing. They write, “In inflation-adjusted dollars, manufacturing value added reached its all-time high in the second quarter of 2024.” This level, they note, was 34 percent higher than its level when China joined the World Trade Organization in 2000.
The reason output rose while employment fell is that worker productivity rose a lot. With more-productive workers, fewer workers are needed for a given output. This phenomenon is worldwide. Since the early 1970s, manufacturing employment as a share of total employment has fallen in Australia, Canada, France, Italy, Japan, the Netherlands, and the UK. This has even happened more recently in China.
The “culprit” is not free trade. The authors cite a 2017 study by Ball State University economists Michael Hicks and Srikant Devaraj that found that about 88 percent of recent job losses in US manufacturing were due to productivity improvements rather than to imports.
What about the idea that in various trade agreements “we” have reduced our tariff rates more than our trading partners have? The opposite is true. Under NAFTA, the authors note, Mexico’s government reduced its tariffs on US imports from about 12.5 percent to zero, Canada’s tariffs on US imports fell from about 4.2 percent to zero, and US tariffs on imports from Canada and Mexico fell from 2.7 percent to zero. Moreover, after China joined the WTO, Beijing cut its average tariff rate from 14.6 percent in 2000 to 4.7 percent in 2014. The US government didn’t change its tariff rate on imports from China.
The Financial Crisis
One of best chapters takes on the myth that deregulation caused the 2007–9 financial crisis. The authors show that on the contrary, heavy regulation that pushed mortgage lenders to lend to high-risk borrowers was a major factor in the overvaluation of housing.
The Clinton administration had used the Community Reinvestment Act to withhold approval of banks opening ATMs and new branches if the banks did not substantially increase subprime housing loans. President George W. Bush continued these policies. Both administrations pushed Fannie Mae and Freddie Mac to drop their standards. By 2008, Fannie’s and Freddie’s required quota of subprime loans had reached 56 percent.
Those who blame deregulation often point to the Gramm-Leach-Bliley (GLB) Act of 1999, which had made it easier for financial-services holding companies to compete in banking, insurance, and the securities business through subsidiaries. The Gramm named in the act is, of course, co-author of the book I’m discussing. While that does give Gramm an incentive to justify his bill, the fact is that no one has been able to point to anything in the bill that contributed to the financial crisis. Indeed, as the authors note, financial institutions that had used their newfound freedom to diversify did better than other firms that didn’t.
The best part of the chapter is the discussion of why the US economy took so long to recover after the Great Financial Crisis. Why was the recovery so anemic? The Obama administration had imposed a “tidal wave” of new regulations. Also, Obama expanded the welfare state. In the fifty-five months after the start of the Great Recession, the number of food stamp (SNAP) recipients had grown from 26 million to 46 million. Normally, during a recovery, the number of food stamp recipients falls.
One notable lack is any mention of Federal Reserve chairman Ben Bernanke’s tight monetary policy, which helped cause the Great Recession and also slowed the recovery. While base money expanded, making monetary policy look loose, Bernanke tightened by starting, in October 2008, to pay interest on bank reserves. That gave banks an incentive to pull back on lending.
Income inequality and poverty
To address the claims that US income inequality is high and rising and that US poverty is evidence of capitalism’s failure, the authors draw heavily on data that Gramm and co-authors John Early and Robert Ekelund presented in their 2022 book, The Myth of American Inequality. I reviewed their book here. The authors point out that the Census Bureau steadfastly refuses to count any income in kind, which is a large part of the expanded US welfare state. It also refuses to count even some money income if the money is from Earned Income Tax Credit. The Census Bureau also refuses to subtract taxes from income, a distortion that overstates relevant income for the top income quintile.
The authors point out that if you include all income and subtract all taxes paid, you come up with a ratio of the average income of a household in the top quintile to the average income of a household in the bottom quintile of 4 to 1. This differs from the 16.7 to 1 ratio that the Census Bureau reaches by not counting all income and by not subtracting all taxes.
The authors also lay out how the Census Bureau exaggerate the Gini coefficient, which is higher when income inequality is higher. By doing the calculation correctly, the authors conclude that the Gini coefficient, rather than having risen as the Census Bureau claimed, fell slightly between 1967 and 2017.
On poverty, Gramm and Boudreaux note that when reporting the official poverty rate, the Census Bureau purposely omits 88 percent of the benefits the government gives to poor American families. Taking account of those benefits leads to the conclusion that only about 2.5 percent of US households are in poverty.
What about the claim made by Feeding America that “44 million people face hunger in the United States”? Feeding America draws on responses to a USDA survey that asked participants if at any time in the previous twelve months they had ever worried about being unable to buy the food they needed. What that means, note the authors, is that if someone had even one such day in the previous year, he evidenced “food insecurity.”
The authors do note a problem, though. The extensive welfare state means that there is little incentive to get out of the lowest quintile by working. They point out that the explosion of poverty benefits since 1967 has driven the employment rate for the bottom 20 percent of income earners to drop from 67 percent to 36 percent.
Conclusion
One of the biggest risks in this country is that governments will continue to hamper free markets with massive spending programs and intrusive regulations. The people who push these bad policies probably share many of the myths that Gramm and Boudreaux have so effectively refuted. If we see a reversal of spending and regulation, the two authors will surely deserve some of the credit.
