Commentary: A Helping Hand, Not Just An Invisible Hand

For capitalism to prevail, the widening gap between rich and poor must be addressed

Thirty-five years ago, University of Chicago economist Milton Friedman wrote Capitalism & Freedom, a spirited defense of free markets and small government. In the years since, the book became a manifesto for unchaining economies. New generations of economists, at Chicago and elsewhere, embraced its tenets as they fashioned groundbreaking theories to explain human behavior or how financial markets work. Free trade, fiscal discipline, deregulation, and competition became the watchwords of executives and conservative politicians in the U.S. A new orthodoxy--actually a late 20th century brand of an orthodoxy first set forth by Adam Smith--took root in boardrooms across America. The planned economies of the Soviet Union and Eastern Europe collapsed, and new governments unleashed a brash capitalism on their citizens. Emerging nations just entering the global marketplace became fresh converts to the belief that "free is good"--free markets, free trade, free competition, and the free flow of technology and ideas--even if, often, these nations were hardly free politically.

COUNTERREVOLUTION. For every revolution, though, there is a counterrevolution. In books and articles, journalists and economists are warning about the limits and failures of global free markets and suggesting new interventions by government to reverse these bad effects. No less an anticommunist than George Soros, the Hungarian-born investor who gave millions to support democracy in Eastern Europe, has sounded the alarm in the February issue of the Atlantic Monthly. His worry: Unbridled self-interest and laissez-faire policies may destroy capitalism from within.

So who's right? Are free markets an unalloyed good? Or do they do irreparable harm? As with all competing brands of faith, the truth lies somewhere between the two poles. "Perhaps we should be saying: `Free is good--but read the fine print,"' observes Claudia D. Goldin, an economic historian with Harvard University.

Free-market policies have enhanced growth around the world. But there have been losses, too, the most notable for individuals and groups of individuals who, by reason of personal history, educational attainment, or skill, have slipped down the economic ladder even as others have climbed to new heights. Friedman believes this is a temporary consequence of economic dynamism, and he has always stressed that free markets don't guarantee equal outcomes. But in a politically free society in which cultural norms and moral values still have power, the persistence and worsening of unequal outcomes is troubling. If free-market capitalism is to prevail, free-market apostles must allow these issues to be addressed.

Worsening income inequality in the U.S. is not a new story. A vast literature in the economics profession has documented the widening gap between income returns to high school graduates and income returns to college graduates, as well as the noteworthy disparity within groups. In 1980, the median male college graduate earned about one-third more than the median male high school graduate, but by 1993, the premium had grown to more than 70%. College grads lost just a bit of their lead in 1995, the last year for which data are available. But cyclical improvement cannot undo the long-term trend that is driving a wedge between the better-educated and less-educated in America.

While the trend is not new, the struggle to assign blame for it continues apace. In his just-published book Has Globalization Gone Too Far?, economist Dani Rodrik of the John F. Kennedy School of Government at Harvard University suggests that globalization has been a bigger factor in explaining the wage gap than the consensus of economists believes. Most estimates say that trade explains only 10% to 20% of the wage gap. But it's important to look beyond direct import competition to see the broader effects that globalization can have, Rodrik observes.

Wage bargaining, for instance, is likely to be strongly affected by managers' predilection to cite international competition as a reason to keep costs low. Over time, this erodes union power. Corporations, meanwhile, flit from country to country, often depriving their home country of tax revenues--revenues that might help finance social safety nets. Now, says Rodrik, governments are forced to curtail social insurance at precisely the time when markets are becoming more and more open to harsh global competition.

Compelling arguments are mustered in support of the view that technology is the key factor responsible for the wage gap. In a new study, David H. Autor and Lawrence F. Katz of Harvard University and Alan B. Krueger of Princeton University find that 30% to 50% of the increase in the relative demand for more-skilled workers over the past 25 years can be explained by the spread of computer technology. The diffusion of this technology has occurred in every industry, and the rising demand for skilled workers and the increasing returns to education occurred across industries as well. Eli Berman at Boston University finds the phenomenon of skills-biased technological change to be pervasive across the developed world. And even in some developing countries, such as Mexico, where theory suggests that low-wage workers would benefit from increased trade, similar wage gaps between skilled and nonskilled workers have appeared.

Open borders have allowed goods, capital, ideas, and technology to move at will, while labor, by its very nature, has remained a relatively stationary item subject to the vicissitudes of the global marketplace. Free markets are the vehicle, the apparatus, by which these changes are playing out. There is no chance, even most critics of free markets concede, of rolling back the clock and imposing protectionist or other restrictive measures. Nor should there be a desire to do so, given the great gains that have been won--and may yet be won--through globalization and technological breakthroughs. But it's not unreasonable to look for ways to enable more people to share in the gains.

"There shouldn't be anything inherently blocking the addressing of these issues," says former Senator Bill Bradley. "Markets are efficient and don't pretend to be equitable." In fact, in the U.S., the labor market itself is responding to the changes that have occurred over the past two decades as more people head for college to obtain the credential that will reward them financially. When the supply of college grads swells and the supply of less educated workers shrinks, there might be some improvement in relative wages for the less skilled. Similarly, the Clinton Administration is focusing on education--though Bradley and others caution that new proposals such as a subsidy to pay for community college will merely jack up the price of the two-year programs rather than broaden access.

MISSING THE MARK. But these responses in the marketplace and by government may not sufficiently ameliorate inequalities. What's more, the strong polarities that remain between free-market theorists and their dissenters suggest that current remedies for both free-market excesses and government ineptitude may be missing the mark. It's time to look at how these two dominant sectors affect the third vitally important sector known as the community, or civil society. Historically, civil society has developed independently of both the market and government. But there are bonds and linkages that develop over time, and corporate actions and government policies can easily affect the health and welfare of communities.

It's one thing for a company to meet global competition by shedding some low-wage workers and reallocating resources toward computers and high-skilled workers. It's quite another thing for a company that's a major employer in a community to pull out, lock, stock, and barrel, and relocate overseas. That employer does have an obligation to the community it has left in the lurch. And if localities are going to trip over each other to offer tax breaks and other giveaways to companies to set up shop, they ought to demand a hefty quid pro quo in the form of job guarantees from the companies to the community.

Similarly, it may be true that government hasn't spent money well in its assistance programs, and that the poor should move off welfare and into work. But just how will that be accomplished? Recent studies show that for many single mothers, the biggest obstacle to obtaining work isn't lack of education or even lack of job opportunities. It is, rather, an overriding concern for the well-being of their children in dangerous neighborhoods that keeps them at home. Government monies haven't improved those neighborhoods, and their absence likely won't either. A different solution might be: directing funds to help families move out of crime-ridden public housing and into communities where they can feel more secure about their families, more socially engaged, and thus better able to leave home and go to work. The government's Moving To Opportunity program, funded after the Los Angeles riots, is beginning to do just that.

CONVENIENCE? Recent work in academia suggests that community and civil society have an important role to play in promoting economic growth. The political scientist Robert D. Putnam, in his 1993 book Making Democracy Work, studied variations in civic traditions in modern Italy and their correlation with regional success. More recently, Putnam and economist John F. Helliwell of the University of British Columbia in Vancouver concluded that, holding initial income constant, regions of Italy with a more developed "civic community"--as measured by a composite index of voter turnout, newspaper readership, and density of sports and cultural associations--had higher growth rates from 1950 to 1990.

Increasingly, both conservatives and liberals recognize that civil society can and should play a beneficial role in the economy. For political conservatives, it may be a convenience to suggest that neighborhoods and communities can pick up where government leaves off. And for liberals, the impulse to promote community values comes as a response to a perceived national obsession with individual self-interest. But whatever the reasons, the new interest in the economic role of social groups, neighborhoods, and communities promises to alter the terms of a tired debate between the relative merits of government and free markets.

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