The Economic Ignorance of Trump and Sanders

By Jon Hartley & Glenn Hubbard

Monday, March 21, 2016

This month marks the 240th anniversary of the publication of Adam Smith’s The Wealth of Nations, the watershed rationale for a free-market economy. Today, in the 2016 U.S. presidential race, populist candidates including Donald Trump and self-described socialist Senator Bernie Sanders are running against many of the central tenets of Smith’s ideas — and with considerable popular success.

The Sanders and Trump platforms range from protectionist anti-trade measures to expanded entitlement spending. Such policies are more popular than in previous elections and in some cases even pushing other candidates, especially Hillary Clinton, to grudgingly endorse them. Yet centuries of economic research have demonstrated that on a host of issues, from trade to taxes, economic policy that fosters free markets is critical to economic growth.

Our presidential candidates in 2016 should remember that Adam Smith’s key insight was that individuals working in their own interests are led by “an invisible hand to serve public interest” and benefit the broader society. In particular, Republicans should be reminded of the domestic economic benefits of free trade, particularly those that would come from prospective trade agreements with European and Asian nations.

A recent study by scholars at the Peterson Institute for International Economics finds that a bilateral free-trade agreement with China would increase U.S. exports by almost $400 billion annually, increase U.S. national income by more than $100 billion annually, and add 1.7 million jobs to the U.S. economy over ten years. By contrast, Donald Trump’s proposal to exorbitantly raise tariffs on China ultimately would raise the prices of consumer goods for all Americans, raising the cost of living especially for the poor.

At the same time, Democrats should be reminded of the power of lowering tax burdens to help low-income individuals access opportunity and work. Under the adage that “a rising tide lifts all boats.” President John F. Kennedy championed across-the-board tax cuts and their distributional benefits. The Kennedy tax cuts, enacted under President Johnson in 1964, were followed by falling unemployment and the second longest period without recession in U.S. history.

Expansion of the earned-income tax credit (EITC), first introduced by President Gerald Ford in 1975, could help strengthen labor-force participation, which is still close to all-time lows and cannot be attributed entirely to the aging of the population, as participation levels for people of all ages are lower.

Similarly, lower corporate taxes could help stem the tide of tax inversions whereby companies reincorporate abroad through acquisition because of America’s high 35 percent corporate rate, currently the highest rate among member countries of the Organisation for Economic Co-operation and Development. Senator Sanders’s and Hillary Clinton’s likely failure to reduce the tax burden on corporations and individuals would continue to drive corporations out of the U.S. and reduce the number of private-sector jobs for all Americans, particularly the poor.

Then there are the fiscal lessons needed to assure our continued prosperity. They must be instilled in several 2016 candidates.

In new estimates, the Congressional Budget Office projects that if current laws remain in place, internal federal debt will reach 86 percent of GDP in ten years and 155 percent of GDP in 30 years. These figures are not far from the debt-to-GDP ratios of Italy and Spain.

Perennial deficit spending is the largest contributor to rising federal debt. Our government’s increasing the budget deficit to 2.9 percent of GDP in 2016 marks the first time that the deficit has risen in relation to the size of the economy since peaking at 9.8 percent of GDP in 2009. The CBO expects that, In the absence of a policy change, the government will reach a budget deficit of 5 percent of GDP in 2026, putting the country on an even more unsustainable fiscal path, an issue that our next president must address.

Populist candidates such as Sanders and Trump have rejected the need for entitlement reform, which the CBO projects will claim an increasingly higher share of national spending at the expense of other budget items, including education and infrastructure. Instead, the populist candidates are promoting even larger entitlement programs. They miss an important point: Their proposals would all eventually come back to haunt Americans in the form of higher taxation, and not just for wealthier individuals, given the sheer magnitude of their proposed expansion of government spending and the deficit.

The rise of populist candidates — Trump and Sanders, with Clinton increasingly tagging on — arguably mirrors the recent trends, in wealth and income inequality, documented by economists such as Thomas Piketty, who achieved international fame with his 2014 bestseller, Capital in the Twenty-First Century. However, there is growing evidence that trends in wealth inequality are in fact closely related to strict land-use regulations (zoning laws) and other elements of “crony capitalism.” Those are structural problems that can be corrected without having to raise taxes.

A look at trends in consumption shows that now is the greatest time in human history to be a consumer, given rapid advances in technology and declining consumption inequality, as demonstrated in recent research by Alan Auerbach and Kevin Hassett.

Even so, reducing poverty and restoring growth remain challenges for 21st-century America. Adam Smith’s key finding was that economic well-being for all citizens is highly dependent on their ability to enjoy economic incentives that are hindered by governments as little as possible. We believe that understanding is echoed in some of the free-market strategies outlined above and ignored by leading candidates.

While Adam Smith’s time was marked by great conflict and inequality, including the economic strife underlying the American Revolution and the French Revolution, this period also saw the birth of market economies, which played a leading part in quelling hostilities and providing the mass prosperity that Smith described.