How a Great Power Falls Apart
Decline Is Invisible From the Inside
It has almost become the new Washington consensus: decades of growing economic openness have hurt American workers, increased inequality, and gutted the middle class, and new restrictions on trade and immigration can work to reverse the damage. This view is a near reversal of the bipartisan consensus in favor of openness to the world that defined U.S. economic policy for decades. From the end of World War II on, under both Democratic and Republican control, Congress and the White House consistently favored free trade and relatively unrestrictive immigration policies. Candidates would make protectionist noises to appease various constituencies from time to time, but by and large, such rhetoric was confined to the margins. Almost never did it translate into actual policy.
Then came the 2016 presidential election. Donald Trump found a wide audience when he identified the chief enemy of the American worker as foreigners: trading partners that had struck disastrous trade agreements with Washington and immigrants who were taking jobs from native-born Americans. Everyday workers, Trump alleged, had been let down by a political class beholden to globalist economic ideas. In office, he has followed through on his nationalist agenda, withdrawing the United States from the Trans-Pacific Partnership (TPP) and routinely levying higher tariffs on trading partners. On immigration, he has implemented draconian policies against asylum seekers at the border and undocumented immigrants within the United States, as well as reducing quotas for legal immigrants and slowing down the processing of their applications.
But Trump has not been alone in his battle against economic openness. During the 2016 campaign, he was joined in his calls for protectionism by the Democratic primary candidate Bernie Sanders, who also blamed bad trade agreements for the plight of the American worker. Even the Democratic nominee, Hillary Clinton, who as secretary of state had championed the TPP, was forced by political necessity to abandon her earlier support for the agreement. Democrats have not, fortunately, mimicked Trump’s anti-immigrant rhetoric, but when it comes to free trade, their support has often been lukewarm at best. While some Democrats have criticized Trump’s counterproductive tariffs and disruptive trade wars, many of them hesitate when asked if they would repudiate the administration’s trade policies, especially with respect to China. The political winds have shifted; now, it seems as if those who purport to sympathize with workers and stand up for the middle class must also question the merits of economic openness.
Trade, not tariffs, will improve the plight of regular Americans.
American workers have indeed been left behind, but open economic policies remain in their best interest: by reducing prices for consumers and companies, free trade helps workers more than it hurts them, and by creating jobs, offering complementary skills, and paying taxes, so do immigrants. Instead of hawking discredited nationalist economic ideas, politicians seeking to improve Americans’ economic lot—especially progressives focused on reducing inequality and rebuilding the middle class—should be looking to domestic policy to address workers’ needs, while also improving trade agreements and increasing immigration. That, not tariffs and walls, is what it will take to improve the plight of regular Americans.
Forty years of widening inequality and slow wage growth have left many Americans searching for answers. It may be tempting, then, to blame the United States’ trading partners, many of which have experienced remarkable jumps in GDP and wages. China, perhaps the most spectacular example, saw its GDP per capita expand more than 22-fold from 1980 to 2018—in terms of 2010 U.S. dollars, from $350 to $7,750. Yet during the same period, U.S. GDP per capita grew from $28,600 to $54,500. That’s less in relative terms—advanced economies usually grow more slowly than poor ones—but far more in absolute terms, and enough to significantly boost standards of living.
The problem, however, is that the gains have not been evenly shared. Adjusted for inflation, the average income of the bottom 50 percent of earners stayed nearly flat between 1980 and 2014. For those in the 50th to 90th percentiles, it grew by about 40 percent, lagging far behind expectations based on the experience of prior generations. Among the top one percent, meanwhile, average income has skyrocketed, ballooning by 205 percent over the same period. No wonder so many Americans are disappointed. The U.S. economy has failed to achieve its most basic aim: generating inclusive growth.
Trade does deserve some of the blame. When the United States buys goods from labor-abundant countries such as China and India, the demand for domestic labor falls. This appears to be what happened after the big surge in Chinese imports to the United States in the early years of this century. In a series of oft-cited research papers about “the China shock,” the economists David Autor, David Dorn, and Gordon Hanson estimated that trade with China may have displaced the jobs of one million to two million Americans during this period. But it’s important to keep those numbers in perspective. The U.S. economy is a dynamic place, with more than six million jobs lost and created every single quarter. Moreover, the share of Americans working in manufacturing has been declining steadily since 1950, even as growth in trade has waxed and waned—suggesting that factors other than trade are also at play.
The U.S. economy has failed to achieve its most basic aim: generating inclusive growth.
Indeed, the U.S. economy has experienced other huge changes. Workers have lost bargaining power as unionization has declined (from 30 percent of the labor force in 1960 to less than 11 percent today) and large companies have steadily increased their market power (corporate profits as a share of GDP are 50 percent higher than they were in prior decades). Perhaps most important, technology has disrupted countless industries and lowered the demand for less educated labor. Most economists believe that technological change is a far more important factor than international trade in explaining the disappointing outcomes in American labor markets. Across all industries, the returns to education have increased, as less educated workers are disproportionately displaced by automation and computerization. And although manufacturing output continues to rise, manufacturing employment has fallen, as capital takes the place of labor and workers steadily move into the service industry. Yet in spite of all this evidence about the effects of technological change, politicians still point fingers at foreigners.
Critics of trade on both the left and the right contend that much of the problem has to do with bad trade deals that Washington has struck. On the left, the concern is that trade agreements have prioritized the interests of corporations over those of workers. On the right, it is that trade agreements have focused on the goal of international cooperation at the expense of U.S. interests. Trump has argued that U.S. trade deals have been tilted against the United States, contributing to the large trade deficit (meaning that the country imports more than it exports) and hollowing out the manufacturing sector. Sanders has echoed these concerns in the past, for example, claiming that the North American Free Trade Agreement (NAFTA) cost 43,000 jobs in Michigan and is behind Detroit’s urban decline.
But just as trade in general is not to blame for the woes of the American worker, neither are the specifics of individual trade deals. In fact, the terms of trade agreements are typically highly favorable to the United States. That’s because such deals usually require U.S. trading partners to lower their trade barriers far more than the United States must, since Washington tends to start off with much lower trade barriers. Such was certainly the case with Mexico, which, prior to NAFTA, had tariffs that averaged ten percent, compared with U.S. tariffs that averaged two percent.
This is not to say that trade agreements cannot be improved; useful tweaks could counter the excessive prioritization of intellectual property and reduce the reach of the mechanism by which investors and states resolve disputes, which critics allege gives companies too much power to fight health and environmental regulations. The TPP attempted to modernize NAFTA by placing a greater emphasis on the rights of workers and protecting the environment, and future agreements could go even further.
That said, it is easy to overstate the stakes here. Even ideal trade agreements would do little to address economic inequality and wage stagnation, because trade agreements themselves have little to do with those problems. Compared with other factors—the growth of trade in general, technological change, the decline of unionization, and so on—the details of trade agreements are nearly inconsequential. In fact, in the late 1990s, just after the adoption of NAFTA, the United States saw some of the strongest wage growth in four decades. As studies by researchers at the Congressional Research Service and the Peterson Institute for International Economics have shown, any disruption to the labor market caused by NAFTA was dwarfed by other considerations, especially technological change. And even when trade has cost jobs, as with the China shock, the effect did not depend on the particulars of any trade deal. There was and is no U.S. trade agreement with China, just the “most favored nation” status the country was granted when it joined the World Trade Organization in 2001—a status that it would have been hard to deny China, given the country’s massive and growing economy. What really mattered was the mere fact of China’s emergence as an economic powerhouse.
Critics of trade are also dead wrong when they argue that U.S. agreements have expanded the trade deficit. In fact, it’s the result of borrowing. As economists have long understood, trade deficits emerge whenever a country spends more than it earns, and trade surpluses arise whenever a country earns more than it spends. Trade deficits and surpluses are simply the flip side of international borrowing and lending. Some countries, such as the United States, are borrowers. They consume more of others’ goods than they send abroad, and they pay the difference in IOUs (which take the form of foreign investment in U.S. stocks, bonds, and real estate). Other countries, such as Germany, are lenders. They loan money abroad, accruing foreign assets, but receive less in imports than they send in exports. Which country is getting the better end of the deal? It is hard to say. U.S. households enjoy consuming more now, but they will eventually have to repay the debt; German households get returns on their investments abroad, but they forgo consumption in the present.
What this means is that if policymakers wish to reduce the U.S. trade deficit—and for now, it is not alarmingly large—they should reduce borrowing, which they can accomplish by shrinking the budget deficit. Instead, policymakers are moving in the opposite direction: the budget deficit has swelled in recent years, especially after the 2017 tax cuts. The new U.S. tariffs, meanwhile, have done nothing to improve the trade deficit. That came as no surprise to economists.
As easily debunked as these myths about trade are, they clearly have a powerful hold on policymakers. That is troubling not merely for what it reflects about the state of public discourse; it also has profound real-world implications. As they lambast trade, politicians are increasingly reaching for protectionist policies. Yet for American workers, such measures only add insult to injury, making their lives even more precarious. They do so in four distinct ways.
First and foremost, tariffs act as regressive taxes on consumption. Although the Trump administration likes to claim that foreigners pay the price of tariffs, in truth, the costs are passed along to consumers, who must pay more for the imports they buy. (By this past spring, the cost of the trade war that began in 2018 exceeded $400 per year for the average U.S. household.) Beyond that, tariffs fall disproportionately on the poor, both because the poor consume more of their income and because a higher share of their spending goes to heavily tariffed products, such as food and clothing. That is one reason why progressives in the early twentieth century, outraged by the inequality of the Gilded Age, pushed for moving away from tariffs and toward a federal income tax: it was widely recognized that tariffs largely spared the rich at the expense of the poor. Now, the reverse is happening. After having championed tax cuts that disproportionately benefited well-off Americans, the administration has tried to collect more revenue from regressive taxes on trade.
Second, tariffs and trade wars wreak havoc in U.S. labor markets by raising costs for American companies. Many large U.S. manufacturers are heavily dependent on imports. Boeing is a top U.S. exporter, but it is also a major importer, relying on crucial parts from around the world. General Motors now pays over $1 billion in annual tariffs, no doubt one factor behind the company’s recent decision to shutter a plant in Ohio. When tariffs interrupt global supply chains, they disadvantage U.S. companies relative to foreign ones. If the goal is to make the United States a more internationally competitive place to locate jobs and direct investment, protectionism is a completely backward approach.
Tariffs and trade wars wreak havoc in U.S. labor markets by raising costs for American companies.
Third, trading partners do not sit on their hands when Washington raises tariffs on their products. Already, the Chinese, the Indians, and the Europeans have slapped serious retaliatory tariffs on U.S. goods. The victims of these measures include soybean farmers in Iowa and Minnesota (who have lost market share to Canada as Chinese buyers look elsewhere) and whiskey distillers in Kentucky and Tennessee (who have seen their exports to Europe and elsewhere plummet).
Finally, trade wars harm the global economy and U.S. trading partners, weakening Washington’s network of alliances and jeopardizing the cooperation required to deal with pressing international problems. Recent meetings of the G-7 and the G-20 have been dominated by discussions aimed at diffusing trade conflicts, distracting precious diplomatic attention from climate change and nuclear nonproliferation. It is easy to take peace and international cooperation for granted, but they are prerequisites for the success of the U.S. economy in the decades ahead. The world is witnessing another rise in economic nationalism, which makes it easy for politicians and publics to embrace nationalist tendencies in other spheres. It is worth remembering that after the last era of globalization came to a halt, what followed was the Great Depression and World War II.
Protectionism is harmful for most American workers, but even more destructive are policies that make the United States less welcoming to immigrants. Setting aside the Trump administration’s actions against refugees and the undocumented—a serious moral stain on the country—its efforts to limit immigration are also economically harmful.
Immigration has long been an enormous boon for the U.S. economy. Study after study has shown that it is good for economic growth, innovation, entrepreneurship, and job creation and that almost all economic classes within the United States benefit from it. Even though only 14 percent of the current U.S. population is foreign-born, immigrants create a disproportionate number of businesses. Fifty-five percent of the United States’ $1 billion startups were founded or co-founded by immigrants, and more than 40 percent of the Fortune 500 companies were founded or co-founded by immigrants or their children. In recent decades, immigrants have accounted for more than 50 percent of the U.S.-affiliated academics who have won Nobel Prizes in scientific fields.
Immigrants also provide countless skills that complement those of native-born American workers. Highly educated foreigners with technological skills (such as computer programmers) make up for persistent shortages in the U.S. high-tech sector, and they complement native-born workers who have more cultural fluency or communication skills. Less skilled immigrants also fill labor shortages in areas such as agriculture and eldercare, where it is often difficult to find native-born workers willing to take jobs.
Immigration has long been an enormous boon for the U.S. economy.
There is little evidence that immigration lowers the wages of most native-born workers, although there is some limited evidence that it may cut into the wages or hours of two groups: high school dropouts and prior waves of immigrants. In the case of high school dropouts, however, there are far better ways to help them (such as strengthening the educational system) than restricting immigration. As for prior waves of immigrants, given how substantial their economic gains from migration are—often, they earn large multiples of what they would have made back home—it’s hard to justify their subsequent slower wage growth as a policy concern.
Immigrants have another economic benefit: they relieve demographic pressures on public budgets. In many rich countries, population growth has slowed to such an extent that the government’s fiscal burden of caring for the elderly is enormous. In Japan, there are eight retired people for every ten workers; in Italy, there are five retirees for every ten workers. In the United States and Canada, although the budget pressures of an aging population remain, higher immigration levels contribute to a healthier ratio of three retirees for every ten workers. It also helps that recent immigrants have above-average fertility rates.
Many objections to immigration are cultural in nature, and these, too, have little grounding in reality. There is no evidence that immigrants, even undocumented ones, increase crime rates. Nor is there evidence that they refuse to integrate; in fact, they are assimilating faster than previous generations of immigrants did.
Given the many benefits from immigration, greater restrictions on it pose several threats to American workers. Already, the United States is beginning to lose foreign talent, which will hurt economic growth. For two years straight, the number of foreign students studying in U.S. universities has fallen, which is a particular shame since these students disproportionately study science, technology, engineering, and mathematics—areas in which the country faces large skills shortages. Encouraging such students to stay in the country after graduation would help the United States maintain its edge in innovation and promote economic growth. Instead, the Trump administration is discouraging foreign students with visa delays and a constant stream of nationalist rhetoric. Restricting immigration also harms the economy in other ways. It keeps out job creators and people whose skills complement those of native-born workers. And it increases the pressure on the budget, since restrictions will lead to a higher ratio of retirees to workers.
A more sensible immigration policy would make it easier for foreign students to stay in the United States after graduation, admit more immigrants through lotteries, accept more refugees, and provide a compassionate path to citizenship for undocumented immigrants currently living in the United States. Promoting U.S. interests means more immigration, not less.
While reducing trade and immigration damages the prospects of American workers, free trade and increased immigration are not enough to ensure their prosperity. Indeed, despite decades of relative openness to trade and immigration, wages remain stagnant and inequality high. This has dire implications. As the economist Heather Boushey has argued, inequality undermines the U.S. economy by inhibiting competition and stifling the supply of talent and ideas. Unmet economic expectations also fuel voter discontent and political polarization, making it easy to blame outsiders and embrace counterproductive policies. For the sake of both the country’s economy and its politics, economic growth needs to be much more inclusive.
To achieve that, the United States needs, above all, a tax system that ensures that economic prosperity lifts all boats. The Earned Income Tax Credit is a powerful tool in that regard. A credit targeted at lower-income workers that grows as those workers earn more, the EITC subsidizes their work, making each hour of it more lucrative. This credit should be expanded in size, it should reach further up the income distribution, and it should be made more generous for childless workers—changes that would particularly benefit those lower- and middle-class Americans who have seen their wages stagnate in recent decades. This policy would work well alongside an increase in the federal minimum wage, which would help combat the increased market power of employers relative to employees.
Beyond these steps, the federal government should set up a wage insurance program, which could make up some of the difference in lower wages for workers who have been displaced by foreign competition, technological change, domestic competition, natural disasters, or other forces. The federal government should also make greater investments in infrastructure, education, and research, all of which would benefit workers by increasing their productivity and thus their incomes. And it should strengthen the safety net, making improved health-care access and affordability a top priority.
None of this will be cheap, of course. To raise revenue, the U.S. tax system needs to be modernized. For corporations, Congress should curb international tax avoidance, closing loopholes and reforming minimum taxes so as to raise government revenues without chasing profits offshore. Congress should also strengthen individual and estate taxation, and it can do so without resorting to extreme rates. For the income tax, it can cap or end various deductions and preferences; for the estate tax, it can raise rates and reduce exceptions. And it can beef up enforcement of both. Congress should also enact a long-overdue carbon tax. Coupled with the other policies, a carbon tax could raise substantial revenue without harming poor and middle-class Americans, and it would fight climate change.
For the sake of both the country’s economy and its politics, economic growth needs to be much more inclusive.
Finally, policymakers need to reckon with corporations’ growing market power. They should modernize antitrust laws to put more emphasis on labor and modernize labor laws to suit the nature of work today, making sure that they adequately protect those in the service sector and those in the gig economy. Although large companies are often good for consumers, their market power narrows the share of the economy that ends up in the hands of workers. So the balance of power between companies and their workers needs to be recalibrated from both ends: policies should empower labor movements and combat companies’ abuses of market power.
In the end, global markets have many wonderful benefits, but they need to be accompanied by strong domestic policies to ensure that the benefits of international trade (as well as technological change and other forces) are felt by all. Otherwise, economic discontent festers, empowering nationalist politicians who offer easy answers and peddle wrong-headed policies.
American workers have every reason to expect more from the economy, but restrictions on trade and immigration ultimately damage their interests. What those who care about reducing inequality and helping workers must realize, then, is that protectionism and nativism set back their cause. Not only do these policies have direct negative effects; they also distract from more effective policies that go straight to the problem at hand. On both sides of the aisle, it’s time for politicians to stop vilifying outsiders and focus instead on policies that actually solve the very real problems afflicting so many Americans.