The United States and The Myth of Free Market - The Role of the Government In Historical Perspective

"The Wealth of the Nation" by Seymour Fogel via Wikimedia Commons

In his bestseller Free to Choose economist Milton Friedman offered a vision of American economic history that revolved around the idea of freedom. He wrote:

"Ever since the first settlements of Europeans in the New World America has been a magnet for people seeking adventure, fleeing from tyranny, or simply trying to make a better life for themselves and their children ... When they arrived, they did not find streets paved with gold; they did not find an easy life. They did find freedom and an opportunity to make the most of their talents. Through hard work, ingenuity, thrift, and luck, most of them succeeded ...

"The story of the United States is the story of an economic miracle and a political miracle that was made possible by the translation into practice of two sets of ideas .... One [of them] was embodied in the Wealth of Nations, the masterpiece [by] Adam Smith [which] analyzed the way in which a market system could combine the freedom of individuals to pursue their own objectives with the extensive cooperation and collaboration needed in the economic field ... The second set of ideas was embodied in the Declaration of Independence, drafted by Thomas Jefferson" (Milton Friedman: Free to Choose: A Personal Statement, 1990, Introduction).

Milton Friedman's books have become a holy scripture of economics, an ideology that does not tolerate dissent. After years of progress in the post-war period, in which mixed economies created a golden age of capitalism, Milton Friedman and other economists set about destroying the work of previous generations, not by inventing a new theory, but by bringing back the liberal (i.e. laissez-faire) philosophy of Adam Smith.

They re-wrote history so as to suit their needs, they selectively chose facts that supported their ideas, while ignoring facts that contradicted them. Market dogmatists launched a worldwide disinformation and indoctrination campaign, backed by conservative groups and corporations, and later co-opted by politicians, who turned market dogmas into state ideology.

Market dogmatism, however, is profoundly unhistorical. Prior to its advent in the 1970s, it was common knowledge that the United States had, for a very long time, pursued an interventionist, government-led economic policy. For instance, the tariff debate was one of the most important issues in US politics. As a 1944 book written by a group of twenty-five prominent US scholars, such as Harold F. Williamson, explained:

"The [Civil War] marked a decisive turn in the history of tariff policy ... The need for revenue became more urgent as the war progressed, and Congress responded to this need by setting up an elaborate system of excise taxes and greatly increased tariffs on imports ...

"The most extensive revision of the tariff occurred in 1864, when, after scanty discussion and under the stress of war, Congress passed a bill raising the average rate on dutiable commodities to 47 per cent, as compared with about 20 per cent in 1860. 

"For a period of nearly 20 years, this war tariff remained the basic public regulator of our foreign trade ...Ultimately the public ceased talking about the 'war tariff' and adjusted itself by and large to the fact that the wartime expedient of extremely high import rates had become a permanent institution" (Robert G. Albion: The Growth of the American Economy: An Introduction to the Economic History of the United States, ed. Harold F. Williamson, 1944, p. 560).

The book goes as far as to claim that the emergence of a strong manufacturing sector was probably hastened by the war, which reduced "the influence of the agricultural, low-tariff South", a change which "meant that a predominantly open, world-dependent, and relatively undeveloped economy had become a predominantly closed, self-sufficient, and intensively organized economy" (ibid., p.751).

Milton Friedman and other market dogmatists succeeded in demonizing protectionism, even though the United States and many other countries developed while they had tariffs.

In the present article, we shall briefly analyse the government-led economic policy of the United States in the post-independence era and show how the shift from a mixed market economy towards a self-regulating market economy (an economy with a minimum degree of government intervention) impacted American companies.

Alexander Hamilton and the Protection of 'Infant Industries'

As economist Chang Ha-joon explained in his book Bad Samaritans, Britain pursued a mercantilist policy in America. The thirteen colonies were forbidden from levying import tariffs, from exporting products that competed with British products, and their manufacturing sector was restricted. London wanted America to produce raw materials and buy goods manufactured in Britain (Chang Ha-Joon: Bad Samaritans: The Guilty Secrets of Rich Nations and the Threat to Global Prosperity, pp. 48-49).

None other than Adam Smith argued that the American colonies should refrain from developing their own industries and, instead, should focus on agriculture. In The Wealth of Nations he wrote:

"It has been the principal cause of the rapid progress of our American colonies towards wealth and greatness that almost their whole capitals have hitherto been employed in agriculture. They have no manufactures ...

"Were the Americans, either by combination or by any other sort of violence, to stop the importation of European manufactures, and, by thus giving a monopoly to such of their own countrymen as could manufacture the like goods, divert any considerable part of their capital into this employment, they would retard instead of accelerating the further increase in the value of their annual produce, and would obstruct instead of promoting the progress of their country towards real wealth and greatness" (Adam Smith: The Wealth of Nations, Book II, Chapter V).

Public opinion in the colonies and, subsequently, in the newly-founded United States of America, was divided on the issue of economic development. Some, like Thomas Jefferson, agreed with Adam Smith's idea of a self-regulating market without government interference. As he stated in his first inaugural address (March 4, 1801):

"[T]he sum of good government [is] a wise and frugal Government, which shall restrain men from injuring one another, shall leave them otherwise free to regulate their own pursuits of industry and improvement, and shall not take from the mouth of labor the bread it has earned."

Others, however, disagreed.

One of the most influential proponents of a government-led economic policy was Alexander Hamilton, the first US Secretary of the Treasury. In 1791, he submitted to Congress a Report on the Subject of Manufactures, in which he argued that the United States government should actively promote the manufacturing sector through a series of interventionist policies.

The origin of Hamilton's ideas can be traced back to the tradition of enlightened monarchies and European, especially British, mercantilism. As Max M. Edling pointed out, the idea that "the economy, society, and the state formed an interdependent whole that could not be analyzed separate from one another" was a feature of eighteenth- and early nineteenth century political economy (Max M. Edling: Political Economy, in: A Companion to Thomas Jefferson, ed. Francis D. Cogliano, 2012, p. 439).

Alexander Hamilton believed that it was desirable for the United States to develop its own manufacturing sector in order to achieve economic prosperity, increase job opportunities, maintain the balance of trade with foreign countries, and promote individual talents in various fields of employment.

He was aware that the US economy was backward when compared with that of Britain and other European countries. He understood that US manufactured goods could not compete with foreign products, not only abroad, but also at home. To describe the imbalance of economic development between the US and foreign countries, Hamilton coined the term ' infant industries' (Chang, pp. 49-50).

Hamilton proposed to develop American industries through a system of protective tariffs, import restrictions, subsidies and other measures aimed at nurturing nascent local industries to make them competitive. Hamilton's Report laid out the following governmental strategies:

1. "Protecting duties - or duties on those foreign articles which are the rivals of the domestic ones intended to be encouraged."

2. "Prohibitions of rival articles, or duties equivalent to prohibitions."

3. "Prohibitions of the exportation of the Materials of Manufactures." This measure - which had also been used in England - aimed at preventing the US from becoming a raw material exporter; Hamilton understood that manufactured products had an added value which would be earnt by foreign manufacturers, and that the US would remain backward if it specialized in exporting raw materials.

4. "Pecuniary bounties. It is a species of encouragement more positive and direct than any other, and, for that very reason, has a more immediate tendency to stimulate and uphold new enterprises, increasing the chances of profit, and diminishing the risks of loss, in the first attempts." Hamilton addressed the doubts which many had regarding such subsidies. He argued that people mistrusted subsidies because these appeared as a way of "giving away the public money without all immediate consideration." However, he believed that there was "no purpose to which public money can be more beneficially applied, than to the acquisition of a new and useful branch of industry; no consideration more valuable, than a permanent addition to the general stock of productive labor."

5. "Premiums". Premiums were subsidies aimed at promoting "some particular excellence or superiority, some extraordinary exertion or skill, and are dispensed only in a small number of cases."

6. "The exemption of the materials of manufactures from duty."

9. "Judicious regulations for the inspection of manufactured commodities" with the purpose of "[c]ontributing to prevent frauds upon consumers at home, and exporters to foreign countries; to improve the quality, and preserve the character of the national manufactures".

10. "The facilitating of pecuniary remittances from place to place" through the "general circulation of bank paper." Hamilton advocated the establishment of a central bank, which was opposed by proponents of market self-regulation such as Thomas Jefferson and James Madison.

11. "The facilitating of the transportation of commodities," comparable to present-day projects of infrastructure building.

It is likely that nowadays Hamilton's proposals would be dismissed by a wide majority of the American public. Leftists would argue that those measures would cause trade wars, while right-wingers would denounce them as socialism. Market dogmatists would say that government control would create inefficiency and market distortions. 

Initially Hamilton's impact on the US government's policy was relatively limited. The average tariff on foreign manufactured goods was raised from 5% to around 12%. However, the liberal faction, led by Thomas Jefferson, succeeded in stalling protectionist policies.

But in 1812, the Anglo-American War broke out. Faced with British aggression, the US Congress raised tariffs to 25%. At the same time, imports from Britain and other European countries were naturally reduced due to the conflict. The manufacturers who emerged during this period lobbied for the continuation of protection policies. In 1816 and 1820, the tariff was further increased to 35% and 40%, respectively.

The protectionist policies of the US were thus firmly established. The tariffs remained one of the most important issues in US politics. Until the Second World War no politician dared to drastically alter the Hamiltonian model (see Chang pp. 50-51).

Moving Away From Protectionism

On January 25, 1962, US President John F. Kennedy addressed a "special message" to the Congress on the issue of foreign trade policy. In his speech he laid out the arguments in favour of open trade and the reduction of tariffs. The ideas he put forward may sound familiar today:

"A more liberal trade policy will in general benefit our most efficient and expanding industries-industries which have demonstrated their advantage over other world producers by exporting on the average twice as much of their products as we import-industries which have done this while paying the highest wages in our country...

"The American businessman ... will have a unique opportunity to compete on a more equal basis in a rich and rapidly expanding market abroad which possesses potentially a purchasing power as large and as varied as our own. He knows that, once artificial restraints are removed, a vast array of American goods, produced by American know-how with American efficiency, can compete with any goods in any spot in the world...

"The American consumer benefits most of all from an increase in foreign trade. Imports give him a wider choice of products at competitive prices ..."

Kennedy argued that tariffs should be reduced and that global market integration would be beneficial to the US.

"[W]e must reduce our own tariffs if we hope to reduce tariffs abroad and thereby increase our exports and export surplus. There are many more American jobs dependent upon exports than could possibly be adversely affected by increased imports. And those export industries are our strongest, most efficient, highest paying growth industries. It is obvious, therefore, that the warnings against increased imports based upon the lower level of wages paid in other countries are not telling the whole story."

Nevertheless, American sentiment was still against the idea of market liberalization. Being aware of public opinion, Kennedy reassured the Congress that a range of protective measures would be retained:

"[A]mple safeguards against injury to American industry and agriculture will be retained. Escape clause relief will continue to be available with more up-to-date definitions. Temporary tariff relief will be granted where essential. The power to impose duties or suspend concessions to protect the national security will be retained."

The 1960s were, indeed, a period of transition and readjustment. Up until the Second World War, US economic policy had been protectionist. The following excerpt from a 1964 book illustrates this point:

"The process of imposing taxes on imports necessarily implies some protection for domestic producers, even though the rate is moderate. An American businessman has been able to read more than this, however, in our tariff legislation. A rate of 90 per cent, for example, on toys in the Tariff of 1930, suggests that our Congress wishes a toy industry to be developed.

"The investor who responds to this stimulus feels that he has 'a vested interest' in tariff protection and will resist later congressional attempts to lower the rates, even after the protected industry has become established. In a sense, the use of a tariff in this way is a departure from laissez faire and puts it in the same category as premiums, bounties, loans, and subsidies. The tariff places business in special relationship to government" (Asher Isaacs and Reuben E. Slesinger: Business, Government and Public Policy, 1964, p. 381, my emphasis).

In 1934, the Reciprocal Tariff Act gave the President the authority to cut duties on any item on the tariff list by as much as 50% in return for reciprocal advantages on the market of any foreign country.

In the post-war era the United States began to seek stronger economic co-operation with other countries, but they did so tentatively. As late as 1951, Congress passed a "peril point" clause, providing that no tariff concessions should be made if they threatened US domestic industries (ibid.).

Under the General Agreement on Tariffs and Trade (GATT) the United States espoused an ever more liberal concept of trade that culminated in the establishment of the World Trade Organization (WTO).

However, the reduction of tariffs has not benefited US manufacturing, nor has it increased the standard of living of the middle class. On the contrary, the US has lost flexibility, as it has renounced essential tools of economic policy-making for the sake of an abstract concept of a self-regulating market. Interestingly enough, contemporary economists completely ignore the fact that the US used to be a heavily regulated economy for about 150 years. Milton Friedman's vision of a "free market" is but a myth.

Although we shall not attempt here to analyse the decline of American manufacturing since the 1970s, we shall provide one interesting example - which is representative of many other cases - of a US company that, facing competition from foreign subsidized companies, was unable to compete. The company was Zenith Electronics. Founded in 1918, Zenith Electronics had around 11,000 employees in the early 1960s. Presently it has less than 1,000.

In the 1970s Zenith repeatedly pleaded with the US Treasury Department to levy tariffs on Japanese electronics. Zenith argued that the Japanese government was subsidizing its own enterprises, helping them dump their goods on the US market. By that time the mood in Washington had completely shifted from protectionism to liberal trade.

In 1975 Zenith filed a petition to the US government:

"Zenith Radio Corporation, having good and sufficient reason to believe that bounties and grants are being paid or bestowed, directly or indirectly, upon the manufacture, production and export of dutiable merchandise ... continuously being imported into the United States in vast quantities from Japan hereby respectfully requests that the Secretary of the Treasury investigate, ascertain and determine or estimate the net amounts of each such bounty and grant and levy appropriate countervailing duties in accordance with the mandate of Section 303, Tariff Act of 1930" (quoted in: Philip J. Curtis: The Fall of the U.S. Consumer Electronics Industry: An American Trade Tragedy, 1994, p. 154).

Zenith's petition was eventually rejected. Incidentally, 1975 was the last year in which the US had a trade surplus.