Which Kind of Economics?

The Myth of the Rational Voter: Why Democracies Choose Bad Policies by Bryan Caplan (Princeton University Press, 276 pages, $29.95)

America Works: Critical Thoughts on the Exceptional U.S. Labor Market by Richard B. Freeman (Russell Sage Foundation, 191 pages, $19.95)

Economic analysis can con-strict our imagination and choices, or it can allow us to evaluate choices with greater clarity and insight and help us to achieve the goals of a prosperous and decent society. The two books under review here show contemporary economics in its most dismal and luminous forms. Both argue that public policy is seriously off track, but the similarity ends there. One writer assumes that economists always know best, and he provides a misleading and constricted view of America's economic alternatives. The other has a deep respect for market forces as well as an appreciation of their limits, and he provides a far more useful guide to some of the critical economic choices that the country faces today.

In The Myth of the Rational Voter, Bryan Caplan claims that because voters don't understand his version of conservative economics, they are unable to evaluate economic policy alternatives correctly. In fact, according to Caplan, who is an economics professor at George Mason University, non-economists consistently support policies that they think will help them but will actually make them worse off. In other words, we would be better off if everyone without an economics degree stayed home on Election Day.

The big problem with Caplan's argument is that he fails to show that his version of economics gives us the optimal policies. For example, conventional neoclassical economics predicts that raising the minimum wage will lead to job losses for some of those affected by the increase. Research on recent increases in the minimum wage, however, reveals that their employment effects hover around zero. Some research finds slight job losses, much finds no effect, and a few studies find a positive impact on jobs. Is it possible that the majority of voters who support moderate increases in the minimum wage know this literature better than Caplan?

Or take another example: For years, economists of Caplan's stripes believed that if the unemployment rate fell below 6 percent, inflation would spiral. Yet unemployment fell in the 1990s, hitting 4 percent in 2000, and inflation decelerated. It turns out that the allegedly irrational voter who ignored most professional economists was right.

Of course, voters aren't steeped in economic research nor are they necessarily rational about economic policies. When they have a direct stake, people sometimes have far more nuanced views than Caplan would allow. Regarding trade, for example, Caplan believes that voters suffer from what he calls an "antiforeign bias." He imagines the typical non-economist saying about this issue: "Foreigners? Could it really be mutually beneficial for us to trade with them?" Yet, a New York Times/CBS poll from earlier this year showed that although two-thirds of respondents believe trade is good for the U.S. economy, a slight majority (51 percent) believe we've lost more than we've gained from globalization. People are beginning to understand, better than some economists, that while expanded trade has boosted growth, the benefits haven't reached them, and this understanding is leading them to support politicians such as Sens. Sherrod Brown and Jim Webb who speak to this inequality. That's not irrational.

In the absence of evidence that Caplan's economics can reliably point us toward superior outcomes, the structure of his argument crumbles. Economists, he concedes toward the end, "are often accused of arrogance," and to help prove this point, he has given us a book that is a prime example of why that description so often seems apt.

Richard Freeman's America Works is an altogether different kind of book. Freeman, a Harvard labor economist with a long career of careful, empirical research and a deep historical knowledge of American political economy, provides us with one of the most convincing and authoritative accounts of the strengths and weaknesses of the U.S. economy. This is a slim, readable volume that both celebrates market forces and provides a stark warning of the need to strengthen the institutions that hold those forces in check.

At the heart of America Works is a detailed, thoroughly documented critique of changes in the labor market and political economy over the past few decades. America is not working the way that Freeman thinks it should, can, or has in the past, and he's not happy about it. The analysis starts with the recognition that the U.S. economy is an exception from patterns prevailing elsewhere: "More than any other advanced country, the United States relies on the competitive labor market to determine the well-being of workers and the living standards of their families." In comparative perspective, our markets have become increasingly unfettered by collective bargaining, national health insurance, safety nets such as unemployment insurance, mandated vacation time, worker training, or virtually any dimension of what is broadly called the "social contract."

In other words, relative to every other advanced economy, we let markets rip. The problem is that during the past few decades, they've been ripping up the social fabric. The result is much higher levels of inequality, and Freeman, a master of international comparisons, provides tons of compelling and readable evidence.

This is not an original point, but given Freeman's depth of understanding of both sides of this equation—markets and their buffers—he develops his theme with exceptional clarity and effectiveness. In chapters on diminished unions, weak social insurance and porous safety nets, the rising clout of executives relative to the rest of us, and globalization, Freeman paints a clear picture of how, under the rubric of deregulation and expanded trade, economic power has shifted from labor to capital.

These developments jammed the mechanisms that in earlier decades ensured a much more equitable distribution of the fruits of productivity growth. The result is that since the latter 1970s, wages, income, and wealth have been accumulating at the top of the scale, leading to levels of inequality we haven't seen in this country since the Roaring Twenties. Moreover, inequalities of this magnitude are self-reinforcing: They purchase a politics that exacerbates them (see Bush tax cuts), and block pathways to opportunities for the have-nots.

In a mode that is too rare among academic economists, Freeman worries that such distributional dynamics are "unhealthy for American ideals of political classlessness and shared citizenship. The term ‘two Americas' … is more than political rhetoric. It is reality."

Moreover, according to Freeman, things don't have to be this way. Many writers on economics see an inexorable trade-off between growth and inequality; in the words of influential Washington Post columnist Steven Pearlstein, "There is no realistic high-growth, low-inequality solution."

Freeman flatly rejects this notion. He recognizes that some of his "conservative colleagues believe that Americans have no choice but to ‘suck it up' and accept growing inequality and insecurity at work, though they would never use such strong language … I reject these prescriptions for doing nothing."

His program for restoring balance comprises the last chapter of America Works. It's a terse discussion, and while some may find the ideas to be too bare-bones, Freeman hits precisely the right level of detail for this kind of book. He offers two sets of proposals, the first targeted at workers and firms, the second at worker bargaining power. The first set includes boosting the pay of low-wage workers through higher minimum wages and an expanded Earned Income Tax Credit (those arguing against minimum wages always set these two ideas up as oppositional, but Freeman is right that we need both), national health care (among other advantages, it would "lower the marginal cost of hiring labor"), greater public investments, and more profit sharing.

The second set includes greater corporate governance as an antidote to irresponsible boards run by old-boy networks, and expanding "modes of representation for workers beyond the dichotomy between a collective bargaining contract and nothing." In earlier work that's now widely accepted, Freeman almost single-handedly reversed economists' negative assessment of unions' impact by showing that organized labor pushes back against inequality without hurting productivity growth.

Now, however, Freeman advocates "open-source unionism," a pretty different creature from the current form. For one, it requires neither majority status nor collective-bargaining contracts; in fact, such organizations lack the ability to represent workers in a particular office or factory and cannot bargain with management over wages and benefits. Instead, think of these groups as membership organizations, like the AARP, that represent the cause of labor writ large. (The AFL-CIO has already created one such organization, Working America, which now has more than a million and a half members.) If open-source unions developed successfully, they could give voice to the majority of workers, who, according to Freeman's survey data, want to be represented by a union but don't belong to one now.

Of course, open-source unions might not succeed, and one can certainly worry about the effectiveness of unionism that doesn't involve collective bargaining. From the perspective of a political movement representing labor's concerns (didn't there used to be a party that did that?), I like the idea of open-source unionism. But Freeman himself would probably grant that relative to the direct bargaining of traditional unions, it is only an indirect way to reconnect growth and living standards.

What Freeman ultimately shows is that, yes, "America works," but it could work much better. For a while now, it's worked in a manner that's fundamentally inconsistent with the other side of American exceptionalism—the part about opportunities for all and fair rewards for true merit and for anyone willing to make a gainful effort. This invaluable book points the way back to that truly exceptional America.

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