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How to Fix American Capitalism

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from the magazine

How to Fix American Capitalism

End insider privileges by renewing the freedoms to build, to work, to sell, and to learn. Autumn 2020
Economy, finance, and budgets
Politics and law

A February 2019 Harris poll found that roughly half of younger Americans would “prefer living in a socialist country.” Millennials may not fully grasp the consequences of the government owning the means of production, but they certainly don’t like how American capitalism is working for them. They have a point. Over the past 40 years, insiders have increasingly captured the American economy—from homeowners opposed to new housing construction near them to incumbent firms that benefit from the overregulation of employment to interest groups that have transformed the federal government into the equivalent of a pension system with a nuclear arsenal. The young are usually outsiders; the bill for the insiders’ triumph has been laid in their laps.

The Covid-19 pandemic reinforces this dynamic. Middle-aged teachers, protected by powerful unions, Zoom their classes from the comfort of their homes, and students get lost in the shuffle. The mortality risk of the disease to the young is tiny; yet they are told to give up the freedom of their youth to protect the rest of us. The irony is particularly bitter because America’s lockdown policies did little to protect the most vulnerable older Americans who live in nursing homes.

What many young people today don’t realize is that socialism is a machine for empowering insiders. Few insiders have ever been rewarded more assiduously than the nomenklatura of the Soviet Union. Few governments have been as gray—in every sense of the word—as the Brezhnev regime. A vast expansion of the American government, as imagined by today’s Democratic Socialists, would create its own privileged elite.

From its inception, by contrast, capitalism was designed for outsiders. Its original apostles, such as Adam Smith, argued that entrepreneurs needed freedom from the royal regulations that limited trade and the formation of new enterprises. When the government controls decisions to work or to start a business, political pull becomes a prerequisite for success. The whole point of economic freedom is that all people—not just the connected—can use their talents to help themselves and, potentially, to change the world.

These days, capitalism’s advocates often focus more on defending the status quo than on promoting outsider opportunity. If capitalism is to win over the young, that must change—and a new freedom agenda can help make that happen. In January 1941, Franklin Roosevelt announced his four freedoms (of speech and worship, from want and fear) that helped frame his objectives for World War II, which the nation would enter before the end of that year. Our contemporary outsiders would benefit from a renewal of four key freedoms: to build, to work, to sell, and to learn. The young need fewer land-use restrictions that make it tough to provide affordable housing in productive areas. They need fewer employment rules that limit their ability to find work, as well as fewer business regulations that suppress entrepreneurial energies. And—even before these other important things—they need new educational options that liberate them from underperforming educational monopolies.

In 1981, the social scientist Mancur Olson published his magisterial The Rise and Decline of Nations: Economic Growth, Stagflation, and Social Rigidities. Olson had already won acclaim for The Logic of Collective Action, which explained why some groups received an outsize slice of the political pie. In his new book, Olson turned to the question of why nations fail. His thesis: nations lost dynamism when insiders managed to stack the rules against disruptive outsiders.

Stable societies with unchanged boundaries, Olson observed, “tend to accumulate more collusions and organizations for collective action over time.” Instead of accepting rules that encourage overall growth, these collusive organizations—trade groups and labor unions were paradigmatic examples—fight to keep what they have, slowing down “a society’s capacity to adopt new technologies and to reallocate resources in response to changing conditions,” thus reducing economic efficiency. Decline follows.

Olson pointed to Japanese stagnation under the Tokugawa shogunate, when, “before Admiral Perry’s gunboats appeared in 1854, the Japanese were virtually closed off from the international economy.” Ruling Japanese society, he writes, “were any number of powerful za, or guilds, and the shogunate or the daimyo often strengthened them by selling them monopoly rights.” The guilds “fixed prices, restricted production and controlled entry in essentially the same way as cartelistic organization elsewhere.”

A second example: Great Britain, “the major nation with the longest immunity from dictatorship, invasion and revolution” and, consequently, Olson explained, suffering “this century a lower rate of growth than other large, developed democracies.” In Olson’s view, the weak performance resulted from limits on change established by a “powerful network of special-interest organizations,” which included labor unions, industrial groups, and aristocratic cliques. By the 1970s, after the conservative government of Edward Heath fell in a losing battle with striking miners, many deemed Britain ungovernable. Olson contrasted the British situation with that of postwar Germany and Japan, where the chaos and destruction of wartime defeat wiped away established industrial and retail groups, leaving the field open to newcomers like Soichiro Honda or the Albrecht family (creators of international supermarket giant Aldi), who could work economic magic.

“Collective action takes time and skill, and suburbs have proved particularly effective at blocking development.”

The word “ungovernable” was also used to describe New York in the 1960s and 1970s, when Mike Quill’s transit union ran roughshod over Mayor John Lindsay’s attempts to control public-sector wage growth. New York was a long-established city with lots of political collusion. The old Tammany Hall could broker deals to keep Gotham going, but Lindsay’s successor, Abe Beame, proved too weak to resist any special interest that wanted more spending or government favors. New York’s spending kept rising even as public services worsened, until bankruptcy loomed and public power wound up in the hands of the unelected Municipal Assistance Corporation. Thankfully, New York reformed itself economically, at least to some extent, under Mayors Rudolph Giuliani and Michael Bloomberg, as Britain did under Prime Minister Margaret Thatcher. Sufficiently strong leaders can buck entrenched insiders.

When I first read Olson in the 1980s, I believed that the American political system was robust enough to prevent the domination of insiders. The nation would continue to be a place where outsiders could flourish. These days, I’m less confident.

Olson’s vision really started to sway me when I worked on land-use regulation 20 years ago. Harvard’s then-president, Neil Rudenstine, envisioned a contemporary art museum on the Charles River, designed by renowned architect Renzo Piano. The museum would have summoned tourist dollars and, while under construction, provided construction jobs—but it would also block the river views of a small number of well-situated local residents. Those residents organized and developed the community muscle to slow the museum’s construction—and the idea eventually was scrapped. Instead of a museum, the community got a park, preserving their views. Whatever one thought of the outcome, the system protected the insiders.

Variations on that story have played out from California to Connecticut in recent years. Local homeowners have found multiple excuses for rejecting building projects that might block their views or, say, generate more traffic. Driving to work, I pass by placards that my wealthy neighbors have erected protesting the “Weston Whopper,” a planned affordable-housing project that would add 200 apartments to a suburb with a current population density of only about one person per acre. The only reason that the development might happen is a state law that lets developers bypass local land-use regulations in communities with a paucity of inexpensive housing.

Restrictions on new development present a classic battle of insiders versus outsiders. Outsiders benefit from new housing construction, for example, gaining the opportunity to live in a successful community that they otherwise might not be able to afford; insiders dislike the community inconvenience of new building, and they worry that their own homes might become more affordable. In cities, businesses, real-estate developers, and banks often support new construction and sometimes carry the day; in suburbs, incumbent homeowners have the loudest voice and typically triumph.

As Olson suggested, collective action takes time and skill, and better-educated suburbs have proved particularly effective at blocking development. To succeed, though, antidevelopment groups need rallying cries that go beyond self-interest, and green causes have frequently provided them. In 1973, the Friends of Mammoth v. Board of Supervisors of Mono County case required any significant new building in California to file an Environmental Impact Review, putting a huge hurdle in front of developers. The irony of blocking projects in places like the Bay Area is that such development would be vastly greener than construction in, say, Houston or Las Vegas, thanks primarily to coastal California’s more temperate climate.

In cities, historic preservation has often been the hurdle. The outcry over the destruction of the old Penn Station in 1963 helped galvanize a citywide movement that brought passage of the Landmarks Law of 1965. The Landmarks Commission empowered any community group to make the case that their part of New York—not just a beloved building, but whole neighborhoods—was “historic” and consequently almost unalterable. By 2010, more than 15 percent of the nonpark land in Manhattan south of 96th Street was in a historic preservation district.

Because areas like lower Manhattan and Berkeley have enjoyed enormous economic growth, limiting construction there means that fewer people can benefit from that growth. In the past, Americans could move to booming places because it was easy, for instance, to put up cheap balloon-frame houses on the frontier or erect tenements on the Lower East Side of Manhattan. Today, starter homes in Silicon Valley go for more than $1 million, while townhouses in Greenwich Village, a neighborhood that preservationists fought to keep pristine, now routinely sell for $5 million and up.

The construction bust has enriched older homeowners but kept younger would-be buyers from accumulating wealth. In 1983, the median 35- to 44-year-old had $56,000 in housing wealth; in 2013, that age bracket held just $6,000 in housing wealth. The 90th-percentile 65- to 74-year-old had $280,000 in housing wealth in 1983; three decades later, that group boasted $440,000 in housing wealth.

Bernie Sanders’s proposal to spend more money on young people was a key component of his presidential run. (JIM WEST/REPORT DIGITAL-REA/RE DUX)

In 1961, economist Benjamin Chinitz argued that New York was more resilient than Pittsburgh because New York possessed a culture of entrepreneurship, originally inculcated by the garment industry, where anyone with a good idea and a couple of sewing machines could start a business. By contrast, gritty cities like Pittsburgh, dominated by large smokestack industries that tended to snuff out small-scale entrepreneurial activity, eventually faced a crisis when those industries grew less profitable, and the local economy struggled to adjust.

Love for small business is one of the few universals in American politics. In a 2018 Gallup poll, just 56 percent of Americans viewed capitalism positively; but 92 percent had a positive view of small business, and 86 percent viewed entrepreneurs positively. Government at all levels has policies intended to help small businesses, but there’s little evidence that these programs are effective—and even when bureaucrats try to help, they impede small-business creation by imposing new regulations. The New York City Business License and Permit index presents a daunting compendium of licenses and certifications that can be required to start a business in the city—such as the Esthetics License (needed if you want to “conduct beauty treatment”) and the Certificate of Fitness for Fire and Emergency Drill Instructor (necessary to “lead fire drills in buildings that do not require a Fire Safety Director”).

Such overregulation represents a second way that the deck gets stacked in the American economy against outsiders. The decline of American entrepreneurship is a discouraging trend of the last 30 years. In 2015, economist John Haltiwanger documented numerous signs of diminished business dynamism in the United States. In the early 1980s, he noted, America’s startup rate exceeded 13 percent, which meant that about one-eighth of all firms had just begun. The startup share fell to 10 percent near the end of the Clinton years and below 8 percent during the Great Recession. While no consensus exists about the causes of this dramatic drop, expanding business regulation is a plausible candidate.

During this period, highly educated entrepreneurs moved increasingly into cyberspace, which remained a regulatory Wild West. The digital economy has grown radically because of Internet services like Facebook and Google, of course, but also because of the shift of retail operations to the Internet. The research of economist Austan Goolsbee and others shows that some of the rise of e-commerce reflected firms’ desire to escape local sales taxes—but sites like Amazon also avoid local retail regulations. Still, fleeing into cyberspace often requires some competence at coding, which is rare among the less skilled, who then wind up working disproportionately in physical retail spaces that bear the full burden of regulation; this increases American inequality.

Business regulations, like the housing kind, tend to benefit established players. Urban restaurateurs don’t want new food trucks setting up in their neighborhoods; they want to preserve their local monopolies, which was Olson’s point. Customers lose out, too; but typically, they’re too disorganized to lobby effectively against regulations. Uber proved a partial exception, betting that swiftly establishing a healthy reservoir of regular customers would stop the service from getting blocked by regulators. But insiders are finding ways to limit ride-sharing, allegedly out of concern for underpaid drivers, as with California’s AB5 measure classifying such drivers as employees, not independent contractors, which will raise employment costs considerably, likely shrinking driving opportunities. Curtailing ride-sharing will harm many drivers, in other words, not help them. A better way to aid them would be to encourage the entry of competing services.

One of the most egregious ways that government favors insiders is occupational licensing, typically presented as a way to protect consumers. Economists Morris Kleiner and Alan Krueger documented that, in the late 1950s, less than 5 percent of American workers needed some form of occupational license. Licensing in fields with a real public-health impact—pharmacy, say—may protect some consumers, but it’s hard to see why the person selling you flowers or your eyeglass frames needs certification.

Licensing can deter someone from starting a new job or experimenting with new occupations. If you think that you might like to be a florist, you could just try it out, in a free environment. If floristry requires a long process of certification, though, you’re more likely to stick with your current job. Occupational licensing also makes it harder to move across states to seek work, since licensing requirements vary.

For many of us, the folly of these regulations was driven home during the Covid-19 lockdowns, because we started doing these licensed tasks from home. Cutting hair is one of the more regulated occupations across the United States. Yet by the second month of lockdown, my wife was giving me a haircut that was about as good as most professional cuts that I have received.

Government rules also deter job creation by mandating extensive employee benefits. The most obvious costs come from Social Security, workers’ compensation, and Medicare, which cumulatively average $2.85 per hour—increasing the effective hourly minimum wage from $7.25 to more than $10. The Fair Labor Standards Act also requires overtime pay for nonexempt workers. Other rules have made it easier for workers to sue their employers, adding a further potential cost to hiring.

Individual states and localities impose rules that drive up employment costs, too, such as Oregon’s $12 minimum wage or the $16 minimum wage in Seattle. The national minimum remains too low typically to have much impact on older workers, but it does matter for the employment prospects of younger workers with fewer skills. Economist Jeffrey Clemens found that Congress’s 2007–09 increases in the national minimum wage decreased the probability of being employed by about 5 percentage points for workers between the ages of 16 and 30 who lacked a high school diploma, in states that had previously kept their minimums low. In other research, Clemens and Michael Wither found that minimum-wage hikes led to similarly substantial reductions in the probability that minimum-wage workers would rise to monthly earnings levels over $1,500.

Private-sector unions have weakened, but public-sector unions remain strong—and they protect older and established insiders. Government puts aside little for its workers during the early years of their employment, so if an employee leaves to go somewhere else well before retirement, he or she gets little. Payments get backloaded for older workers nearing retirement, so they can cash in big—as many are doing now. Also, because politicians promised older generations of government workers such generous pensions, creating a major public debt problem, many states have started reforming their retirement systems to reduce benefits. The next generation of public workers—just starting out—won’t receive anything like the benefit levels of boomers. (And younger government workers, economist Maria Fitzpatrick’s research has shown, don’t value their benefits nearly as much as politicians think they do—making such spending even more wasteful.) Public-sector pensions also favor men over women. Older men, report Valentin Bolotnyy and Natalia Emanuel, find it easier to rack up overtime during their last years on the job, since they usually have less responsibility for other family members. Those extra hours translate into permanent pension differences.

Twenty-four percent of the national budget now goes toward Social Security, and another 8 percent funds benefits for retired public workers, including veterans. Another 15 percent is spent on Medicare. Altogether, spending on the elderly now makes up 47 percent of the federal budget.

Some form of old-age pension system is a matter of basic decency, and no one wants to see the elderly on the streets without decent health care. But the political might of older voters—who live disproportionately in the crucial swing state of Florida—has been strikingly effective at blocking sensible reforms that could reduce the cost of the system for younger voters. When Social Security began in 1935, American life expectancy was 61, and only 7.8 million Americans were over 65. Today, life expectancy is 79, and 49.2 million Americans are over 65. Raising the retirement age would obviously make retirement benefits more financially sustainable. Yet older voters’ power has made such a change almost impossible.

“Younger Americans find themselves attracted to politicians, like Bernie Sanders, who promise more spending on them.”

Means-testing benefits for the elderly would also help reduce the bill, but it would be no less difficult politically. Part of Roosevelt’s political brilliance was to present Social Security as an entitlement, which workers paid for themselves over time—even though, for years, no worker’s contribution has covered the expense of his or her benefits. People get angry if what they feel they’ve paid for gets taken away. Even the wealthiest retirees, easily able to pay for their own retirements, would view Social Security cuts as a betrayal.

When Medicare began in 1965, health care was usually inexpensive; indeed, few pricey procedures existed. The program’s unlimited promise to cover reasonable medical procedures thus seemed manageable. The genius of American capitalism responded with an array of medical innovations—and the Medicare bill exploded. Unlike nationalized health-care systems that must balance their budgets, Medicare has never seriously asked whether new procedures provide sufficient benefits to cover their expense. Our medical-innovation machine keeps humming, and younger taxpayers keep picking up the tab.

The irony is that all this spending did so little to protect America against the scourge of Covid-19. The U.S. spends more per person on health care than any other country, and yet it has had (as of September 7, 2020) 58 deaths per 100,000 Americans. Germany, Norway, and Switzerland come next in spending among large countries, but they averaged fewer than 12 deaths per 100,000. The young can understandably feel frustrated when the government spends oceans of money on health care for the old and can offer younger Americans facing a pandemic nothing more than perpetual quarantine.

Younger Americans see the massive flow of public spending toward the old, and they understand the difficulties facing reform. They thus find themselves attracted to politicians, like Bernie Sanders, who promise more spending on them. Visions of Medicare for All seem far more plausible to young voters than proposals to cut benefits already enjoyed by the elderly. But America needs policies that will empower the young, not make them a new generation on the dole.

The expansion of occupational licensing makes it harder for people to start businesses ranging from hair salons to florist shops. (JERRY HOLT/STAR TRIBUNE/GETTY IMAGES)

In education, too, America has favored insiders. Few institutions do more to protect the established than tenure, which means that teachers—both in colleges and secondary schools—essentially have jobs for life, even if they’re incompetent. Students at least can choose their own colleges and courses, providing some protection against pedagogic ineptitude. In public high schools and below, however, tenure means that students have little recourse. Stanford economist Eric Hanushek estimates that simply “replacing the bottom 5–8 percent of teachers with average teachers could move the U.S. near the top of international math and science rankings with a present value of $100 trillion.” Good teachers improve the adult earnings of students, while bad ones exact a lifetime penalty on the young, as Raj Chetty, among others, has shown. The tenure system protecting weak teachers imposes terrible costs on our children.

Insiders’ power to block change has been a steady feature of the education-reform wars over the last 20 years. Joshua Angrist and others have documented the strong positive effects of charter schools in Boston. Thanks to the political clout of teachers’ unions, the growth of those schools has been capped. Should schools try paying teachers for performance, like workers in any normal industry? Absolutely not, say the institutions that protect teachers’ interests. That clout has been particularly on display during the Covid-19 pandemic, where teachers’ unions have regularly opposed live instruction, despite overwhelming evidence that large numbers of students, especially from deprived backgrounds, were getting little or nothing from virtual instruction.

Two generations ago, distinguished academics, such as Milton Friedman, and brilliant polemicists, such as William F. Buckley, fought to make the cause of freedom more attractive to younger Americans. They operated in a post–New Deal America widely perceived as embracing robust government engagement in the economy. When the economic status quo broke down, as it did during the stagflation of the 1970s, Ronald Reagan–style free-market economics offered an alternative—after all, it couldn’t be blamed for the era’s economic travails.

The American economy’s current state provokes plenty of unhappiness among the young, but that’s unlikely to lead, this time, to a straightforward Reaganite revival. For several decades, America’s leaders have largely spoken the language of free enterprise, despite the extension of regulations on all levels of government. To many, economic freedom sounds like more of the same, not something new.

An effective alternative to the status quo and social democracy must, I believe, focus on empowering outsiders. Many of those outsiders have suffered significantly during the pandemic, and insiders should be willing to sacrifice a few of their privileges as compensation. To build a political agenda around the four freedoms of learning, working, selling, and building, four specific policies would provide a good start.

Start with the right to learn, which precedes the other freedoms. Insider control over traditional K–12 education is, at present, too strong to achieve any radical reform within existing schools. Charter schools sadly remain a niche product, so pushing for their expansion—and for greater school-choice options more broadly—is necessary. Another alternative that could open up new education opportunities would be vocational training that bypasses the school system entirely. Washington could pay for programs inculcating marketable skills—from plumbing to computer programming. These programs could be competitively sourced, meaning that labor unions and community colleges and for-profit entrepreneurs could compete to offer them. But providers would get paid only if students learned real skills. Access to vocational vouchers could go not only to teenagers but also to displaced workers, or to anyone without a solid job.

Second, we should establish a stronger right to work. All employment regulations should undergo rigorous cost-benefit analysis and have automatic sunset provisions. The Social Security system should also be made friendlier to the young. The payroll taxes that fund Social Security could be eliminated for those under 30 and phased in later in life. Younger workers and their employers would initially pay nothing into the system. That shift would eliminate a large tax-related barrier to hiring the young and make it more financially attractive for young people to work. That reform would reduce revenues, true; but raising the age of retirement could offset the lost funds.

Third, Americans need greater freedom to sell and to launch new businesses, especially of the non-digital kind. The Internet’s platforms may make it easy to sell goods these days, but services and experiences are provided live and thus are often highly regulated. The next generation’s entrepreneurs should be able to create abundant opportunities outside of eBay—above all, in poorer areas. The path to liberating physical entrepreneurialism is clearer in cities, since more customers are clustered together for creative local service providers. But starting a business should be easier everywhere.

The need to ease business regulations is particularly acute as America attempts to recover from the economic dislocation caused by Covid-19. America’s small businesses entered into the pandemic typically with only a tiny cushion of cash. Government loans, coming through the Paycheck Protection Program, offered a lifeline to many, but thousands of small businesses will still close their doors. The best way to preserve our vital small-business ecosystem is not to throw money at every struggling business but instead to make it as easy as possible for new businesses to open after the pandemic has passed.

As with employment regulations, a top-to-bottom review of business regulations, subjecting them to ruthless cost-benefit analysis, would be welcome, but that could take years. A speedier approach might be to experiment with entrepreneurship districts. They could combine one-stop permitting with shared maker spaces and targeted training programs. The permitter could be made accountable for the speed of the process.

Fourth, we need more freedom to build. Since the Clinton administration, I have regularly interacted with officials at the Department of Housing and Urban Development, and they’ve always wanted to reduce the local barriers to building that push up prices. Their wishes have had almost no influence, largely because land-use decisions at the local level are not easy to control from Washington—and the notion that HUD would preside over local building permits is a little scary, anyway. State legislatures are the natural intermediate institutions that can push localities to build more. In many cases already, state governments have reduced the power of local land-use controls. The best federal approach in this area would be to deploy financial incentives to encourage state legislatures to do the right thing. Federal transportation spending is partially meant to build the infrastructure needed by new construction. If a state isn’t allowing any construction in high-demand areas, shouldn’t the federal government reduce its infrastructure support? Use money to nudge states—and let states nudge communities.

Today, capitalism seems unattractive to the young because it is stacked against them. America’s current outsiders will have far better lives in a free system, however, than in any new socialism, which would invariably privilege connected apparatchiks (among the other failings it would bring). The cause of freedom will need to present itself as a radical break with the status quo to win the hearts and minds of a new generation.

Top Photo: Young employees, even those at leading firms, increasingly view the market economy with skepticism. (RICHARD LEVINE/ALAMY LIVE NEWS)

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