The Market and the Macroeconomic Social Contract

After many years in which conservatives habitually paid lip service to free markets, a new trend of conservatives criticizing capitalism and the free-market system has emerged, in ways traditionally characteristic of the left. Republican senators such as Marco Rubio and Josh Hawley are advocating a new conservative populism by attacking inequality, big corporations, international trade, and other key features of contemporary capitalism. The new think tank American Compass offers broader leadership for conservative critics of free markets.

If market capitalism successfully absorbs these critiques, it might become more robust and adaptable, better able to address the present discontentment, at a time when polls have long shown that most people think the country is on the wrong track. On the other hand, conservatives conspiring with the left against free markets could wreck the best economic system in history.

Market capitalism—which relies on private enterprises financed by banks, savings, and shareholders to run most of the production and exchange activities in society—has been the basis for American liberty and prosperity for generations. Much regulation and redistribution are compatible with an economic system having an essentially market capitalist character. But policy should work with and through markets instead of trying to disrupt or replace them.

Free market arguments have sometimes been overapplied, as in finance and technology, but more often, they have been underapplied, as in healthcare, education, and housing. To fix the social contract, we need more market capitalism, not less. A less market-capitalist America would be poorer and less free. And the freedom of action that capitalism offers to individuals and families is indispensable right now for social conservatives who want to lead non-mainstream, countercultural lives. We need to reform market capitalism, not reject it.

The Late, Great Macroeconomic Social Contract: When Low Unemployment and Inflation Meant a Good Economy

First, let me suggest why the social contract has been unraveling. In some societies there is a prevailing opinion, grounded in experience, that the society offers people a fair deal, because if people follow the prescriptive advice that is in general circulation, life outcomes that satisfy widely accepted notions of the good life will follow fairly reliably. In such cases, gratitude is widely felt to be appropriate, and radical discontent seems unreasonable. This is what I mean by the term “social contract.” Obviously, this sense of social contract is somewhat elusive to define and measure. Still, I think most readers would agree that in the later decades of the twentieth century the United States had more of a sense of social contract with respect to economic matters (as distinct from, say, foreign policy, race relations, or civil liberties) than we do today.

In the 1950s and 1960s, people who remembered the Great Depression were grateful that jobs were plentiful at last. In the 1970s, people were alarmed by rising prices and joblessness. Jimmy Carter attacked Gerald Ford for the high “misery index,” the sum of the inflation and unemployment rates, only to be attacked by Ronald Reagan when it went higher still. Then, throughout the 1980s and 1990s, as inflation and unemployment trended down, people increasingly thought the economy was good. Inflation and unemployment weren’t everything—the late 1990s also saw a surging stock market and an uptick in productivity growth—but they were the main focus.

Why did most people think low unemployment and low inflation meant a good economy? Economics does not offer much reason to attach such importance to these particular variables; the explanation lies in a sense of social contract.  People were expected to work in the prime of life, and to save for a rainy day and for retirement. If unemployment was low, they could work. If inflation was low, savings would retain their value. People whose failure to work or save left them destitute had only themselves to blame. Society might still provide welfare, but out of mercy, not justice. Unemployment and inflation had to be avoided because, if they got out of hand, they would weaken or break the social contract.

From Complacency to Grievance

Since 2000, the inflation and unemployment rates have mostly stayed fairly low, but people no longer think the economy is good. The biggest reason why is probably the stagnant or declining purchasing power of sub-median wages with respect to the necessities of middle-class life. For working-class men, on average, inflation-adjusted wages have been slipping for a generation. Women and the college-educated have mostly seen their wages hold steady or grow modestly, while there have been huge gains at the top of the pay scale. But official Consumer Price Index inflation masks a troubling shift in relative prices, whereby many luxuries, such as flights and gigantic TVs, have gotten cheaper, while necessities like health care, higher education, and housing have gotten much more expensive.

Productivity growth, trending 3–4 percent in the mid-twentieth century, slowed in the mid-1970s and has generally been 1.5 percent or lower since then, reflecting the underperformance of technological innovation. The idea that technology is underperforming may seem counter-intuitive to a population that has been exhilarated and discombobulated by the birth of the internet and the emergence of mass cellular telephony. But rapid technological progress has largely been confined to the IT and communications sectors. In other respects, the typical American home of 2020 is much more similar to the typical American home of 1955 than the typical home of 1955 was to that of 1890. And what productivity growth has occurred has involved a lot of automation and outsourcing, biasing the wage distribution in favor of skilled workers and the well-connected.

Since people did not expect median wage stagnation, many got into trouble through choices that seemed responsible at the time, and that society tended to encourage, especially pursuing homeownership and higher education. Again, the sense of social contract depends on people feeling like they have a chance at a flourishing life, provided that they make choices aligned with the society’s received wisdom: go to college, get and stay married, get a job, buy a home. For many, though, college has not led to middle-class earnings, as browsing College Scorecard data will quickly reveal. Homeownership proved ruinous for many in the aftermath of the housing bubble—in 2009, 11.59 percent of homeowners were “under water,” i.e., had negative equity, on their mortgages—and too many jobs prove to be transient and/or ill-paid dead ends. More often than in the past, many people can’t find a marriage partner.

Many of today’s economic grievances date to the 1980s and 1990s. But a series of false hopes long kept economic disillusionment at bay. In the 1990s, the internet-driven New Economy looked like it would solve all problems. After the dot-com bubble popped, a housing boom briefly became the panacea, raising people’s notional net worth even as their wages underperformed. During the long aftermath of the 2008 financial crisis, discontent deepened. And then, after a brief phase of robustly rising working-class wages in 2017–2019, the COVID-19 crisis set everything back once again.

Where We Need More Intervention

Free market principles have been overapplied and underapplied, depending on the sector of the economy. In recent decades, exaggerated notions of “market efficiency” motivated a sweeping agenda, which was sometimes thwarted and sometimes abetted by vested interests. Two areas where free-market logic may have been overapplied were finance and technology.

Finance must navigate a permanent tug-of-war between diversification and transparency. The financial system works best if it is infused with morality. If the mere pursuit of profit runs the show, finance degenerates into Ponzi schemes and bubbles. Unfortunately, “market efficiency” claims have contributed to the elevation of shareholder-value maximization as the preeminent goal of business. Players in the financial sector have enforced this norm, acquiring and reorganizing companies to maximize profits. But businesses shouldn’t only seek to maximize profits. The economy is full of imperfect competition and other “market failures,” so businesses often have opportunities to do good disproportionate to the resources expended, in ways that neither increase profits nor jeopardize their sustainability. They impoverish society in many subtle but cumulatively large ways if they neglect such opportunities in favor of shareholder value maximization. The refusal of big telecoms in recent decades to deploy decent broadband service to many rural areas because they could only expect what one executive dismissively called “infrastructure returns” is an example.

As for innovation, economist Maria Mazucato’s recent book The Entrepreneurial State, which traces a huge range of invention and innovation to government involvement, is a good reminder that there was never actually any reason to believe that capitalism produces optimal rates of R&D and innovation. Ideas are naturally nonrival. As such, they can be treated as “public goods,” or they can be made excludable through a regime of intellectual property. While free marketeers’ skepticism about the government’s ability to “pick winners” in cutting edge technology has merit, it’s time to turn toward more federal funding of R&D and soft-touch economic planning for technological change through programs like the Endless Frontier Act, which is currently wending its way through Congress.

Where We Need More Competition

Meanwhile, important areas where free-market logic has been underapplied include health care, education, and housing and land use. These over-regulated, over-priced sectors need a strong dose of the competitive discipline and innovative freedom characteristic of market capitalism.

In health care, the real challenge of how to pay for emergency care has become a pretext for comprehensive cost insulation and weird payment arrangements that result in “surprise billing.” Reform must start by reasserting the basic principle that the obligation to pay must originate from informed consent, and aggressively impose price transparency on the healthcare industry through state and federal regulations, on pain of medical providers’ being forbidden to bill patients if the cost of services was not published and easily discoverable in advance of care. That done, everyone needs to be properly incentivized to do their part in bringing health care costs down. Patients with assets should pay for care, and certificate of need and occupational licensing laws that restrict supply should be rolled back.

In education, voucher and charter schools have disappointed some hopes for improved learning productivity growth. On the other hand, they seem to raise educational attainment in the long run, while letting parents educate children in their own values. To improve educational outcomes, academic, moral, and cultural, policies that favor challengers to the public school monopoly—vouchers, charter schools, educational savings accounts, etc.—should be pursued vigorously.

Universities play an important role in maintaining and developing civilization’s heritage of ideas, and for the sake of that, they deserve some insulation from the pressures both of free markets and politics. However, our century-long expansion of college education has been motivated less by a desire to cultivate ideas than by a desire to inculcate job skills and raise people’s earning power. Many do raise their earning power by going to college, but others don’t. The U.S. Department of Education reported in April 2020 that 20 percent of student loan debt is in default, but most student debt is not dischargeable in bankruptcy, an important privilege of universities. Free market reforms of higher education should hold schools more accountable for the labor market outcomes of graduates, while leveling the playing field for autodidacts and non-traditional education providers.

Finally, zoning and land-use laws prevent sufficient home-building in areas of high demand, which drives up housing prices in high-productivity metro areas and prevents people from moving to opportunity. Freer markets in land use and housing development would be the most effective affordable housing policy.

The best solutions to America’s economic grievances are in harmony with the market capitalist tradition that has always been the key to its freedom and strength. Conservatives in particular need to recognize this, bring this perspective to the negotiating table, and then find a way to give the rising generation a social contract it can believe in.