The New Wealth of Nations
by Christopher DeMuth

The nations of North America, Western Europe, Australia, and Japan are wealthier today than they have ever been, wealthier than any others on the planet, wealthier by far than any societies in human history. Yet their governments appear to be impoverished – saddled with large accumulated debts and facing annual deficits that will grow explosively over the coming decades. As a result, government spending programs, especially the big social-insurance programs like Social Security and Medicare in the United States, are facing drastic cuts in order to avert looming insolvency (and, in France and some other European nations, in order to meet the Maastricht treaty’s criteria of fiscal rectitude).

American politics has been dominated for several years now by contentious negotiations over deficit reduction between the Clinton administration and the Republican Congress. This past June, first at the European Community summit in Amsterdam and then at the Group of Eight meeting in Denver, most of the talk was of hardship and constraint and the need for governmental austerity (‘Economic Unease Looms Over Talks at Denver Summit,’ read the New York Times headline).

These bloodless problems of governmental accounting are said, moreover, to reflect real social ills: growing economic inequality in the United States; high unemployment in Europe; an aging, burdensome, and medically needy population everywhere; and the globalization of commerce, which is destroying jobs and national autonomy and forcing bitter measures to keep up with the bruising demands of international competitiveness.

How can it be that societies so surpassingly wealthy have governments whose core domestic-welfare programs are on the verge of bankruptcy? The answer is as paradoxical as the question. We have become not only the richest but also the freest and most egalitarian societies that have ever existed, and it is our very wealth, freedom, and equality that are causing the welfare state to unravel.

Equal enjoyment

That we have become very rich is clear enough in the aggregate. That we have become very equal in the enjoyment of our riches is an idea strongly resisted by many. Certainly there has been a profusion of reports in the media and political speeches about increasing income inequality: the rich, it is said, are getting richer, the poor are getting poorer, and the middle and working classes are under the relentless pressure of disappearing jobs in manufacturing and middle management.

Although these claims have been greatly exaggerated, and some have been disproved by events, it is true that, by some measures, there has been a recent increase in income inequality in the United States. But it is a very small tick in the massive and unprecedented leveling of material circumstances that has been proceeding now for almost three centuries and in this century has accelerated dramatically. In fact, the much-noticed increase in measured-income inequality is in part a result of the increase in real social equality. Here are a few pieces of this important but neglected story.

First, progress in agriculture, construction, manufacturing, and other key sectors of economic production has made the material necessities of life – food, shelter, and clothing – available to essentially everyone. To be sure, many people, including the seriously handicapped and the mentally incompetent, remain dependent on the public purse for their necessities. And many people continue to live in terrible squalor. But the problem of poverty, defined as material scarcity, has been solved. If poverty today remains a serious problem, it is a problem of individual behavior, social organization, and public policy. This was not so 50 years ago, or ever before.

Second, progress in public health, in nutrition, and in the biological sciences and medical arts has produced dramatic improvements in longevity, health, and physical well-being. Many of these improvements – resulting, for example, from better public sanitation and water supplies, the conquest of dread diseases, and the abundance of nutritious food – have affected entire populations, producing an equalization of real personal welfare more powerful than any government redistribution of income.

The Nobel prize-winning economist Robert Fogel has focused on our improved mastery of the biological environment – leading over the past 300 years to a doubling of the average human life span and to large gains in physical stature, strength, and energy – as the key to what he calls ‘the egalitarian revolution of the 20th century’ (here and elsewhere I draw heavily on Fogel, forthcoming). He considers this so profound an advance as to constitute a distinct new level of human evolution. Gains in stature, health, and longevity are continuing today and even accelerating. Their outward effects may be observed, in evolutionary fast-forward, in the booming nations of Asia (where, for example, the physical difference between older and younger South Koreans is strikingly evident on the streets of Seoul).

Third, the critical source of social wealth has shifted over the last few hundred years from land (at the end of the 18th century) to physical capital (at the end of the 19th) to, today, human capital – education and cognitive ability. This development is not an unmixed gain from the standpoint of economic equality. The ability to acquire and deploy human capital is a function of intelligence, and intelligence is not only unequally distributed but also, to a significant degree, heritable. As Charles Murray and the late Richard J. Herrnstein argue in The Bell Curve, an economy that rewards sheer brainpower replaces one old source of inequality, socioeconomic advantage, with a new one, cognitive advantage.

But an economy that rewards human capital also tears down far more artificial barriers than it erects. For most people who inhabit the vast middle range of the bell curve, intelligence is much more equally distributed than land or physical capital ever was. Most people, that is, possess ample intelligence to pursue all but a handful of specialized callings. If in the past many were held back by lack of education and closed social institutions, the opportunities to use one’s human capital have blossomed with the advent of universal education and the erosion of social barriers.

Furthermore, the material benefits of the knowledge-based economy are by no means limited to those whom Murray and Herrnstein call the cognitive elite. Many of the newest industries, from fast food to finance to communications, have succeeded in part by opening up employment opportunities for those of modest ability and training – occupations much less arduous and physically much less risky than those they have replaced. And these new industries have created enormous, widely shared economic benefits in consumption; I will return to this subject below.

Fourth, recent decades have seen a dramatic reduction in one of the greatest historical sources of inequality: the social and economic inequality of the sexes. Today, younger cohorts of working men and women with comparable education and job tenure earn essentially the same incomes (Furchtgott-Roth and Stolba 1997). The popular view would have it that the entry of women into the workforce has been driven by falling male earnings and the need ‘to make ends meet’ in middle-class families. But the popular view is largely mistaken. Among married women (as the economist Chinhui Juhn has demonstrated), it is wives of men with high incomes who have been responsible for most of the recent growth in employment.

Fifth, in the wealthy Western democracies, material needs and desires have been so thoroughly fulfilled for so many people that, for the first time in history, we are seeing large-scale voluntary reductions in the amount of time spent at paid employment. This development manifests itself in different forms: longer periods of education and training for the young; earlier retirement despite longer life spans; and, in between, many more hours devoted to leisure, recreation, entertainment, family, community and religious activities, charitable and other nonremunerative pursuits, and so forth. The dramatic growth of the sports, entertainment, and travel industries captures only a small slice of what has happened. In Fogel’s estimation, the time devoted to nonwork activities by the average male head of household has grown from 10.5 hours per week in 1880 to 40 hours today, while time per week at work has fallen from 61.6 hours to 33.6 hours. Among women, the reduction in work (including not only outside employment but also household work, food preparation, childbearing and attendant health problems, and child rearing) and the growth in nonwork have been still greater.

There is a tendency to overlook these momentous developments because of the often frenetic pace of modern life. But our busy-ness actually demonstrates the point: time, and not material things, has become the scarce and valued commodity in modern society.

Social equality

One implication of these trends is that in very wealthy societies, income has become a less useful gauge of economic welfare and hence of economic equality. When income becomes to some degree discretionary, and when many peoples’ incomes change from year to year for reasons unrelated to their life circumstances, consumption becomes a better measure of material welfare. And by this measure, welfare appears much more evenly distributed: people of higher income spend progressively smaller shares on consumption, while in the bottom ranges, annual consumption often exceeds income. (In fact, government statistics suggest that in the bottom 20 percent of the income scale, average annual consumption is about twice annual income – probably a reflection of a substantial underreporting of earnings in this group.) According to the economist Daniel Slesnick, the distribution of consumption, unlike the distribution of reported income, has become measurably more equal in recent decades.

If we include leisure-time pursuits as a form of consumption, the distribution of material welfare appears flatter still. Many such activities, being informal by definition, are difficult to track, but Dora Costa of MIT has recently studied one measurable aspect – expenditures on recreation – and found that these have become strikingly more equal as people of lower income have increased the amount of time and money they devote to entertainment, reading, sports, and related enjoyments (National Bureau of Economic Research 1997).

Television, videocassettes, CDs and home computers have brought musical, theatrical and other entertainments (both high and low) to everyone, and have enormously narrowed the differences in cultural opportunities between wealthy urban centers and everywhere else. Formerly upper-crust sports like golf, tennis, skiing and boating have become mass pursuits (boosted by increased public spending on parks and other recreational facilities as well as on environmental quality), and health clubs and full-line book stores have become as plentiful as gas stations. As some of the best things in life become free or nearly so, the price of pursuing them becomes, to that extent, the ‘opportunity cost’ of time itself.

The substitution of leisure activities for income-producing work even appears to have become significant enough to be contributing to the recently much-lamented increase in inequality in measured income. In a new AEI study, Robert Haveman finds that most of the increase in earnings inequality among U.S. males since the mid-1970s can be attributed not to changing labor-market opportunities but to voluntary choice – to the free pursuit of nonwork activities at the expense of income-producing work.

Most of us can see this trend in our own families and communities. A major factor in income inequality in a wealthy knowledge economy is age – many people whose earnings put them at the top of the income curve in their late fifties were well down the curve in their twenties, when they were just getting out of school and beginning their working careers. Fogel again:

That more young people are spending more time in college or graduate school, taking time off for travel and ‘finding themselves,’ and pursuing interesting but low- or non-paying jobs or apprenticeships before knuckling down to lifelong careers is a significant factor in ‘income inequality’ measured in the aggregate. But this form of economic inequality is in fact the social equality of the modern age. It is progress, not regress, to be cherished and celebrated, not feared and fretted over.

The welfare state

Which brings me back to my contention that it is our very wealth and equality that are the undoing of the welfare state. Western government today largely consists of two functions. One is income transfers from the wages of those who are working to those who are not working: mainly social-security payments to older people who have chosen to retire rather than go on working and education subsidies for younger people who have chosen to extend their schooling before beginning work. The other is direct and indirect expenditures on medical care, also financed by levies on the wages of those who are working.1 It is precisely these aspects of life – nonwork and expenditures on medical care and physical well-being – that are the booming sectors of modern, wealthy, technologically advanced society.

When the Social Security program began in America in the 1930’s, retirement was still a novel idea: most men worked until they dropped, and they dropped much earlier than they do today. Even in the face of our approaching demographic crunch, produced by the baby boom followed by the baby bust, we could solve the financial problems of the Social Security program in a flash by returning to the days when people worked longer and died younger. Similarly, a world without elaborate diagnostic techniques, replaceable body parts, and potent pharmaceutical and other means of curing or ameliorating disease – a world where medical care consisted largely of bed rest and hand-holding – would present scant fiscal challenge to government as a provider of health insurance.

Our big government-entitlement programs truly are, as conservatives like to call them, obsolete. They are obsolete not because they were terrible ideas to begin with, though some of them were, but because of the astounding growth in social wealth and equality and because of the technological and economic developments which have propelled that growth. When Social Security was introduced, not only was retirement a tiny part of most people’s lives but people of modest means had limited ability to save and invest for the future. Today, anyone can mail off a few hundred dollars to a good mutual fund and hire the best investment management American finance has to offer.

In these circumstances it is preposterous to argue, as President Clinton has done, that privatizing Social Security (replacing the current system of income transfers from workers to retirees with one of individually invested retirement savings) would be good for Warren Buffett but bad for the little guy. Private savings – through pension plans, mutual funds, and personal investments in housing and other durables – are already a larger source of retirement income than Social Security transfers. Moreover, although there is much talk nowadays about the riskiness of tying retirement income to the performance of financial markets, the social developments I have described suggest that the greater risk lies in the opposite direction. The current Social Security program ties retirement income to the growth of wage earners’ payrolls; that growth is bound to be less than the growth of the economy as a whole, as reflected in the financial markets.

Similarly, Medicare is today a backwater of old-fashioned fee-for-service medicine, hopelessly distorted by a profusion of inefficient and self-defeating price-and-service controls. Over the past dozen years, a revolution has been carried out in the private financing and organization of medical care. The changes have not been unmixed blessings; nor could they be, so long as the tax code encourages people to overinsure for routine medical care. Yet substantial improvements in cost control and quality of service are now evident throughout the health-care sector – except under Medicare. These innovations have not been greeted by riots or strikes at the thousands of private organizations that have introduced them. Nor will there be riots in the streets if, in place of the lame-brained proposals for Medicare ‘spending cuts’ and still more ineffective price controls currently in fashion in Washington, similar market-based innovations are introduced to Medicare.

Prospects for reform

In sum, George Bush’s famous statement in his inaugural address that ‘we have more will than wallet’ was exactly backward. Our wallets are bulging; the problems we face are increasingly problems not of necessity, but of will. The political class in Washington is still marching to the tune of economic redistribution and, to a degree, ‘class warfare.’ But Washington is a lagging indicator of social change. In time, the progress of technology and the growth of private markets and private wealth will generate the political will to transform radically the redistributive welfare state we have inherited from an earlier and more socially balkanized age.

There are signs, indeed, that the Progressive-era and New Deal programs of social insurance, economic regulation, and subsidies and protections for farming, banking, labor organization, and other activities are already crumbling, with salutary effects along every point of the
economic spectrum. Anyone who has been a business traveler since the late 1970’s, for example, has seen firsthand how deregulation has democratized air travel. Low fares and mass marketing have brought such luxuries as foreign travel, weekend getaways to remote locales, and reunions of far-flung families – just twenty years ago, pursuits of the wealthy – to people of relatively modest means. Coming reforms, including the privatization of Social Security and, most of all, the dismantling of the public-school monopoly in elementary and secondary education, will similarly benefit the less well-off disproportionately, providing them with opportunities enjoyed today primarily by those with high incomes.

I venture a prediction: just as airline deregulation was championed by Edward Kennedy and Jimmy Carter before Ronald Reagan finished the job, so the coming reforms will be a bipartisan enterprise. When the political class catches on (as Prime Minister Tony Blair has already done in England), the Left will compete vigorously and often successfully with the Right for the allegiance of the vast new privileged middle class. This may sound implausible at a moment when the Clinton administration has become an energetic agent of traditional unionism and has secured the enactment of several new redistributive tax provisions and spending programs. But the watershed event of the Clinton years will almost certainly be seen to be not any of these things but rather the defeat of the President’s national health-insurance plan in the face of widespread popular opposition.

The lesson of that episode is that Americans no longer wish to have the things they care about socialized. What has traditionally attracted voters to government as a provider of insurance and other services is not that government does the job better or more efficiently or at a lower cost than private markets; it is the prospect of securing those services through taxes paid by others. That is why today’s advocates of expanding the welfare state are still trying to convince voters to think of themselves as members of distinct groups that are net beneficiaries of government: students, teachers, women, racial minorities, union members, struggling young families, retirees, and so forth. But as the material circumstances of the majority become more equal, and as the proficiency and social reach of private markets increasingly outstrip what government can provide, the possibilities for effective redistribution diminish. The members of an egalitarian, middle-class electorate cannot improve their lot by subsidizing one another, and they know it.

With the prospects dimming for further, broad-based socialization along the lines of the Clinton health-care plan, the private supply of important social services will continue to exist and, in general, to flourish alongside government programs. Defenders of the welfare state will thus likely be reduced to asserting that private markets and personal choice may be fine for the well-off, but government services are more appropriate for those of modest means. This is the essence of President Clinton’s objection to privatizing Social Security and of the arguments against school choice for parents of students in public elementary and high schools. But ‘capitalism for the rich, socialism for the poor’ is a highly unpromising banner for liberals to be marching under in an era in which capitalism has itself become a profound egalitarian force.

The new battlegrounds

Where, then, will the battlegrounds be for the political allegiance of the new middle class? Increasingly, that allegiance will turn on policies involving little or no redistributive cachet but rather society-wide benefits in the form of personal amenity, autonomy, and safety: environmental quality and parks, medical and other scientific research, transportation and communications infrastructure, defense against terrorism, and the like.

The old welfare-state debates between Left and Right will be transformed into debates over piecemeal incursions into private markets that compete with or replace government services. Should private insurers be required to cover annual mammograms for women in their forties? Should retirement accounts be permitted to invest in tobacco companies? Should parents be permitted to use vouchers to send their children to religious schools? Thus transformed, these debates, too, will tend to turn on considerations of general social advantage rather than on the considerations of social justice and economic desert that animated the growth of the welfare state.

Political allegiance will also turn increasingly on issues that are entirely nonmaterial. I recently bumped into a colleague, a noted political analyst, just after I had read the morning papers, and asked him to confirm my impression that at least half the major political stories of the past few years had something to do with sex. He smiled and replied, ‘Peace and prosperity.’

What my colleague may have had in mind is that grave crises make all other issues secondary: President Roosevelt’s private life received less scrutiny than has President Clinton’s, and General Eisenhower’s private life received less scrutiny than did that of General Ralston (whose nomination to become chairman of the Joint Chiefs of Staff was torpedoed by allegations of an extramarital affair). There is, however, another, deeper truth in his observation. The stupendous wealth, technological mastery, and autonomy of modern life have freed man not just for worthy, admirable, and self-improving pursuits but also for idleness and unworthy and self-destructive pursuits that are no less a part of his nature.

And so we live in an age of astounding rates of divorce and family break-up, of illegitimacy, of single teenage motherhood, of drug use and crime, of violent and degrading popular entertainments, and of the ‘culture of narcissism’ – and also in an age of vibrant religiosity, of elite universities where madrigal singing and ballroom dancing are all the rage and rampant student careerism is a major faculty concern, and of the Promise Keepers, over a million men of all incomes and races who have packed sports stadiums around the United States to declare their determination to be better husbands, fathers, citizens, and Christians. Ours is an age in which obesity has become a serious public-health problem – and in which dieting, fitness, environmentalism, and self-improvement have become major industries.

It is true, of course, that the heartening developments are in part responses to the disheartening ones. But it is also true that both are the results of the economic trends I have described here. In a society as rich and therefore as free as ours has become, the big question, in our personal lives and also in our politics, is: what is our freedom for?

References

Fogel, R. forthcoming, The Fourth Great Awakening: The Political Realignment of the 1990s and the Future of Egalitarianism, University of Chicago Press, Chicago.

Furchtgott-Roth, D. and C. Stolba 1997, Women’s Figures: The Economic Progress of Women in America, Independent Women’s Forum and American Enterprise Institute, Washington D.C.

National Bureau of Economic Research 1997, Less of a Luxury: The Rise of Recreation since 1888, Working Paper 6054, June.

The New Wealth of Nations: Australian Postscript
Charles Richardson

America is in something of a triumphalist mood lately. East Asia may be in crisis, the European economies are sluggish, the third world is still languishing, but the U.S. economy goes from strength to strength. Other social indicators are following suit; its cities are cleaner and safer, and its people more optimistic, than they have been for many years. In a recent editorial, the New Republic boasts (somewhat improbably) that ‘Now Los Angeles has fewer burglaries than Sydney, Australia.’

If Chris DeMuth were merely expressing this triumphalism, his words would be interesting but hardly worth repeating here. He clearly believes, though, that his message is broader than that: he is speaking to ‘the wealthy Western democracies’ as a whole. Their prosperity, he says, is unprecedented, and is revolutionary in its implications. Most of our social problems are the result of that prosperity, and the process of coming to terms with it will make big changes in our politics before it is through.

So does Australia fit the bill? As far as economics are concerned, DeMuth’s message certainly rings true. Our anxieties seem out of all proportion to our economic problems. The signs of long-term prosperity are there in our increased consumption of leisure and education, shorter working hours and greater equality of the sexes. So too the media’s concentration on trivia (travel rorts, Cheryl Kernot’s love life) in the absence of more serious issues.

As compared with the U.S., our clearest economic failing is unemployment. Our antiquated industrial relations system has delivered us an unemployment rate almost twice the American. But even there, the terms of the debate have shifted considerably. It is not so very long ago that even economics teachers ridiculed the idea that excessive wage rates had something to do with unemployment. Now, particularly with the example of New Zealand so close at hand, there is a growing recognition that unemployment is a matter of social choice: it is the price that we pay for our rigid wage system and generous unemployment benefits.

DeMuth tells us that our main problems are political, not economic; that our institutions have not yet adjusted to the conditions of prosperity, and that when they do, the parties of the left will probably take the lead in reform. Australia, if anything, is further down that track than the United States. The Hawke and Keating governments boldly started the privatisation of old-age pensions that America is still contemplating. Our health care system has its own major structural problems, but it has at least avoided the taxpayer subsidy of private insurance that has pushed their system out of control. Our funding of primary and secondary education is already halfway to a ‘voucher’ system – and, not coincidentally, our schools are greatly more successful at their task than America’s.

In short, our ‘welfare’ sector, while hardly the envy of the world, is in better shape than we usually admit. It would be in better shape still if it confined itself to a genuine welfare role – that is, to looking after those at the lower end of the income scale, instead of paying bonuses to the middle class and the wealthy. This is the unspoken reality of the ballooning transfer payments here and in other western countries: they have very little to do with the relief of poverty, and much to do with the already well-off transferring money to themselves.

Australia has also maintained a more egalitarian distribution of wealth than the United States, but we can still take to heart DeMuth’s warning of how misleading such statistics can be. The big story is the long-term trend away from a distribution based on inherited wealth and power. Even within a single country, the distribution of natural ability and application (and luck, a factor he omits) is much more equal than the distribution of inherited property. Looking at the world as a whole the difference is even more striking, and the extension of economic opportunity to the millions in the third world is one of the big results of globalisation just starting to emerge.

DeMuth mentions the word only in passing, but the fact of globalisation underlies much of his argument. No economy is big enough to remain prosperous in isolation. The breakup of empires and the advance of technology are bringing new markets, new suppliers and new competitors on stream all the time. Expanding horizons mean expanding insecurity; new choices can be new sources of anxiety, and each new way to succeed in business (such as electronic commerce) is also a new way to fail.

Most of all, globalisation contributes to the powerlessness of governments and the obsolescence of the old policies of statism. Dr Mahathir can rail all he likes against Jews and currency speculators, but he cannot exclude their influence without shutting down much of his economy. From the statist point of view, things can only get worse: greater mobility of labor and capital means a vanishing tax base, inability to control currency and investment flows, and fresh tides of new ideas and information that will force reluctant governments to liberalise or be destroyed.

None of this means subscribing to a crude economic determinism. The triumph of technology and globalisation is not inevitable, and we should not underestimate the threat that politics could pose. The last sustained period of globalisation, around the turn of the century, was stopped in its tracks by World War I; international trade has only recently returned to similar levels. Protectionism, nativism and populism are powerful forces, both in Australia and elsewhere, and governments may well be tempted to try the Luddite road.

While prosperity is clearly fuelling the push towards political change, it is not so clear that all of our problems can be traced to prosperity. A better description might be that our wealth and our problems are both effects of individual freedom. Established power structures have broken down, and individuals have been set free to use their creative power. The cultural anarchy of California turned out to be a better motor for progress than the rigid discipline of the ‘Asian values’ school. But people do lack moral signposts: the old authoritarian moral codes are dead, and it will take time to build up a new one. The doomsayers may be wrong about the big picture, but we cannot dismiss all of their complaints as unfounded.

Even at the best of times, the uses to which people put their freedom are not always attractive. The richness of diversity cannot be had without the price of tolerating things that we may not like. As James Q. Wilson said in last year’s John Bonython lecture, the free market ‘is human nature revealing itself, and human nature is a mixed bag ... What you see is what you get.’

Christopher C. DeMuth is president of the American Enterprise Institute for Public Policy Research. This address was published in the October 1997 issue of Commentary; reprinted by permission of the author.

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