The people are now contending for freedom, and would to God they might not only obtain but likewise keep it in their own hands.

—Anonymous, “The People Are the Best Governors,” 1776

“THE TELECOMMUNICATION REVOLUTION MADE AMERICA, and the world, a much smaller place, facilitating large-scale organization and centralization. Corporations grew exponentially amid traumatic spasms of global capitalist development. . . . The rich amassed great fortunes, a prosperous section of the middle class grew more comfortable, and hard times pressed on most everyone else.”¹ This passage describes not the beginning of the twenty-first century but the end of the nineteenth and the conditions that, according to historian Charles Postel, laid the groundwork for a populist movement in the United States: globalization, a telecom revolution, and a widening income gap.

Those conditions closely resemble the conditions prevailing today. And once again, some form of populism seems inevitable. For promarket forces, this situation represents both a threat and an opportunity—a threat because populist movements tend to emphasize redistribution and egalitarianism, which can impede meritocracy and thus destroy incentives and diminish economic growth; and an opportunity because a populist revolt can provide the political resources to fight crony capitalism. When diffuse interests confront concentrated ones, the former generally lose, as we’ve seen. The fight against crony capitalism can be won only if the public joins the fight, shaming those who abuse their power and speaking out against the damage that crony capitalism inflicts on us all. The current moment could hardly be more favorable. Public resentment against the bank bailouts and the Bush and Obama administrations’ favorable treatment of finance is running high. A concerted campaign against the corruption in Washington should find a sympathetic reception.

In any country other than the United States, promarket populism would be an oxymoron. Promarket ideas tend not to be very popular, and in the short term, populist movements can get easy consensus by pushing for massive redistributions of wealth. The United States has a more positive populist tradition than other countries do, however. By understanding this tradition, we may be able to channel the new populism into saving rather than destroying free markets.

THE GOLDEN AGE

The term populism is often used pejoratively; indeed, it can be an effective label with which to delegitimize a movement. Movements and parties often label themselves “popular,” not “populist,” to avoid this stigma. Yet it is fair to say that all forms of populism share an exaltation of “the people” and some form of resentment against the “dominant elite.”²

Historically, populism surfaces when a sizable percentage of a country’s population becomes economically disenfranchised. This is what happened to small farmers at the end of the nineteenth century in America; to the small bourgeoisie wiped out by inflation in pre-Nazi Germany; and to the middle class in Latin America after the commodities booms of the 1920s and World War II left it much poorer. Populist resentment and protest tend to be triggered less by the actual state of living conditions than by the decline (or relative decline) of those conditions. And such decline, unfortunately, is visible in today’s America.

Let’s take a short trip in time back to the end of World War II, when America enjoyed a huge victory dividend—one that especially favored the middle class. From the mid-1940s to the beginning of the 1970s, US GDP grew at an average of 3.7 percent per year, and income inequality fell. In 1939, a typical high school graduate earned 29 percent less than a college graduate; in 1975, he earned just 22.5 percent less.³ In 1975, too, the average American was earning 74 percent more than his father had.⁴ The American Dream seemed within everyone’s reach.

As Adam Smith taught, the wealth of nations is ultimately determined by their productivity. And the United States boasted a gigantic productivity advantage relative to the rest of the world, which allowed it to distribute the newly created wealth throughout its population. One reason for the advantage was America’s protection of property rights—a rarity in the world of that era. In 1946, only 6 percent of the people in the world lived under even somewhat democratic regimes.⁵ With Mao’s victory in China, 34 percent of the world’s population was under the boot of communist regimes.⁶ Moreover, several Western democracies (such as France and Italy) found themselves threatened from within by strong communist parties. What company would choose to move to a country where the communists might take over any day?

Also contributing to America’s productivity was its workforce. Thanks to its democratic (indeed populist) tradition, the postwar United States was also one of the most educated countries in the world. In 1950, when 44 percent of the world’s population was illiterate and only 8.2 percent held high school degrees, the corresponding figures in the United States were 2.2 percent and 37 percent.⁷ Again, what company would want to relocate to a country where most of the population was illiterate?

The United States had still more factors increasing its productivity. For one, the physical destruction of war had left it nearly unscathed. Whereas 16 percent of the industrial plants in Germany, 26 percent of those in Japan, and 8 percent of those in France had been destroyed, the American industrial base was fully intact.⁸ Furthermore, the military effort had compelled American companies to modernize and improve their productivity, making the United States by far the top industrial force in the world. Also, a postwar commodities’ glut lowered the real prices of oil, iron ore, and other inputs. In fact, the real prices of industrial commodities halved between 1950 and 1970, enabling the US to improve its standard of living quickly.⁹

In short, America had a stable environment, advanced technology, and an educated workforce. Those three conditions were then rare, if not unique, in the world, and they explain why US companies had little desire to outsource their operations. America had a monopoly (or quasi-monopoly) on safe and efficient places in which to produce, and the wealth flowing from this monopoly benefited the entire nation.

The post–World War II generation flourished in these favorable market conditions—but it also took the liberty of appropriating some of the benefits belonging to future generations. Critics of America’s Social Security system have called it a Ponzi scheme, which is not as ridiculous as it may sound. In a Ponzi scheme, earlier investors get paid with the money deposited by later investors, with the very first investors enjoying an entirely free lunch and handing the bill to the people who follow them. If enrollment is mandatory, a Ponzi scheme can continue for a long time—in the case of Social Security, as long as the economy and the population continue to expand. Provided that future generations are much richer or much more populous than the current one, the scheme works.

However, if economic growth or population growth—or, worse, both—slow down, the magic disappears. The generation in the workforce contributes more than it ever expects to reap in the future, simply to compensate for the slowdown. We see this reality unfolding today not only with Social Security but with other entitlement programs, such as Medicare.

THE WORLD IS CATCHING UP

The good news is that, over the last sixty-five years, American values have spread across the globe. Most communist countries and autocracies have become democracies. Today, 55 percent of the people in the world live in democracies. Now that China has embraced capitalism, only 2 percent of the people in the world live under truly communist regimes.¹⁰ And much of the world has embraced basic market principles. Generalized education has become the rule, not the exception: a full 71 percent of the people living in OECD countries have high school degrees.¹¹ In short, America has succeeded in nation-building after all—not by force but by example.

The bad—or, better, the challenging—news is that this global progress has shrunk America’s comparative advantage. In part, we have ourselves to blame. The percentage of college graduates in the United States has not increased much over the last thirty years, and the quality of education that non-college-graduates receive has decreased.¹² Rather than recognize that this historical anomaly is over, too many Americans feel entitled to prosperity without an education. But much of the blame (or, rather, credit) for this American decline belongs to other nations. It’s a lot easier to catch up than to keep the lead. When you’re catching up, you can look around and figure out what works and what does not. If you’re in the lead, it’s harder to know where to go and much easier to make mistakes.

An example of the United States’ relative decline is the recent history of the New York Stock Exchange. Until the end of the millennium, the NYSE was the gold standard in the stock-exchange world. During the 1990s, the number of foreign companies listed on the NYSE quadrupled;¹³ meanwhile, the European exchanges, including London, saw declines in their share of world companies listed. In the first decade of the new millennium, the tide turned. At the beginning of the 2000s, 82 percent of the equity raised by the initial public offerings of foreign companies outside their domestic markets was raised in the US; at the end of the decade, the figure was only 10 percent.¹⁴ In 2000, new foreign listings in the NYSE outpaced foreign “delistings,” or removals from the NYSE, by a 3.5-to-1 ratio. In 2007, the balance was reversed and foreign delistings exceeded foreign listings by a 14-to-1 ratio.¹⁵ What happened?

According to many commentators, the relative decline in the attractiveness of the US market can be blamed on excessive financial regulation. ¹⁶ But the relative improvement in the rest of the world’s exchanges is an important reason as well. One way to measure this improvement is to examine stocks listed in more than one exchange, since most of the trades in these stocks will naturally migrate to where they can be executed more cheaply. In the early 1980s, more than half of the trades in these stocks took place in the United States. But by the end of the 1990s, the fraction of trades taking place in local exchanges had grown larger than the fraction taking place in the US.¹⁷ This suggests that at the beginning of that decade, it was cheaper to trade in New York, and by the end, in the local exchanges. Exploiting the second-comer advantage, foreign exchanges had installed more efficient trading platforms than those in the United States. Many of the managers of these foreign exchanges had received their training in US business schools and had learned how to organize and market exchanges. The local regulators learned better rules from the United States, too. Competition intensified.

THE MODERN FARMERS

As the world catches up, the telecommunications revolution has been obliterating geographical distance. This process of globalization is not all that different from the one that occurred in the nineteenth century, when railways, steel hulled steamships, and the introduction of the telegraph integrated the world economy to a greater degree. All of a sudden, farmers had to stop producing for local markets alone and instead respond to world prices. The first to exploit the opportunities offered by this integration made millions; most of the rest got squeezed.

The populist party that emerged against this backdrop viewed its primary targets as railroads and banks. The movement was a visceral reaction to the messengers of globalization: the railroad companies buying wheat for the global market and the banks enforcing the loans that farmers could no longer pay.

The modern “farmers” reeling from globalization include high school graduates not all that different from the middle-class people who in a previous generation enjoyed very comfortable lives. When Robert McNamara joined the Ford Motor Company in 1945, under 1 percent of the firm’s managers had college degrees;¹⁸ nowadays, a person can’t even get an interview without one. But the newly economically displaced also include college-educated engineers and accountants—and soon lawyers, teachers, and even doctors. If railways and steamboats integrated markets by shattering transportation costs, the technology revolution is making distance itself less and less relevant. It used to be that most services, from fixing computers and tutoring to accounting and legal services, required the provider’s physical presence. A manager in Palo Alto couldn’t hire a secretary in Bangalore, even though such a secretary would be far cheaper than one in Palo Alto. But as communication technologies improve, a secretary sitting 10,000 miles away will soon be almost as convenient as one sitting outside your office. Secretaries in Palo Alto will find themselves competing with secretaries in Bangalore. This will depress the salaries of the American secretaries and increase the salaries of the Indian ones. It is a great opportunity for the Indian middle class and a great threat to the American middle class.

This foreign challenge is quickly expanding to almost all services, including more knowledge-intensive ones. As videoconferencing becomes more sophisticated and cheaper, teaching, tutoring, and legal services will be done at a distance. In 2001, the first transatlantic surgical procedure took place: using fiber optics and a robotic surgical instrument, a doctor in New York performed a gall bladder operation on a patient in Strasbourg. While these operations are still experimental, we are not far from the time in which a local technician will insert an endoscopic camera and a top surgeon thousands of miles away will perform the operation. ¹⁹ While this process, in America, will open extraordinary opportunities for the most talented workers in their fields—they will see demand for their services in every corner of the globe—it will have a negative impact on the salaries of their more ordinary counterparts.

THE POPULIST REACTION

Not surprisingly, worries about the economic effects of globalization are reflected in declining public support for free trade. In 2001, according to a regular survey conducted by the Pew Research Center, 49 percent of Americans were in favor of the North American Free Trade Agreement (NAFTA), which liberalized trade among Canada, the US, and Mexico, while only 29 percent were against it. In 2010, only 35 percent supported NAFTA and 44 percent were against it—and 55 percent (wrongly) believed that NAFTA had produced a net loss in jobs, with only 8 percent thinking it had generated new jobs. The loss of support for free trade is even stronger among Republicans than among Democrats. In 2010, only 28 percent of Republicans thought NAFTA a good idea, and support was even weaker, 24 percent, among Tea Party supporters.

As I’ve shown, a major factor supporting the American free-market system is a public consensus that wealth is the just compensation for hard work and, as such, is attainable by anybody who puts in the effort. A December 2011 Pew survey shows that a large percentage of Americans still believe this to be the case, but the proportion is dropping fast. In 1998, 74 percent of Americans agreed with the statement “Most people who want to get ahead can make it if they are willing to work hard.” As of 2011, that figure had fallen to 58 percent.

Doubtless contributing to this decline is the widespread perception that banks and other large firms have been playing according to a different set of rules. Several years after the subprime crisis, no mortgage brokers have been convicted for fraudulent misrepresentation of data on loan applications. This is odd, given research showing that 30 to 70 percent of early payment default can be attributed to a fraudulent misrepresentation on the original application.²⁰ Small wonder, then, that the level of trust toward these institutions has plummeted. In a BBB/Gallup poll administered in April 2008, 42 percent of the respondents said they trusted financial institutions and 53 percent said they trusted large companies. In a similar poll taken eight months later, those percentages dropped to 34 and 12 percent, respectively.²¹ Three years after that (in October 2011), the percentage of people who said they trusted banks had fallen a bit more, to 33 percent, while the percentage who said they trusted large companies had risen, but only to 16 percent.²²

The question, then, given these trends, is no longer whether populist pressure will have a strong influence on policy decisions but how. Will it work to destroy or to improve the market system that has brought so much well-being?

WHICH POPULISM?

Outside the United States, populism is generally associated with two equally bad extremes. On the one hand, there is reactionary populism, which can develop when Machiavellian leaders stoke primitive feelings—racism, fear, religious intolerance—to build support for an otherwise unpopular regime. An example is Peronism, the movement started in 1940s Argentina by Juan Perón, at the time the secretary of labor. Peronism exploited Argentinean nationalism to promote a form of corporate nationalism, blurring distinctions between corporations and government. The Fascist and Nazi movements were more frightening forms of reactionary populism.

On the other hand, there is left-wing populism, which plays on envy and class warfare, pitting have-nots against haves in an effort to destroy meritocracy and introduce a new, political allocation of resources. The most extreme form of left-wing populism was Mao Zedong’s mad Cultural Revolution, which, in the years between 1966 and 1976, wiped out China’s intellectual elite and cost the country millions of lives.

America, too, has had its share of ugly populism, including that of the Ku Klux Klan and segregationist politician George Wallace. But there is another, more positive strain in American history, extending back to the American Revolution itself, in which the elite and nonelite formed an alliance against the colonial power.

Far from populists themselves, the Founding Fathers designed a system of checks and balances to prevent a mob-led degeneration of the new republic.²³ Nevertheless, there were populist elements in the colonists’ fight against the British Crown, which they perceived as a conflict between liberty and power.²⁴ With the election of Thomas Jefferson as president in 1800 and the subsequent demise of the Federalist Party, the populist strains of the American Revolution became mainstream. These populist elements resurfaced with the election of Andrew Jackson in 1828, and later with the creation of the People’s Party (1891), with which the Democratic Party fused in 1896, nominating William Jennings Bryan as its presidential candidate.

In fact, rather than the exception, populism has been the rule of American politics. The two exceptions have been periods of unprecedented growth, prosperity, and social mobility: the frontier era, which lasted until 1890, and the industrial golden age between 1945 and 1970.

Thanks to this tradition, American populist political movements have tended to be quite different from those elsewhere.

For example, the political goal of the People’s Party, which played a significant role in US history between 1891 and 1908, was not to overthrow the existing political system but to improve it through economic and political reforms. The People’s Party protested against banking and railroads, the big economic powers of the day, for the same reason that American colonists protested against the powerful East India Company a century earlier: they believed that these interests unduly influenced the political process and rendered state and federal governments “corrupt, oppressive and unrepresentative of the people.”²⁵

Furthermore, the People’s Party was not anti-intellectual. In fact, it came to be known as “a reading party” and a “writing and talking party.”²⁶ Its members were anti-elite and believed that the elites had been captured by the dominant economic interests. The party’s fundamental message was “This is our polity, in which we, the democratic sovereign, have a right to practice government by the people; but we have been shut out for power by corrupt politicians and an unrepresentative elite who betray our interests, ignore our opinions, and treat us with contempt”²⁷—a message that resonates to this day.

Yet despite this legitimate tradition, the term populism still has a negative connotation for many Americans. Partly this is because some of the nation’s populist movements have been represented by flawed or destructive personalities—from Louisiana governor Huey Long, who was accused of bribery and dictatorial tendencies, to the anti-Semitic priest Father Charles Edward Coughlin. Another reason is that populist movements, above all in Latin America, have a terrible economic record. Populist programs that focus on economic redistribution, as many outside America have, can have a positive short-term effect on the private consumption of the poor, who naturally tend to consume a greater percentage of their income than the wealthy. Together with massive government spending, though, redistributive programs have created huge fiscal deficits—deficits that eventually force the government to cut expenses and raise taxes. Then, as the economy struggles, the very workers who are the populists’ constituency find themselves worse off. Income redistribution also reduces the incentive of companies to invest, which in turn reduces workers’ productivity and their real wages.²⁸

If it is well understood that populist economic policies unleash such problems, why don’t populist leaders change the policies? A recent paper hypothesizes that the policies are necessary for populist leaders to be elected in the first place.²⁹ In divided societies where the power of the entrenched elite is large, politicians need to signal to voters that they aren’t in cahoots with that elite. Unless they advocate policies that benefit the lower class immediately, even at greater cost later on, populist leaders won’t be able to differentiate themselves from the ruling elite. In short, the most damaging forms of populism manifest themselves in societies where a closed elite rules, detached from the rest of the population.

Only in a country with a credible populist tradition can populist movements avoid radical and counterproductive programs. It is thanks to America’s moderate populist tradition that we have a Bill of Rights. It is thanks to this tradition that we invented antitrust law before economists fully worked out the reasons that it was a good idea. And it is thanks to this tradition that senators are no longer nominated but elected, a process that limits corruption.

PROMARKET POPULISM

Even in the United States, populism has typically not been promarket. At a time when markets weren’t that competitive, the populist revolt against the excessive power of large corporations brought us the first government agency (the Interstate Commerce Commission) and the first regulation to keep railway prices low. Squeezed by the globalized markets, farmers looked to the government for protection. The public perception was that the interests of ordinary people were better protected through the political process than through the marketplace. For this reason, American populism tended to support an activist government.

Today, the situation is quite different, opening the possibility of a fully promarket populism. The perception that Americans have of markets remains positive. According to a survey conducted as part of the Chicago Booth/Kellogg School Trust Index, 46 percent of Americans agree with the statement “The free market system is the best way to protect the interest of ordinary Americans,” while 22 percent disagree. The public’s trust in government, by contrast, is low. Over 50 percent of Americans declare that they trust the government very little or not at all. This lack of trust is due at least partly to the perception that the government acts in the interest of a few large corporations or special interests, rather than in the interest of the country as a whole. In December 2008, for example, when Americans were asked in whose interest they thought Treasury Secretary Henry Paulson had acted during the financial crisis, 50 percent responded, “in the interest of Goldman Sachs.”³⁰ To a similar question asked about President Obama in December 2009, 32 percent responded, “in the interest of the financial industry,” and 22 percent, “in the interest of the unions.” Support for big business is virtually nonexistent. Only 16 percent of Americans trust large corporations (a figure lower than the percentage who trust the government), and 53 percent agree with the statement “Big business distorts the functioning of markets to its own advantage.”

Is it possible to build a populist political agenda that reflects this support for free markets and distrust of government and big business? Is it possible to design policies that reset the economic balance in favor of the ordinary American without massive government intervention, which would interfere with economic freedom and suppress growth? In short, is it possible to recapture the lost genius of American prosperity?