Why do European countries have lower levels of poverty and inequality than the United States? We used to think this was a result of American anti-government sentiment, which produced a government too small to redistribute income or to attend to the needs of the poor.
But over the past three decades scholars have discovered that our government wasn’t as small as we thought. Historians, sociologists and political scientists have all uncovered evidence that points to a surprisingly large governmental presence in the United States throughout the 20th century and even earlier, in some cases surpassing what we find in Western Europe.
For example, European banks did not have to contend with regulations separating commercial and investment banking, as American banks did under the Glass-Steagall Act of 1933. Until the 1980s, taxes on capital income were higher in the United States than in most European countries, where taxes on labor were and still are higher. U.S. bankruptcy law has been harder on creditors and easier on debtors than any of the countries of Europe, even after bankruptcy reform here in 2005.
Or consider the famous case of the thalidomide babies in the late 1950s and early 1960s. Thalidomide was a drug given to pregnant women for nausea. It caused devastating birth defects, from stunted limbs to spina bifida, and many babies died. Thalidomide was widely available in Europe and produced thousands of cases of birth defects there.
But the Food and Drug Administration kept thalidomide off the U.S. market, successfully using aggressive governmental intervention to protect children from a pharmaceutical company with a dangerous product. They would be in their early 50s now, those babies saved by the FDA. I wonder sometimes how many of them are walking around today complaining about big government.
But if Europe has been so favorable to business, how did it end up with lower poverty and inequality rates? To understand this, we have to let go of the idea that governments are the opposite of markets, or that welfare spending kills capitalist production. European countries do have larger public welfare states, and this brings down their poverty and inequality rates. But in return, European corporations received a gift: a political economy biased against consumption and geared toward production.
Beginning after World War II, Germany, France and several other countries aimed to restrain private consumption and channel profits toward export industries, in a bid to reconstruct their war-devastated economies. Loose regulation was part of this business-friendly strategy. Some scholars have even called these European policies “supply side,” in that they focused on incentives for producers, at the expense of demand-side measures that would benefit consumers. They were one ingredient in Europe’s spectacular postwar growth.
The United States, on the other hand, developed a consumer economy based on government-subsidized mortgage credit, a kind of “mortgage Keynesianism.” Increasing consumption was a Depression-era response to a problem that puzzled observers at the time.
On the one hand, unemployment and hunger were everywhere. On the other, the government was actively engaging in crop destruction to raise prices — like the great pig slaughter of 1933, in which millions of piglets and pregnant sows were destroyed so that hog prices would go up. In the words of Huey P. Long, the populist governor and senator of Louisiana: “Why is it? Why?
Too much to eat and more people hungry than during the drought years; too much to wear and more people naked; too many houses and more people homeless than ever before. Why? This is a land of super-abundance and super-plenty. Then why is it also a land of starvation and nakedness and homelessness?”
The true answer to Long’s question — at least as far as we understand it today — is that a restricted money supply was constraining the economy. But observers at the time thought that the problem was that wealth was concentrated in so few hands that consumers did not have purchasing power to buy the goods that lay rotting in the fields. Increasing consumer purchasing power became the paradigm that drove economic policy during the New Deal and for decades after.
A central element of this was increasing homeownership by encouraging citizens to take on large debts for the purchase of homes, beginning with the creation of the Federal Housing Administration under Franklin D. Roosevelt. Roosevelt thought the FHA could revive the economy; the chairman of the Federal Reserve at the time called it “the wheel within the wheel to move the whole economic engine.” Where Europeans focused on restraining consumption, Americans saw consumption as the machine that drives growth — and we still do.
Understanding this fundamental divergence between the United States and Europe sheds new light on several episodes of recent history. It suggests that in the 1980s, when Ronald Reagan tried to deregulate industry, he was actually pushing the United States in the direction of Europe. He was successful to some degree, although partly because European regulation moved in our direction as much as we moved in theirs. This history also explains the current resistance in Europe, especially Germany, toward Keynesian stimulus.
One might imagine that countries with large welfare spending would be happy to raise spending even more on government programs. But the more fundamental goal of the postwar European political economy has been to rebuild industrial production through a focus on investments and exports. Keynesian spending to stimulate consumption is foreign to this goal.
A consumption bias, economists argue, is not a bad thing, as it leads to cheaper goods for Americans. And after all, someone has to do the consuming — otherwise, whom would the Germans and Chinese export to? But a consumption bias has distributional consequences that we are only beginning to understand. Some studies suggest that it undermines support for the welfare state, because as consumers come to depend on private assets — especially their homes — for their well-being, they appear to become less interested in providing for the welfare of others.
A consumption bias also focuses the efforts of the left on increasing private consumption. It was activists on the left who pushed for greater credit access for African-Americans and women in the 1960s and 1970s, and rightly so, because if credit is how Americans make ends meet, then those without access to credit are economically sidelined. But credit access does nothing for the truly poor, those who are not deemed creditworthy. Someone has to do the consuming, but if one country ends up as the world’s consumer for a long time, as America has, a political tradition can take root that works against the interests of the poor.
Pointing out all the ways in which the U.S. government has been more interventionist than European governments seems to alarm partisans on both the left and the right. Activists on the right can no longer pretend that U.S. history is about small government. Those on the left are equally alarmed, because pointing out the ways in which the government has been hostile to business can undermine their calls to be even more hostile to business.
But poverty reduction is not about hostility to business. It’s about strategies like promoting saving over borrowing. We don’t need regulations as loose as postwar Europe’s, but if reducing poverty and inequality is the goal, we do need to rethink our love affair with consumption.
Monica Prasad, an associate professor of sociology and faculty fellow in the Institute for Policy Research at Northwestern University, is the author of “The Land of Too Much: American Abundance and the Paradox of Poverty.”