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How the Collapse of Communism Has Undermined Faith in American Capitalism

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How the Collapse of Communism Has Undermined Faith in American Capitalism

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At their presidential campaign stops, U.S. Senators Bernie Sanders and Elizabeth Warren charged that American capitalism has, since the early 1970s, been “rigged” and “corrupted” by the rich and powerful for self-aggrandizement, to the detriment of middle- and lower-income Americans.
The drumbeat continues in the media: The root cause of American workers’ economic problems over the past half-century has been the “disastrous” policies of the U.S. government, including the diminishment of union bargaining power, suppression of real wages by corporate elites, destruction of the country’s once vibrant manufacturing-based communities and decreases in taxes on the rich instead of greater expenditures on workers’ “human capital.”

For evidence, progressives in politics, media, and academe point to an array of charts showing a long-term stagnation in worker real wages and an “obscene” growth in income and wealth inequality, fueled in part by out-of-control executive pay taken from all other lower-pay employees. A slight majority of American “millennials” has bought their arguments and now favors socialism over capitalism.

While acknowledging that economic history is the product of many interacting currents of events, I focus on a powerful but unheralded force shaping U.S. income and wealth patterns over the last five decades, the growth in global market competitiveness substantially boosted by the downfall of communist economies worldwide, but especially in China, since the late 1970s.

In effect, China undertook massive deregulation of its economy with weak roots taking hold in the early 1970s but growing in leaps after 1978. Over the following four decades, China moved from Marxian socialism to a version of (crony) capitalism. In the process, it stirred global economic forces that undercut faith in American capitalism (especially among young Americans) and moved presidential candidates to blame American capitalism as a flawed system and to press for socialist reforms in the United States. These came first in the mid-1980s in the form of a “new industrial policy” and, more recently with, proposals for redistributive policies designed to temper worker real-wage stagnation, growing income and wealth inequality, and surging executive pay. The downfall of the Soviet Union in the late 1980s compounded the Chinese-based market pressures on U.S. income and wealth patterns.

Contrary to the critics’ claims, I argue here that, given these seismic economic shifts in the global economy, American capitalism adjusted pretty much as should have been expected. Moreover, no one should be surprised if the lamented income and wealth patterns of the past are reversed in the coming 2020s and beyond; here is some (albeit tentative) evidence that the reversal is underway and could be abetted if regimes in China and Russian insist on increasing their authoritarian controls.

U.S. Economic Dominance Post-World War II

From World War II into the 1960s, the United States dominated the world economy, mainly because the economies of Japan and European countries had to be rebuilt. China fell to the communists in 1949, after which Mao Zedong walled off his country from the rest of the world, fortifying the United States’ global economic dominance.

China’s creation of a state-owned and directed economy, with severe internal restrictions on labor and capital mobility, resulted in three decades of relative economic and technological decline. China’s economic restrictions also had the unheralded effect of shielding U.S. workers from competition from hordes of unskilled and lowly paid Chinese workers.

From the late 1940s to 1973, American manufacturing workers had labor market demand on their side, resulting in a 73 percent increase in real average wages. After 1973, however, workers’ real wages began falling gradually through the 1990s, only to creep upward thereafter (except during the Great Recession). Between 1973 and the spring of 2019, real average wages fell 5.4 percent.

The Slowdown in Real Wages After the Early 1970s

Why the turnaround in real-wage growth pre- and post-1973 (other than fringe benefit growth)? I suggest a major force: growth in global market competitiveness, spurred by several factors hidden in plain sight:

  • • By the late 1960s, Europe and Japan had recovered from the war to become major competitors of U.S. firms.
  • • The OPEC oil embargo in 1973 and the inflationary spiral of the 1970s imposed added downward pressure on real wages.
  • • U.S. military interventions in foreign lands after the early 1970s diverted scarce resources into tank and bullet production, leaving fewer resources for boosting production of consumer and capital goods—and worker real wages.
  • • Dramatic reductions in global transportation and communication costs (aided by ever-cheaper computers and the Internet’s advent) intensified price competitiveness in all markets, adding more downward pressure on worker wage growth.

In the early 1970s, China was still in the grip of a communist ideology that made economic equality the preeminent policy goal over economic growth. The major means of production were largely state-owned and production specialization and price incentives were shunned as “bourgeois.” Productivity growth was sluggish, because China’s central planners could not appreciate various local economies awaiting exploitation across its vast but centrally controlled economy. The Chinese economy ossified (as did the economies within the former Soviet Union), which, unintentionally, boosted U.S. workers’ market demand and real wages.

Before the late 1970s, Marxist ideology “chained” China’s 430 million or so workers to their jobs through restrictions (under the “hukou” system) on movements from collective farms and state-run enterprises. By the mid-1970s, the Chinese economy was grossly inefficient. Ninety percent of the people lived in abject poverty, with starvation a continuing problem. Many Chinese economists feared the collapse of the national economy.

The Communist Downfall and American Wage Stagnation

“Marx, Engels and their followers never anticipated that the rise of Chinese capitalism would undermine faith in American capitalism, pushing American politicians and voters toward socialism.”

In 1848, Karl Marx and Friedrich Engels admonished “workers of the world” to unite and rise up against their capitalist masters, assuring all they had “nothing to lose but their chains.” They never considered their words would be most relevant in communist countries and the “chains” to be lost would be communist controls, unlocked gradually with market-based freedoms of inefficiencies the controls generated. Marx, Engels and their followers never anticipated that the rise of Chinese capitalism would undermine faith in American capitalism, pushing American politicians and voters toward socialism.

How so? Rigor mortis had barely set in after Mao’s death in 1976 before elite Chinese Communist Party (CCP) members began searching for an economic revival from identifying unappreciated “objective economic laws” to guide the economy and for a reinterpretation of the country’s ongoing “revolution” to include “the liberation of the productive forces” from central plans. With his elevation to premier in 1978, Deng Xiaoping began an overhaul of the educational system, replacing its ideology-based admission process with a merit-based one. Chinese leaders also began to search among successful market economies for capitalistic reforms, while professing allegiance to socialist principles. There were no off-the-shelf plans, especially since they sought to use markets to reach a “higher stage of socialism” by revitalizing central planning with market competition.

Deng and his allies initiated reforms by declaring that markets were simply a means of coordinating economic activities in both capitalist and socialist systems. Deng’s goal was to develop a market system with “Chinese characteristics,” including the continuation of authoritarian management of market and human rights.

Deng and company had many modern Western economics books, including Milton Friedman’s Capitalism and Freedom (1962), then the bible for market fundamentalism, translated into Chinese. Friedman was invited to give talks in China in 1980, partly because he had received the 1976 Nobel Prize in Economics, but also because of his 1980 documentary “Free to Choose,” which highlighted Hong Kong’s prosperity, largely attributed to that city-state’s reliance on free markets. Friedman was among the first wave of foreign market-based economists and business executives to make consulting pilgrimages to China in the 1980s and 1990s.

After demoting Mao from a near-god to an imperfect mortal, Deng began releasing the country’s built-up “surplus of labor,” measured then in hundreds of millions of workers, hidden within collective farms or state-run enterprises and restricted from taking self-identified improved economic opportunities. In 1978 (the year of the “Great Opening”), Deng began gradually shifting China toward a “socialist market economy” by giving regions more autonomy in production decisions, including allowing farmers to divide up their communal land for private cultivation and profit.

In 1979, the Deng regime created experimental “Economic Zones,” within which production and trade were liberated to attract foreign capital and technology. With time, the Zones proved their worth. By 1981, collective farms were dismantled. Market freedoms were extended to non-farm sectors but with centralized guidance. Marxist economics died, albeit grudgingly for many aging Mao loyalists. Throughout the 1980s, capital and technology imports were freed up in steps. A stock market and financial and banking sectors were developed, along with property rights protections for foreign ownership. Chinese farms and firms were freed to keep their profits on production above set quotas.

The success of the limited shifts to markets and greater pricing freedom was impressive. Agriculture sales rose 99 percent between 1978 and 1982. Rural trade escalated 130 percent. During the 1980s, production by newly created rural “town and village enterprises” grew 30-35 percent per year. By 2015, China’s labor force approached a billion workers, with 288 million Chinese “domestic migrants” (equal to the whole U.S. population in 2000) having moved away from their hukou-bound locations to improved economic opportunities in urban areas.

Tiananmen Square and Market Reforms

The 1989 Tiananmen Square student-led protests, which were partially ignited by a 19-percent inflation rate and calls for greater personal freedoms and human-rights protections, were ended with a massacre of possibly thousands of unarmed protesters on June 4. The Tiananmen protests (as well as the 1989-1991 breakup of the Soviet Union) had interactive effects on both political and economic fronts. They caused the CCP to double down on its efforts to suppress nascent political dissent. They also made Deng ever more determined to push for greater market freedoms, figuring that future protests could be tempered, if not avoided, with further growth in living standards. Market reforms could reduce the need for armed suppression of dissent and, at the same time, pad the CCP’s coffers.

Beginning in 1992, additional economic reforms were introduced, including:

  • • setting local governments into competition for central funding based on their economic growth,
  • • privatizing many state-owned enterprises and giving remaining state enterprises greater production and pricing freedoms and greater claims on firm profits,
  • • breaking up key state-owned enterprises with monopoly power into two or three competitors and introducing the prospects of failure,
  • • adopting a pro-growth tax system,
  • • turning a blind eye toward growing income and wealth inequality, and
  • • further opening China to world trade and encouraging greater direct foreign investment, resulting in a twenty-one-fold increase in the country’s count of manufacturing firms between 1980 and 1996.

By 1993, markets had so proven their worth in upgrading living standards and moving hundreds of millions of people out of poverty that the CCP, under Deng’s leadership, officially recognized China as a “socialist market economy.” Amazingly, the CCP held onto political control of the country (contrary to Friedman’s expectations, which contemporary Hong Kong protests suggest may have only been delayed).

In the 1990s, Chinese private and state producers discovered in earnest their comparative advantages in globalized labor-intensive industries, such as manufacturing. These newly liberated and incentivized workers increased the global labor force by more than their body count as they simply worked harder and smarter, and as they created even more “workers” called robots.

Between 1978 and 2017, China’s GDP grew approximately 30 times, making it the second largest economy in the world in 2017, with prospects of surpassing U.S. total (not per capita) GDP by the mid-2020s. By 2017, China’s extreme poverty rate had fallen to 2 percent. Still, the government’s presence in the economy has hardly vanished, given that about 30 percent of industrial assets are still held by state-owned enterprises.

The Downfall of the Soviet Union and U.S. Growth

By the early 1990s, with the downfall of former Soviet Union, well over a half-billion liberated workers—between one-fourth to one-third of the world’s labor force—had their economic chains loosened, if not broken, intensifying global labor and product-market competitiveness. To remain cost competitive, labor-intensive manufacturing firms worldwide, especially in the United States, began moving capital and production to China (as well as Mexico and elsewhere) and relying evermore on imported inputs and goods, leaving behind destroyed communities that once relied on their manufacturing base. Contributing to such moves was growing global trade liberalization. The average global tariff fell by 45 percent between 1988 and 2017 (and by 94 percent between 1947 and 2017).

These ongoing shifts in global production put downward pressure on U.S. worker real wages and upward pressure on firms’ search for worker productivity increases through labor-saving capital as they competed with Chinese-based firms. Interestingly, the percentage growth in real worker compensation and productivity diverged dramatically around 1973. Capitalism’s critics have misinterpreted this as evidence the American capitalism system is “rigged” against workers—solely at the hands of American capitalists, demeaned as the key economic villains. Amazingly, American workers’ average real wage only “stagnated” (more or less) for a few years and then grew at a much slower pace after about 1973, despite the relatively rapid arrival of hundreds of millions of formerly “chained” communist-state workers onto the world labor market over a relatively short period of time (over a decade or two).

Nevertheless, in the 1980s, “Rust Belt, “deindustrialization,” and the “Great U-Turn” (in worker wages) became progressives’ powerful catchphrases to signal (supposedly) the escalating demise of America’s manufacturing prowess—despite the continuing upward trend in real manufacturing output. Still, the catchphrases captured the economic distress of many American workers who felt that their American Dream had been denied by economic forces beyond their control and understanding. Left-leaning politicians tendered new federal restrictions on capital mobility and a “New Industrial Policy” that would have effectively put many corporate decisions in the hands of plant-based “tripartite councils” or “regional industrial councils,” moving the U.S. economy toward the kind of production controls China was rapidly abandoning.

American Capitalists’ Relative Economic Gains

The sudden onslaught of Chinese workers may have increased Chinese wages, but it decreased the growth in the relative real wages of their global counterparts—and, at the same time, increased the relative value of capital. After all, the liberated Chinese economy substantially increased world demand for capital, which meant the downfall of communism put upward pressures on the relative rewards going to entrepreneurs and stockholders. Understandably, between 1980 until mid-2019, the S&P Index rose by more than 2,700 percent, which padded the pockets of many already-rich Americans and stoked the flames of envy and progressives’ claims of American capitalism being “rigged” against non-rich Americans.

Executives with skills to manage global firms and extended supply chains have always been scarce. With the downfall of communist economies, elite skilled executives became evermore scarce, mainly because they had to do businesses in far-off locations with greater risks of making competitive errors on a global scale. The demand for executive skills became global in scope, while the demand for many workers remained largely local. Understandably, top executives’ compensation surged 1,000 percent between 1978 and 2014, while worker real pay limped upward.

Concluding Comments

The chief admonition that emerges from this brief review of recent global economic history is stark: Don’t blame American capitalism for the post-1973 decline (or just stagnation) in real-wage growth and the extraordinary gains of high-income earners. Markets in the post-communist economic era have worked very much as expected, if not better.

Consider blaming Marx for seducing communists into believing that they could plan a better economy than one expected to emerge from ever-changing global market forces. Blame Mao for taking Marx seriously, and for engineering a massive build-up of a hidden “labor surplus,” ironically, in communist countries, not capitalist. Blame Deng for finally acknowledging the intellectual and operational bankruptcy of Marxist economics and for doing the right thing, liberating Chinese workers, entrepreneurs, and investors.

If Senators Sanders and Warren and others are correct that without progressives’ socialist reforms, the economy will likely remain rigged, then past trends in worker real-wages and inequality will continue. If I am right, China’s labor surplus will likely, sooner than later, be depleted, giving rise to a return of significant real-wage increases for U.S. workers and a truncation (if not a reversal) of U.S. capital outflow to China.

Wait! Evidence indicates that Chinese workers’ real wages have begun to rise, suggesting that its labor surplus has been (more or less) depleted. (Chinese firms began moving production to lower-cost venues before U.S. tariff threats.) Moreover, U.S. real worker wages have risen, albeit slowly, but enough to cause income inequality (as measured by the Gini coefficient) to move recently in reverse. Reshoring of previously offshored jobs to China is on the rise (with foreign direct investment in the United States peaking in mid-2018 just before a slide after the current trade war with China began in earnest).

In the not-too-distant future, there could be heard three cheers for American capitalism from all but socialism’s most committed boosters.


Footnotes

[1] For Senator Sanders’ policy positions, see Associated Press, “Bernie Sanders Confirms Presidential Run and Damns America’s Inequities,” The Guardian, April 29, 2015; and Editorial Board, 2019. “A Tale of Two Economies,” Wall Street Journal, July 4, 2019.

[2] Nicholas Kristof and Sheryl WuDunn, 2020, “Who Killed the Knapp Family?,” New York Times, January 9. Real wage increases of workers with limited education may also been dampened in the United States by the surge in better educated members of the “baby boom generation” who enter labor markets in the mid- to late-1960s and moved up the income ladder in the 1970s and 1980s, a market force that stands apart from capitalism being a “rigged” process (see U.S. Bureau of Labor Statistics“Baby Boomers with More Education Had Higher Growth Rates in Real Earnings at Every Stage of Life,” TED: The Economics Daily, September 5, 2019).

[3] Emmanuel Saez, “Income and Wealth Inequality: Evidence and Policy Implications,” Contemporary Economic Policy 35, no. 1 (January 2017): 7-25. See also Phil Gramm and John Early, “The Myth of ‘Wage Stagnation’,” Wall Street Journal, May 17, 2019.

[4] See 2019. “The Resurgent Left: Millennial Socialism,” The Economist, February 14, 2019.

[5] See Richard B. McKenzie and Dwight R. Lee, 1991. Quicksilver Capital. New York: Free Press.

[6] For details on the following empirical points, see Julian Gewirtz, Unlikely Partners: Chinese Reformers, Western Economists, and the Making of Global China. (Cambridge, MA: Harvard University Press, 2017), p. 33.

[7] Klaus Muhlhahn, 2019, Making China Modern: From the Great Qing to Xi Jinping. Cambridge: Harvard University Press, chap. 10, especially p. 501.

[8] Gautam Jaggi, Mary Rundle, Daniel Rosen, and Yuichi Takahashi, “China’s Economic Reforms, Chronology and Statistics” (working paper 96-5, Peterson Institute for International Economics, Washington, DC, 1996).

[9] As reported in 2019. “Migrant Workers and Their Children,” China Labour Bulletin, May. See also “Migration in China,” n.d. Wikipedia (accessed May 10, 2019).

[10] Brad Delong, “Milton Friedman: Economic Freedom, Human Freedom, Political Freedom,” Delong’s Grasping Reality (blog), August 8, 2008.

[11] See figure 1 in Asian Society Policy Institute, China Dashboard, Winter 2019.

[12] See the chart of worker compensation and productivity growth in Josh Bivens, et al., 2018 (originally published, 2014). “Raising America’s Pay,” Washington: Economic Policy Institute, August 2018.

[13] Critics of the stagnant-wage thesis have argued that, if properly measured, real worker wages trended upward even after 1973, but no one disputes that real-wage growth slowed significantly after 1973. See Donald Boudreaux and Mark Perry, “Myth of a Stagnant Middle Class,” Wall Street Journal, January 23, 2013; and Phil Gramm and John F. Early, “Americans Are Richer Than We Think,” Wall Street Journal, August 21, 2019. In a just-released Brookings Institution study, economist Stephen Ross has fortified the slowdown in “prime-age” workers’ real income growth between two fifteen-year time periods, 1967-1981 and 2002-2016. He found that the median real income growth in the later time period slowed to 8 percent from 27 percent in the first time period. There was a reduction between the two periods in the size of the “middle middle class,” shrinking from 50 to 36 percent of all workers, but that can be largely attributed to their moving up the income ladder to the “upper middle class” and higher income groups. He also found those prime age workers who experienced a large income loss tripled from 4 percent in the 1967-1981 period to 12 percent in the 2002-2016 period, perhaps lending some (but not definitive support) to my argument, which is that the sudden downfall of communism and the rapid rise of capitalism in former communist countries made labor markets more unsettled, given partially to the more rapid mobility of plant and equipment across the globe (see Stephen Ross, Squeezing the Middle Class: Income Trajectories from 1967 to 2016 Washington: D.C.: Brookings Institution, August 2020).

[14] Jeff Cox, “Worker Wage Gains Are Keeping Up with Inflation, And Then Some,” CNBC, February 13, 2019; Harry Moser and Miller Keller, “Reshoring Is on the Rise: What It Means for the Trade Debate,” Industry Week, April 13, 2018. See also Editorial, 2020. “The Economy’s Inequality Dividend,” Wall Street Journal, January 11, 2020.


*Richard McKenzie is the Walter Gerken Professor of Economics professor (emeritus) in the Merage School of Business at the University of California, Irvine. His latest economics book is A Brain-Focused Foundation for Economic Science (2018).

For more articles by Richard McKenzie, see the Archive.


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