Why Old Economic Ideas Are Losing

Why Capitalism is losing support among younger Americans

Now seems as good a time as any to write something about economics. Inflation is up to the highest levels in 30 years, asset prices are down, and a recession seems an almost certainty. As I type this, the SP500 index closed the day down over 4%.

It is against this backdrop that two economists associated with the Hoover Institute, a public policy think tank at Stanford University, published a paper outlining economic principles that they hope will influence government policy heading into the upcoming election cycle. The paper, titled Reinvigorating Economic Governance, was written by John Logan and Kevin Warsh. They open with a defense of American economic success, and a note about the purpose of their paper:

“The American economy is among the most powerful forces for good in the history of humankind. The nation’s economic engine has driven living standards to heights unimaginable at the nation’s founding. Steadily advancing prosperity—bolstered by bursts of scientific and technological discovery—has expanded productivity and greatly improved the quality and duration of life.

The duty of this generation is to ensure that the American economy sustains its strength. And the purpose of this essay is to outline an economic governance framework, based on our nation’s foundational principle of natural liberty, to meet the challenges of our day.”

Logan and Warsh submit that economic prosperity can be traced back to four foundational principles: private property, rule of law, free and competitive markets, and limited government. They argue that these four principles are “...predicates for sustained human progress...”, and are the very same principles that buttressed the United States’ unprecedented rise to global economic power since its founding ~250 years ago. My read of the paper is that Logan and Warsh are arguing in defense of free market Capitalism.

I also don't think it's an accident that Logan and Warsh choose to explicitly address younger Americans with the paper. (See: “The duty of this generation…” in quote above.) American Millenials and Gen Zer's will soon be (and are already) graduating into the positions of authority in the United States, and so will see their influence on the country expand dramatically. But, I have a fear that Logan and Warsh's arguments for Capitalism may fall on deaf ears. To their target audience, Capitalism is nearly a derogatory term.

“Capitalism is Boomer economics, we have better economic theories now.” - Anonymous, 25

"Ian, surely you jest!"

I do I do, but "many a truth...". According to recent polling, just 42% of American Gen Zer’s, the oldest of whom were born in 1997,  hold a positive view of Capitalism, while a majority, 52%, hold a positive view of Socialism. Across the pond in the United Kingdom, a full 67% of young people want to live under Socialism. Logan and Warsh have a tall task ahead of them.

Lest you think this essay is a joke at the expense of my Socialist-leaning contemporaries, I will now argue in their defense. I believe there are very good explanations for why young people are increasingly turning away from Capitalism.

I'll explore two of them below.

Losing sight of the vibrant forest for a few diseased trees

According to Wikipedia, negativity bias “is the notion that, even when of equal intensity, things of a more negative nature (e.g. unpleasant thoughts, emotions, or social interactions; harmful/traumatic events) have a greater effect on one's psychological state and processes than neutral or positive things.” People react much more to bad things than good things.

Negativity bias is a generic phenomenon, but it can be applied to economics. Economic negativity bias means that people have a tendency to notice “bad” economic outcomes (e.g. wealth inequality, inflation, recessions, bubbles, etc.), while simultaneously overlooking “good” economic realities (i.e. general prosperity). This makes sense intuitively. When the economy is sputtering, the effects are felt painfully, but when the economy is doing well, its effects recede into the background.

In his 2006 paper, Good News and Bad News: Asymmetric Responses to Economic Information, Stuart Soroka investigates economic negativity bias, he writes:

“Public responses to negative economic information are much greater than are public responses to positive economic information…media content increases the (concurrent) public reaction to negative information by about 16%. Mass media respond asymmetrically to economic information, and the public then responds asymmetrically to both media content and the economy itself …The asymmetry in public opinion is considerable…media coverage...serve[s] to enhance the effect of negative information.”

Basically, people respond with greater intensity to bad economic information than good economic information. In addition, media covers bad economic news more than good economic news, which enhances people’s already negative response.

Why might this cause people to dislike Capitalism?

Because people place the blame for bad economic information on the underlying economic system. To use the analogy proposed in the section header— people see a few diseased trees and blame the forest in which they are growing.

Ok, so our forest has a few diseased trees, but how come we lose sight of the vibrant rest of it?

The founding fathers of America had no idea how this experiment of America would turn out. How could they? There are few things as risky as starting a new country. There was no guarantee of success, and the odds of an outcome like that has happened were spectacularly small. The American experiment, although imperfect, has produced unprecedented prosperity– or, an incredibly vibrant and prosperous forest.

The graph below shows the GDP per capita since the early 19th century. The green line represents GDP per capita for the United States (+ Canada/NZ/Australia, which contribute a minority), and the black line, far below it, is the World average. The difference between them is something like $40,000 per capita in GDP. I don’t want to overstep my bounds, but if you believe that a greater GDP per capita is a good thing, then according to this graph, something unique and good happened in the United States, and it was probably related to Capitalism.

Why do so many people ignore this overwhelmingly good evidence? Are we just too distracted by the bad? Why might people so easily miss the obvious and dramatic prosperity generated by Capitalism?

One possible explanation might be found in the happiness literature. Gregg Easterbook argues in his book The Progress Paradox that on average people aren’t measurably happier once their average income per capita exceeds just $10,000 per year. In other words, nobody notices how much wealthier they are in America because it doesn’t make them any happier.

In his book, Stubborn Attachments, economist Tyler Cowen adds nuance to this observation. He claims that the observation that people aren’t any happier above a certain level of income isn’t necessarily because they enjoy less of the material comforts they have, but because they continually redefine happiness relative to their existing situation. He writes:

“Thus even a constant level of reported happiness implies growth in real happiness over time, because the word ‘happy’ takes on ever more ambitious meanings as society accumulates more wealth and richer experiences. Life improvements do generally make us happier, while both our expectations for happiness and our reporting standards for ‘being happy’…adjust upwards.”

Basically, the more we have, the more we want, so we don't perceive that we are any happier. But, human progress up the wealth curve does improve material circumstances, we just don't notice that we are better off. This ability to overlook improvements in material circumstances is exactly how the prosperous forest produced by Capitalism goes unnoticed.

Reviewing, we have evidence that people notice negative economic results much more than positive ones, and easily overlook prosperity. It is now pretty easy to see why the combination might lead to a dismissal of Capitalism, the economic system that produces both the easily noticed bad stuff and easily missed good stuff.

China envy

China (correctly) receives its fair share of negative media coverage for doing questionable (evil) things like genocides and welding people’s doors shut to keep them inside. But they also receive a fair amount of admiration for getting stuff done— for building impressive stuff, like the hospitals they finish in a week and the infrastructure they build that doesn't suck(and that they can actually finish). They’ve also been able to produce impressive internet technologies too, companies like ByteDance (TikTok), AliBaba, and Tencent.

China has also amassed an impressive statistical track record in recent decades. Since 1990, China’s GDP growth has averaged over 9%. Over the same period, the United States has managed to average just 2% growth.

When combined, the anecdotes of China’s impressive infrastructure and technological accomplishments, paired with its phenomenal GDP growth, does create a sense of grudging admiration.

How has China done this?

The critical inflection that triggered China’s rise as an economic behemoth were the economic reforms led by Deng Xiaoping in the late 1970s. The following excerpt is from a 1999 report by the Japan Research Institute.

“The reform and open-door policy of China began with the adoption of a new economic development strategy at the Third Plenary Session of the 11th Central Committee of the Chinese Communist Party (CCPCC) in late 1978. Under the leadership of Deng Xiaoping...the Chinese government began to pursue an open-door policy... to achieve economic growth through the active introduction of foreign capital and technology...

...

The government subsequently established a number of areas for foreign investment, including the special economic zones, open coastal cities, the economic and technology development zones, the delta open zones, the peninsula open zones, the open border citiees, and the high-tech industry development zones... The changes brought an entrepreneurial boom that resulted in the emergence of huge numbers of entrepreneurs and venture businesses within China.”

The open-door policy encouraged foreign investment, and dramatically liberalized some, but not all, economic policies. In his paper, Is China Socialist, Barry Naughton writes that by the 1990s:

“…China had completely discarded…socialism and was moving decisively to a market economy. At that time, the question “Is China Socialist?” seemed meaningless to most people. China had shrugged off its old model of socialism, and obviously was never going back. China had officially recognized that no economy that excluded the market could hope to deliver satisfactory outcomes.”

This period in the 1990s is sometimes called the “Wild West Capitalism” era of China’s emergence. But recently the state has reasserted its grip on certain industries. Barry Naughton writes in 2017:

“The government controls at least 85 percent of banking sector assets; the entire telecommunications and transport network; and essentially all education and scientific and technological services. In addition, the Communist Party owns and controls virtually all public media. Small-scale and labor-intensive services, such as retail and restaurants, are of course predominantly private, but government ownership and control is evident in the more capital-intensive and the more human capital-intensive sectors.”

At the risk of grossly simplifying, China has gone from a totally state-controlled economy in the 1970s and prior, to a “Wild West Capitalist” economy in the 1990s, and now back to something approximating a state-controlled Socialist economy.

In a talk from 2015, economist Tyler Cowen gives his explanation for the specific economic activities that China pursued during its high growth era. According to Cowen, after Xiaoping’s reforms, China needed to play “catch up” with the rest of the developed world. They had a massive population, many of which were starting to build wealth for the first time due to Xiaoping’s market-based reforms, but the country itself lacked basic modern infrastructure— buildings, bridges, trains, hospitals, roads, etc.. Cowen generalizes the steps China followed to modernize the country:

“The way decision-making in China is set up, it’s very good at achieving things with a kind of checklist — known tasks that require a lot of resources and a lot of effort, and you throw everything you have at getting it done, and you get it done pretty quickly.”

China’s state-controlled economic system specializes in completing large-scale investment projects, where the market need is obvious. In comparison, the United States seems inept. Case and point being California’s insanely expensive high speed rail project which might never get done.

In April 2022, Pew Research found that Americans were evenly divided over who was the world’s economic super power, with 43% favoring China, and 43% favoring the United States. This is a sharp contrast from that same poll from 2020, when 32%— a full 11% fewer — of Americans favored China as the world’s leading economic superpower. Unsurprisingly, that same 2022 poll found that 45% younger Americans, aged 18 - 29, view China as the economic superpower, and just 37% view the United States that way.

I am not surprised that young people think China has replaced the United States as the world’s economic super power. China apparently has the ability to build high profile stuff in the physical world, and a recent track record of high GDP growth, both of which young Americans have never seen in their own country. It is also widely understood that China is explicitly anti-Capitalism and pro-Socialism. In 2013, Chinese President life Xi Jinping stated this in no uncertain terms.

“There are people who believe that communism is an unattainable hope, or even that it is beyond hoping for—that communism is an illusion. . . . Facts have repeatedly told us that Marx and Engels’s analysis of the basic contradictions in capitalist society is not outdated, nor is the historical-materialist view that capitalism is bound to die out and socialism is bound to win. This is an inevitable trend in social and historical development. But the road is tortuous. The eventual demise of capitalism and the ultimate victory of socialism will require a long historical process to reach completion.”

For young Americans, some of the most impressive economic achievements of their lifetime have been achieved by an openly Socialist state. It’s no wonder they question if it might be a better economic model.

Conclusion

It is completely possible that a free market economy is not the best way to organize society in order to achieve the satisfaction of the needs and wants of all members. But economics is uniquely handicapped by an inability to easily run the experiments that would be necessary to determine that. Instead, we have to rely on actual economies, organizes in actual countries, and can only evaluate the results years later.

Using this method of analysis, imperfect as it is, yields basically one conclusion— if the goal of an economy is the prosperity of as many people as possible, then free market Capitalism has no apparent competition. Even China’s recent success can’t refute this conclusion (at least not if you value human rights and pesonal freedom).

Despite the obvious historical success of Capitalism, support for Socialism is growing among younger Americans at the same time as support for Capitalism is waning. Logan and Warsh are correct that Capitalism needs a defense, and restating the first principles of that system is certainly valuable, but I think they’ll be more successful by recognizing that the first principles are not under direct intellectual attack– at least not among most young Americans. Capitalism is being besieged by the psychological power of negative economic stories, a systemic blindness to prosperity, and an envy of Chinese success.

Those are the culprits that must be confronted.