The March 2026 AIER Business Conditions Monthly (BCM) points to a mixed, still uneven economic outlook. Forward-looking data improved from the prior month, though not convincingly; measures of current activity were somewhat firmer; and lagging indicators remained the strongest of the three categories. At the same time, at least one data point in the coincident group appears unusually large relative to the surrounding series, so the month’s results should be read with some caution.

LEADING INDICATOR (50)

The Leading Indicator came in at 50, with six of 12 components improving, none unchanged, and six deteriorating. Positive movement was spread across several demand-sensitive and forward-looking series. US Average Weekly Hours All Employees Manufacturing SA rose 0.2 percent. US Initial Jobless Claims SA fell 5.1 percent and counted as a positive after inversion. Conference Board US Leading Index Manufacturers’ New Orders Consumer Goods and Materials increased 0.7 percent. Conference Board US Manufacturers New Orders Nondefense Capital Goods Ex Aircraft advanced 4.1 percent, US New Privately Owned Housing Units Started by Structure Total SAAR rose 4.9 percent, and Adjusted Retail and Food Services Sales Total SA increased 1.8 percent.

Those gains were offset by weakness elsewhere. University of Michigan Consumer Expectations Index fell 8.7 percent, while Conference Board US Leading Index Stock Prices 500 Common Stocks declined 3.4 percent. Inventory to Sales Ratio Total Business eased 0.8 percent, United States Heavy Trucks Sales SAAR dropped 2.4 percent, and Debit Balances in Customers Securities Margin Accounts decreased 2.6 percent. The 1-Year to 10-Year US Treasury Yield Spread widened 43.0 percent, but because that measure is one of the inverted series, it was scored negatively.

On balance, the leading data suggest an economy that is not uniformly weakening, but still lacks broad-based thrust. Strength in orders, housing, and retail activity was offset by softness in sentiment, equities, and selected financial indicators.

ROUGHLY COINCIDENT INDICATOR (58)

The Roughly Coincident Indicator registered 58, with three of six components improving, one essentially unchanged, and two declining.

The strongest contributions came from Conference Board Coincident Manufacturing and Trade Sales, up 1.5 percent, and Conference Board Consumer Confidence Present Situation SA, up 4.5 percent. US Employees on Nonfarm Payrolls Total SA also posted a large increase in the file and scored positively. Conference Board Coincident Personal Income Less Transfer Payments was effectively unchanged, rising just 0.05 percent. Offsetting those gains, US Industrial Production SA declined 0.5 percent, and US Labor Force Participation Rate SA edged down 0.2 percent.

The roughly coincident data were somewhat better than the leading group in March, but the picture remains uneven. Current activity measures show some resilience, though the unusually large payroll increase in the workbook may reflect a reporting or data-entry issue and may overstate the apparent strength of the group.

LAGGING INDICATOR (83)

The Lagging Indicator stood at 83, with five of six components improving and one declining.

Most lagging series moved in a direction associated with continued underlying firmness. US CPI Urban Consumers Less Food and Energy YoY NSA increased 5.6 percent. US Commercial Paper Placed Top 30 Day Yield rose 1.5 percent. Conference Board US Lagging Commercial and Industrial Loans advanced 0.7 percent, and US Manufacturing and Trade Inventories Total SA rose 0.9 percent. Conference Board US Lagging Avg Duration of Unemployment fell 1.6 percent and was scored positively because it is inverted. The only declining component was Census Bureau US Private Construction Spending Nonresidential SA, which slipped 0.1 percent.

Overall, the lagging data continue to depict an economy still carrying momentum from prior conditions. Even so, because lagging indicators tend to confirm rather than anticipate turning points, their relative strength does not fully offset the more divided message coming from the leading and coincident indicators. 

DISCUSSION (April/May 2026)

April’s inflation data suggest that the Iran conflict is pushing headline prices higher, but the broader inflation picture remains more contained than the top-line figures imply. Headline CPI rose 0.64 percent in April following March’s 0.87 percent increase, while headline PCE climbed 0.66 percent in March, driven largely by gasoline prices, which surged more than 20 percent amid the conflict. Beneath the surface, however, core inflation remained comparatively restrained: core CPI rose 0.38 percent, though much of that reflected a temporary jump in rents tied to delayed Bureau of Labor Statistics housing surveys following last fall’s government shutdown. Excluding that shelter distortion, core inflation would have been materially softer, while core PCE — the Fed’s preferred gauge — slowed to 0.29 percent as weaker goods inflation offset firmer service categories such as health care and air transportation. Producer prices point to mounting supply chain pressures rather than overheating demand, with headline PPI jumping 1.4 percent in April as higher fuel, freight, and manufacturing input costs rippled through the economy and firms increasingly moved to protect margins. Still, some PPI components feeding into core PCE, including weaker portfolio management fees tied to March’s equity selloff, are likely to restrain near-term inflation readings.

Labor market data continue to point to an economy that is cooling gradually rather than deteriorating outright, with hiring holding up better than expected even as broader measures of labor demand soften beneath the surface. Nonfarm payrolls rose a stronger-than-expected 115,000 in April, above both consensus expectations and estimates of roughly 50,000 jobs needed to stabilize unemployment, though hiring slowed from March’s upwardly revised 185,000 pace. Private-sector hiring accounted for the gains, while government payrolls continued to edge lower. Most notably, trade, transportation, and utilities emerged as the largest source of job creation, adding 60,000 jobs and overtaking health care as the dominant contributor to employment growth — a development consistent with recent improvements in freight activity, purchasing managers’ surveys, and regional manufacturing data that suggest an emerging recovery in portions of the industrial economy. At the same time, job gains elsewhere were less convincing: manufacturing slipped back into contraction, professional and business services cooled, and information and financial activities shed jobs, likely reflecting a combination of cyclical moderation and structural adjustments tied to automation and artificial intelligence. Wage growth remained subdued at 0.2 percent in April, helping to contain labor-cost pressures, though a modest increase in the workweek pushed weekly earnings higher and supported household income.

Beneath the stronger headline payroll figures, however, several indicators suggest labor-market conditions continue to soften incrementally. The unemployment rate edged up to 4.34 percent in April from 4.26 percent, even as labor-force participation declined, with household-survey employment falling and the number of unemployed rising — a reminder that the pace of job creation required to stabilize unemployment may be materially higher than Federal Reserve assumptions imply. March JOLTS data reinforced the view of slower but still-stable labor demand: job openings declined modestly to 6.87 million, layoffs increased slightly, and the vacancy-to-unemployment ratio remained below pre-pandemic norms, signaling reduced tightness and limited inflationary pressure from labor markets. Yet workers showed somewhat greater confidence than expected, with the quits rate ticking up to 2.0 percent. Weekly jobless claims likewise continue to portray a labor market marked more by stability than stress. Initial claims remained historically low through May, consistently below year-earlier levels, while continuing claims stayed contained and the insured unemployment rate held steady at 1.2 percent. Even as AI-driven restructuring increasingly reshapes hiring patterns — particularly in technology and white-collar occupations — layoffs remain concentrated rather than systemic, suggesting employers are adjusting staffing cautiously rather than retrenching broadly. Taken together, the data point to a labor market that remains resilient in the near term but is gradually losing momentum, supporting expectations that the Federal Reserve will remain on hold for now before potentially easing policy later in the year if unemployment continues to drift higher.

Business activity data continue to point to an economy in expansion, though momentum is becoming increasingly uneven as firms contend with rising costs, softer demand in some areas, and cautious hiring. The ISM Services PMI eased modestly to 53.6 in April from 54.0 — still consistent with moderate economic growth — but underlying details softened meaningfully. New orders fell sharply to 53.5 from 60.6, likely reflecting the fading of earlier pull-forward demand ahead of expected price increases, while employment remained in contraction for a second straight month despite an improvement from March. At the same time, price pressures remained intense and broad-based, with the services prices index holding at 70.7 — among the highest readings since 2022 — as firms increasingly cited diesel, gasoline, fuel surcharges, and tariff-sensitive materials as sources of cost pressure. Manufacturing also remained in expansion territory, with the ISM Manufacturing PMI unchanged at 52.7, though the composition of activity was less encouraging. New orders improved modestly, but export demand weakened, production failed to accelerate materially, and factory employment slipped further into contraction. Supplier deliveries slowed, likely reflecting Iran-war-related disruptions and tighter logistics conditions, while the manufacturing prices-paid index surged to 84.6 — its highest level in four years — underscoring mounting pipeline inflation. Taken together, the April ISM reports suggest growth continues but is increasingly constrained by rising input costs, softer demand, and more selective hiring, reinforcing expectations that the Federal Reserve will remain on hold in the near term.

Against a backdrop of still-expanding but increasingly cost-constrained business activity, sentiment data point to growing caution among both firms and households. Small-business optimism remained subdued in April, with the NFIB Small Business Optimism Index edging up only marginally to 95.9 as elevated uncertainty and weakening sales expectations offset modest improvements in profitability and hiring plans. The share of owners expecting stronger real sales over the next quarter fell to its lowest level in a year, underscoring concern that rising prices — particularly for fuel and other inputs — may increasingly weigh on customer demand, while modest improvements in profits appear to be giving some firms room to absorb higher costs through margin compression rather than fully passing them through to consumers. Capital spending and hiring intentions improved slightly but remained historically subdued, reflecting caution around future demand even as labor quality continues to rank among firms’ most persistent challenges. Consumers, meanwhile, grew notably more pessimistic in May, with the University of Michigan sentiment index falling to a record low of 44.8 as elevated gasoline prices and uncertainty surrounding the Iran conflict intensified concerns about the cost of living. Inflation expectations moved sharply higher, with households expecting prices to rise 4.8 percent over the next year and 3.9 percent annually over the next five to ten years, suggesting growing concern that inflation pressures may spread beyond fuel. Measures of current conditions, future expectations, and household finances all deteriorated to record or near-record lows, even as labor-market expectations remained comparatively resilient — helping explain why spending has thus far held up better than confidence. Taken together, the data suggest an economy in which sentiment is weakening faster than underlying activity, with both businesses and households becoming increasingly cautious even as growth continues to hold up in the near term.

Consumer spending data, meanwhile, suggest that households continue to absorb higher costs without materially retrenching, though the composition of spending increasingly reflects pressure from elevated fuel and food prices. Nominal retail sales rose 0.5 percent in April, but with more than 40 percent of the increase driven by higher gasoline expenditures, while retail sales excluding gas rose a more modest 0.3 percent. Even so, underlying demand remained firmer than anticipated: control-group retail sales — a key GDP input — increased a solid 0.5 percent, while restaurants, grocery stores, and online retailers led gains, suggesting consumers continue to spend despite rising cost pressures. Elevated tax refunds and household wealth effects appear to be cushioning activity for now, helping prevent a more meaningful pullback in discretionary spending. Big-ticket purchases, however, show clearer signs of moderation. Light vehicle sales cooled to a 15.92 million annualized pace in April, reflecting affordability pressures from higher gasoline costs, though sales remained above the first-quarter average and growing interest in fuel-efficient and electric vehicles points to some underlying resilience. Housing activity also remained subdued, with existing home sales rising only marginally as elevated mortgage rates, stretched affordability, and rising inventories weighed on demand, while home price appreciation slowed to just 0.9 percent year over year. Consumer spending looks likely to remain resilient in the near term, though higher energy costs are increasingly reshaping spending patterns and weighing on interest-sensitive purchases.

Even as consumer confidence weakens and spending patterns become more selective, business investment and production data suggest firms entered the second quarter on firmer footing than sentiment alone would imply. Industrial production rose a stronger-than-expected 0.7 percent in April following a revised March decline, driven primarily by durable goods output, with motor vehicle production surging 5.3 percent and accounting for roughly one-third of the headline gain. Manufacturing output increased 0.6 percent, business equipment production rose 1.5 percent, and stronger activity in transportation equipment, metals, minerals, agricultural equipment, and electronics pointed to relatively healthy capital spending and industrial demand despite higher energy costs and elevated uncertainty. Softer output in consumer goods excluding autos and energy, alongside declines in mining activity and oil-and-gas drilling, suggests more price-sensitive sectors remain cautious. Productivity data reinforce the picture of a business sector continuing to adapt rather than retrench: nonfarm productivity rose at a 0.8 percent annualized pace in the first quarter, lifting year-over-year growth to 2.9 percent — the strongest reading in two years and consistent with the possibility that technology investment and early AI adoption are beginning to appear in aggregate data. Output growth continued to outpace hours worked, while unit labor costs rose just 2.3 percent annualized, sharply below the prior quarter and easing to 1.2 percent year over year, reinforcing evidence that labor markets are not generating broad inflationary pressure. US firms appear willing to invest and expand production selectively, while stronger productivity growth is helping offset labor costs and cushion the economy against rising input prices and softer consumer sentiment.

The broader policy and financial backdrop points to an economy that continues to expand but faces growing constraints from tighter monetary conditions, elevated inflation risks, and mounting fiscal concerns. Credit availability remains broadly supportive, with the Federal Reserve’s latest Senior Loan Officer Opinion Survey showing only modest tightening in business lending standards, largely stable consumer credit conditions, and some easing in commercial real estate lending terms. Demand for credit, however, has softened in several consumer categories, suggesting borrowing appetite, rather than supply, may increasingly limit activity. The Federal Reserve has recently shifted further in a hawkish direction. Minutes from the April FOMC meeting showed diminishing support for eventual rate cuts, growing discomfort with maintaining an easing bias, and a majority of policymakers indicating further tightening could become appropriate if inflation remains persistently above target. By mid-May 2026, market implied policy rates showed rate market participants placing a 60 percent chance on a one-quarter increase in the Fed Funds rate by December 2026. Energy-related inflation from the Iran conflict, tariffs, supply disruptions, and resilient labor-market conditions have reinforced the Fed’s caution, leaving policymakers in no hurry to ease.

Financial markets have increasingly aligned with this higher-for-longer outlook, though concerns now extend beyond inflation alone. Treasury yields surged in May, with the 30-year yield briefly exceeding 5.2 percent — its highest level since 2007 — as investors reassessed both inflation persistence and the sustainability of US fiscal dynamics. Mounting deficits, rising debt-service costs, and heavier Treasury issuance are increasingly pushing investors to demand greater compensation for holding long-term debt, particularly as higher rates themselves threaten to worsen fiscal pressures. The unusual leadership of the long end of the curve in the recent selloff suggests markets are increasingly pricing fiscal risk alongside monetary restraint. Taken together, the policy outlook points to a Federal Reserve likely to remain on hold for an extended period, balancing elevated inflation risks against the possibility that tighter financial conditions and rising borrowing costs eventually weigh more heavily on growth.

In May 2026, the US economy confronts a difficult but not wholly unfavorable balancing act: robust enough to continue expanding, yet increasingly pressured by higher energy costs, tighter financial conditions, and record levels of policy uncertainty. Headline inflation has been pushed higher by the Iran conflict and energy prices, yet underlying inflation pressures remain more contained than surface-level readings admit; labor markets, consumer spending, and business activity continue to expand despite growing indications of moderation. Households and firms appear to be absorbing higher costs for now — supported by accumulated wealth, stable credit availability, productivity gains, and selective business investment — though confidence has deteriorated notably, and more interest-sensitive sectors such as housing, autos, and portions of discretionary spending are beginning to soften. At the same time, rising long-term Treasury yields, mounting fiscal concerns, and increasingly cautious Federal Reserve rhetoric suggest financial conditions may become a more meaningful headwind in coming quarters, particularly if elevated energy prices persist or inflation broadens beyond fuel and supply-chain-related categories.The near-term growth path remains one of slower but continued expansion rather than outright contraction, with the US economy appearing more vulnerable to policy missteps or external shocks than to an immediate cyclical downturn.

LEADING INDICATOR

ROUGHLY COINCIDENT INDICATORS

LAGGING INDICATORS

CAPITAL MARKETS PERFORMANCE

To Make America Healthy Again, we must first shake up the one-size-fits-all factory model that dominates K-12 education. These years shape children during the most formative period of their lives, laying the groundwork for physical health, mental resilience, and lifelong success. Without a strong foundation built on movement, play, and individual attention, we cannot expect the next generation to thrive. 

The roots of today’s system reach back to the Prussian model of compulsory schooling that the United States imported in the early 1800s. After suffering military defeats, Prussian leaders created the structure to ensure they would never lose another war.  

Schools were engineered to produce obedient soldiers and compliant factory workers, not curious thinkers or healthy citizens. That same rigid structure, devoid of any humanist ideals, still defines American public education two centuries later. 

The Fall of Recess and the Rise of Obesity

Nearly 50 million children, as a rolling average, spend 13 years inside this government-run system. Each day, they sit for seven hours with almost no chance to move or play. Research has demonstrated that some ADHD diagnoses could be caused by adult expectations for children to engage in sedentary activity for long periods.  

Nowhere is the mismatch more obvious than in the dramatic decline of recess. Since the mid-2000s, up to 40 percent of school districts nationwide have dramatically reduced or entirely eliminated recess. Recess time has fallen by 60 minutes since 2001, on average. The driving force behind these cuts was an intense focus on standardized test scores. But science demonstrates that obsession is likely to be counterproductive.  

Research — including the federal government’s own — consistently shows that recess improves attention spans, reduces disruptive behavior, and boosts academic performance. Far from a distraction, unstructured play actually helps children absorb and retain what they learn. 

Students in countries like Denmark, Finland, Japan, and the United Kingdom regularly get breaks after every 45 or 50 minutes of instruction. 

The death of recess has become such a serious concern that the American Academy of Pediatrics released updated guidance on the subject this month – the first revision in 13 years. The new recommendations call for at least 20 minutes of recess and multiple daily breaks, scientifically proven to support both learning and development. 

One in five American children is now obese. This reality makes President Trump’s push to revive the Presidential Physical Fitness Test especially timely. The program encourages schools to treat physical fitness as a core part of education rather than an afterthought. 

I saw this approach in action during a visit to The Academy at the Parc, a microschool nestled in nature in Sebring, Florida. The campus follows a Waldorf-inspired curriculum that emphasizes hands-on projects, regular movement, and fresh meals prepared daily on site. Many families there rely on Florida’s school-choice scholarships to make attendance possible. The difference in energy and focus among the students is unmistakable. 

A similar model thrives at Alpha School in Austin, Texas. Students receive targeted instruction for only a couple of hours each day and devote the rest of their time to hands-on projects and collaborative activities. The results speak for themselves: these children score in the top one percent nationally on academic assessments while staying active and engaged. 

For traditional schools, the problems run deeper than structure and schedule. Public schools are not just failing to educate the minds of children, they’re also having negative impacts on their bodies. The meals served in those same schools often also undermine both physical health and academic achievement.

Medical Overreach in Public Schools

Authoritarians have long viewed compulsory schooling as the ideal vehicle for imposing medical decisions on families without genuine consent. Compulsory vaccination schedules for school attendance, even with limited exemptions for religious and medical reasons, are an especially controversial experiment in school-based social engineering. Those requirements are under review in states that prioritize parental authority and school choice.

During the COVID-19 pandemic, officials in the District of Columbia attempted to require the experimental 2022 vaccine as a condition of enrollment, from Head Start to high school. The data proving students were not at risk from COVID-19 didn’t sway officials. They backed down only when the policy was found to disproportionately exclude minority students, who were less likely to have been vaccinated. Teachers’ unions also prioritized political goals over the wellbeing of students in engineering school closures.

Beyond the sticky questions of vaccinations, an arguably more insidious overprescription crisis in schools has escalated since the advent of No Child Left Behind. Unable to change the educational environment, teachers and school counselors have medicalized childhood impulsivity and increasingly used powerful psychostimulant drugs to alter children until they can conform. Classroom teachers, not pediatricians or even school nurses, are the most likely to suggest an “attention deficit” diagnosis. A growing body of anecdotal evidence suggests children diagnosed with ADHD frequently discontinue medication when they leave traditional schooling and enroll in microschools. 

School vs the The Brain

The one-size-fits-none school calendar virtually guarantees kids will lose much-needed sleep. Early-morning starts are dangerously disconnected from teenage circadian rhythms, and a primary cause of chronic sleep deprivation. Research links sleep disruption generally, and early school start times in particular, to poorer concentration, elevated anxiety and depression, and greater risk of obesity. Nearly all of those are also associated with energy drinks, which many students now rely on. Schools that push their start times later report better attendance, superior academic performance, better physical health, and even fewer car crashes. But ninety percent of public high schools still start before 8:30, contrary to the recommendations of the CDC and the American Academy of Pediatrics.

When discussing the mental burden of public school adolescents, we shouldn’t neglect the ideological and political pressures of the modern classroom. Students report that distress about climate change, national immigration raids, and other distant issues create anxiety and distraction. The school social environment itself can be a source of mental health or behavioral challenges: teen suicides tend to mirror the school calendar, pointing to stress, bullying, and other pressures inside conventional schools. At the other end of that spectrum, assigning administrators to mediate student problems may also reduce opportunities to build psychological resilience. 

The factory school system no longer fits the needs of American families or the health of American children. We must expand school choice, prioritize learning, restore recess, improve nutrition, strengthen physical education, reduce overmedication, build resilience, and protect sleep and play.  

School choice provides the most direct path forward. When families can select microschools or homeschooling programs, children gain far more time for hands-on learning and genuine physical activity. With education freedom, every child has the chance to succeed. No child has to be stuck in a school that’s ignoring best practices. Only by breaking free from the outdated Prussian model can we raise a generation that is both well-educated and truly healthy.

A recent Wall Street Journal article reignited a familiar generational feud between Millennials and Baby Boomers. Drawing on a report by AEI economist Scott Winship, the paper asked which generation had it better — and what unpacking that debate tells us about the health of our modern economy.

Predictably, Millennials and Boomers spun into a frenzy. Millennials cite soaring housing prices, student debt, and federal deficits as forces holding them back. Boomers counter by invoking 1970s stagflation, when skyrocketing inflation and sluggish growth robbed an entire generation of economic opportunity. Both make solid arguments. But in their fury to out-grieve one another, both sides miss the point.

The real question isn’t who had it worse. It’s how we can create the conditions for every generation to have it better. 

The Good News Nobody Wants to Hear

Scott Winship and his coauthor find that when you measure the middle class by purchasing power rather than by relative standing, it hasn’t hollowed out. Just the opposite. The upper-middle class expanded from 10 percent of American families in 1979 to 31 percent by 2024. The share of families too poor to reach middle-class living standards fell from 54 percent to 35 percent over the same period. Despite Millennial groans, the American middle has never been wider.

It’s not only Millennials who reap the benefits of greater economic abundance. The Economist reached a similar verdict about Gen Z, concluding that they are “unprecedentedly rich.” The typical 25-year-old Gen Zer earns an annual household income of over $40,000 — more than 50 percent above what Boomers earned at the same age, after adjusting for taxes, transfers, and inflation. Youth unemployment across the rich world recently hit the lowest point since 1991.

Even the housing and student debt objection doesn’t hold up as cleanly as advertised. In 2022, Americans under 25 spent roughly 43 percent of post-tax income on housing and education combined — slightly below the historical average for that age group from 1989 to 2019.

The Bad News Everybody Hears

Despite these gains, younger Americans face forces that older generations largely didn’t. The median home now costs more than five times the median household income, a ratio that would have seemed dystopian to the generation that bought at two or three times their salary. This explains why the age of first-time homebuyers is now edging above 40, an all-time high.

This imbalance in homeownership is deciding who gets to build wealth through the most reliable vehicle of the American Dream. Baby Boomers hold roughly half of all US wealth, or about $78 trillion, despite representing less than a quarter of the population. In an era before restrictive zoning, Boomers really did have an open door to wealth-building at an earlier age.

A Budget Mismatch

An even starker picture, though, comes from the federal balance sheet. Penn Wharton’s Budget Model recently traced the fiscal footprint of each major demographic group, including the share of federal outlays they receive. Retirees collect $2.7 trillion, or 62 cents of every dollar distributed. Working-age adults (many of them Millennials) get 28 cents. Children and young adults under 26 share 10 cents. On a per-capita basis, the gap is even more pronounced, and the retiree share is projected to only widen as the population ages.

It’s no surprise that older Americans receive an outsized portion of the federal spending pie, as they represent a large and active voting bloc. But what is puzzling is how many in this older demographic assert generational disadvantage, even as they collect a disproportionate share of federal benefits, mostly driven by Social Security and Medicare.

A Pointless Debate?

The generational debate tends to collapse into zero-sum thinking, as if the only remedy is to take from one age group and give to another. That thinking isn’t only unproductive. It’s wrong.

As I’ve argued before, the constraints squeezing younger generations are mostly self-inflicted policy failures, not the inevitable fate of demographic transition. Restrictive zoning and broken permitting systems limit housing supply precisely when young people face their sharpest cost-of-living pressures.

Worse still, the economic damage wrought by uncontrolled federal spending will fall on all generations. U.S. public debt recently crossed 100 percent of GDP for the first time since World War II. Unlike in 1946, there’s no demographic tailwind or peacetime dividend to grow our way out. Penn Wharton projects debt exceeding 190 percent of GDP by 2050. At that point, the generational debate will be long forgotten — replaced by the shared burden of a fiscal reckoning that will impact us all.

Instead of training their sights on each other, Boomers and Millennials — all generations, for that matter — should champion market-based policies that expand opportunity for everyone. Winship’s data put things in a useful perspective: even Americans at the bottom of the income distribution ended up 55 percent richer than their forebears, despite ranking lower in relative terms.

That’s the story worth telling, and one we must continue writing. 

“There is a new world order,” Vice President JD Vance recently declared. “There is a new world order in trade; there is a new world order in globalization.” 

The shift away from the old US-led order is visible in tariff schedules, export controls, energy contracts, investment screening, and trade agreements being built outside the old free-trade consensus. For decades, globalization was sold as a system of American hegemony, open supply chains, and the belief that economic integration would soften political rivalry. China was the ultimate test of that theory. China became richer without becoming Western. Washington’s answer has not been a return to free trade, but the construction of controlled commerce. 

Goods still move, firms still seek markets, and governments still negotiate agreements. What is dying is the idea that trade should be governed primarily by consumers, producers, and prices rather than ministries, security agencies, and negotiated quotas. Free trade is becoming ever more rigidly controlled: managed by states, shaped by security concerns, and increasingly organized through political blocs rather than universal rules of open exchange. 

The Bipartisan Turn Against Free Trade 

The bipartisan turn away from free trade has been a public-policy blunder that favors politically protected industries while neglecting consumers. That is the snowball effect of government intervention: tariffs generate retaliation, retaliation justifies subsidies, subsidies create managed purchase agreements, and managed agreements necessitate new boards, exemptions, and political bargaining. 

The US–China trade war began under Trump in 2018, remained largely intact under Biden, and has escalated further in Trump’s second term. The contrast is striking: while China lowered its average tariffs on the rest of the world from 8.0 percent in early 2018 to about 6.5 percent by early 2022, the United States raised its average tariffs on the rest of the world from 2.2 percent in January 2018 to 18.4 percent today. 

According to PIIE, average US tariffs on Chinese goods stand at 47.5 percent and cover all imports from China, while China’s average tariffs on US goods stand at 31.9 percent. This is no longer temporary leverage. It is structural protectionism. 

The stated justification for tariffs was that they would revive domestic manufacturing. The manufacturing numbers tell a different story. FRED reports that US manufacturing employment stood at 12.596 million in April 2026. That figure remains far below the old industrial-employment base invoked by “Made in America” rhetoric. Tariffs can make industrial revival sound muscular, but they cannot recreate the manufacturing economy of the late twentieth century. Consumers, meanwhile, pay the costs long before the promised factories arrive, if at all.

Roughly a year after Trump’s so-called “Liberation Day” tariff push, the results remain underwhelming: more federal involvement, more uncertainty, and no return to the industrial employment base politicians promised. The contradiction becomes clearest in Washington’s latest China policy. 

Managed Rivalry, Not Free Trade 

The current US-China arrangement shows controlled commerce in practice. The White House presented President Trump’s China summit as a historic breakthrough. China agreed to purchase 200 Boeing jets, with Trump suggesting the order could eventually rise to 750 aircraft. Treasury Secretary Scott Bessent stated, “We’re going to talk about a ‘Board of Investment’ that will be responsible for investment in non-sensitive areas.” 

A second joint organization is in the making, with the White House Fact Sheet stating, “The Board of Trade will allow the United States Government and the Government of China to manage bilateral trade across non-sensitive goods.” On its face, this looks like a diplomatic victory for American manufacturing and global stability. Beneath the triumphal language, however, sits a more revealing reality. This is not free trade, and it is not market competition. It is state-managed bargaining between rival great powers, a cartel logic applied to global commerce. 

Nor was Boeing alone in revealing how corporate access now depends on state diplomacy. Aircraft sales are not being left to open markets alone. They are being negotiated by heads of state, bundled into a broader geopolitical relationship, and tied to questions of supply chains and bilateral stability. The visit, the first by a sitting US president to China in nearly a decade, brought a large corporate delegation to Beijing, including executives from Apple, Tesla, Goldman Sachs, Boeing, Cargill, Visa, Citigroup, Nvidia, BlackRock, and Blackstone. The presence of these firms reveals the contradiction that tariffs promised to bring production home — but the summit was organized around preserving corporate access to China. 

Agriculture shows the same absurdity. In the early trade war, China turned soybeans into a political weapon: after Washington imposed tariffs in 2018, Beijing responded with a 25 percent retaliatory tariff on US soybeans, and US soybean exports to China fell by $9.1 billion that year. A partial recovery in the same sector is being repackaged as a diplomatic victory. US Trade Representative Jamieson Greer has since said he expects “double-digit billion” annual purchases of American agricultural goods over the next three years — roughly restoring the pre-2018 norm. 

The deeper lesson is that farmers are increasingly dependent on diplomatic bargaining rather than open markets, powered by political favor rather than productive capacity or entrepreneurial initiative. China can punish, purchase, or redirect demand depending on relations with Washington. That makes domestic subsidies unavoidable. 

According to the Government Accountability Office, USDA’s Market Facilitation Program provided $23 billion in 2018 and 2019, including $14.4 billion to about 644,000 operations, comprising more than 800,000 individuals. If Chinese purchases resume while subsidies remain, the result is not a restored free market but a but a narrower, more politicized one, with tariffs, subsidies, and politicians deciding who gets rescued.

The Multipolar Response

America’s turn toward managed rivalry forces other powers to insure themselves. As Washington redirects its attention toward China and the Indo-Pacific, Brussels can no longer assume that the old US-led order will organize global trade on its behalf. The result is not isolation, but bloc-building, with the EU–Mercosur and EU-India trade agreements leading the way. 

The EU–Mercosur agreement began provisional application on May 1, 2026, linking the EU with Argentina, Brazil, Paraguay, and Uruguay, creating a trading zone of roughly 700 million people. The agreement supports European exporters by saving firms an estimated €4 billion in customs duties on goods such as car parts, machinery, chemicals, and pharmaceuticals, while also deepening EU access to Latin America’s agricultural products, minerals, and critical raw materials. This is why the European Commission has framed the Mercosur relationship not only as a trade deal, but as part of Europe’s strategy to secure resilient supply chains and reduce strategic dependence.

India offers Europe something Mercosur cannot: scale, services, manufacturing diversification, and Indo-Pacific leverage. After more than a decade of stop-start negotiations, the EU–India agreement is expected to double EU goods exports to India by 2032 and eliminate or reduce tariffs on 96.6 percent of EU goods exports. It is the EU’s most economically significant bilateral trade agreement ever, giving European firms deeper access to the world’s most populous country and one of the fastest-growing major economies. 

Both agreements should be read as geopolitical insurance policies. Europe is not just lowering tariffs; it is securing supply chains, diversifying partners, and building leverage as the United States turns inward and toward Asia. These machinations are not “free trade.” They are negotiated corridors of access, hedged by rules, exceptions, quotas, and strategic objectives. Decades of negotiation, rules of origin, tariff schedules, environmental clauses, quotas, and ratification procedures show that the world is moving away from free trade. 

French President Macron captured the logic clearly: “In the world we live in — with American tariffs and Chinese overcapacity — we must protect our production capacities.” He added that the objective is, “not to be the vessels of two hegemonic powers.” That is the language of bloc strategy. The “secondary” powers are fully aware of the changing status quo. 

The Rise of Managed Globalization in a Multipolar World

Free trade has lost its innocence. The old promise was that open markets would soften rivalry and discipline governments. Instead, the United States tried to liberalize China through trade and found itself managing a powerful rival through tariffs, export controls, aircraft deals, farm purchases, investment boards, and subsidies. Brussels, seeing Washington turn inward and toward Asia, is building its own corridors with Mercosur and India.

This is not the end of globalization, but the end of globalization as a neutral, American-led project. Government intervention, introduced via tariffs, does not stop. Tariffs invite retaliation; retaliation invites subsidies; subsidies invite managed deals; and managed deals invite more bureaucracy. That is controlled commerce: trade still moves, but increasingly through political management rather than open exchange. The world is still trading. It has simply stopped pretending that trade is free from coercive power.

Introduction

This explainer expands upon the earlier AIER explainer “A Brief History of Federal Transfers” by examining the relationship between federal, state, and local governments shaped by transfers and the incentives they create. Transfers enable the federal government to exert influence over state and local policy beyond what direct legislation — or indeed the Constitution — allows.

It outlines the dangers of centralization created by transfers, provides an overview of federal transfers to state and local governments today, and offers solutions for states to minimize their dependence on federal transfers.

Tocqueville’s Evergreen Warning

In his seminal book Democracy in America, Alexis de Tocqueville distinguishes between two types of state centralization. The first type, governmental centralization, occurs when a national government creates “general laws” and deals with foreign affairs. This form reflects a minimal state, protecting person, property, and promises as well as national security. The second type, administrative centralization, occurs when the national government gains power to “regulate the ordinary affairs of society, to rule the diverse parts of the State in the direction of their special affairs, and to be in charge of the daily details of their existence.”

Administrative centralization always fails, Tocqueville argued, because the task “exceeds human power.” No single person has the necessary knowledge to properly manage these affairs, which leads to “incomplete result or exhausts itself in useless efforts.” Furthermore, while it might produce some “great men of history,” administrative centralization is incapable of securing “the lasting prosperity of a people.” Tocqueville writes that in such planning we see “an element of despotism, but not of lasting national strength.” This unique despotism, which he calls “democratic despotism,” destroys a nation’s character by leaving its citizens “irrevocably in childhood; it likes the citizens to enjoy themselves, provided that they think only about enjoying themselves.”

Nearly two centuries later, his warnings are as salient as ever. The federal government involves itself in myriad state affairs and local minutiae, thanks largely to the growing number of federal grants to state and local governments.

Ideally, the relationship between the federal government and the states would be close to what legal scholar Michael Greve calls “Competitive Federalism.” Greve summarizes Stanford Economist Barry R. Weingast’s parameters of “competitive, ‘market preserving’ federalism,” which emphasize:

1. State governments underneath a central government have sufficient authority and independence to compete with other states over “some range” of political and economic policies.
   
2. States control what happens within their borders, but the central government ensures people and goods can move freely between states to avoid “excessive externalities.”
   
3. Transfer payments from the central government to the states are extremely limited.

Today, the US falls short of this model. It suffers from what Greve calls “cartel federalism,” in which the federal and state governments act as “partners in a collective enterprise.” This partnership gives the federal government influence over state and local affairs by using “the production and distribution of rents among politicians, bureaucrats, and concentrated industry sectors.” In return, it softens state and local budget constraints with infusions of federal funds. The result is more centralization and less accountability. Additionally, Greve warns that some forms of decentralization could be pernicious. One such example is the Supreme Court upholding state government interference in national commerce, such as in South Dakota v. Wayfair, Inc. (2018), which permits states to require e-commerce sellers to collect sales tax even if these sellers do not have a physical presence in the state.

In all such cases, the focus is on spending and regulations, rather than solving the problems for which these grants are created in the first place. Despite the clear failings of federal aid, federal policymakers are eager to dole it out and state and local policymakers are eager to accept. The feedback loop reinforces administrative centralization and detracts from individual liberty.

The Constitutional Issues at Stake

The debate over federal transfers reflects a deeper constitutional debate going back to the founding era over the meaning of “promoting the general welfare.” James Madison argued that the meaning of “general welfare” in the preamble must be limited to the Constitution’s enumerated powers. Alexander Hamilton, by contrast, argued for a broader interpretation, claiming that “power ought to be coextensive with all the possible combinations of [the infinite circumstances that endanger the safety of nations].” These two perspectives inevitably carried over into spending and the relationship between federal and state governments.

This same debate entered the discussion of federal transfers in the Supreme Court case South Dakota v. Dole (1987), in which the Supreme Court ruled that Congress may attach conditions to federal funds to influence state policy so long as these conditions promote the “general welfare,” are clearly stated, and are not coercive. In this case, the Court upheld a reduction in highway funding for states that refused to raise the drinking age, calling it “relatively mild encouragement.”

In practice, the Dole framework grants Congress broad latitude to shape state policy indirectly through funding. This issue was revisited in NFIB v. Sebelius (2012), where the Court ruled that threatening states with the loss of all Medicaid funding crossed into coercion. This ruling was narrow and preserved the broader logic of Dole, leaving most conditional funding programs intact.

What appears cooperative is often a system of negotiated dependence, where constitutional doctrine and fiscal incentives work together to shift authority toward the federal government and away from the states.

Why Give Transfers? Why Take Them?

At the federal level, these transfers encourage states to increase spending on issues DC deems important. If state lawmakers were not going to fund something, however, it’s likely because that issue is addressed by the private sector or the costs of such spending exceed any potential benefits.

The “flypaper effect” refers to a phenomenon of states using federal aid for its targeted purpose (i.e., education), only partially reallocating funds to tax cuts or other spending. Evidence is mixed, but the flypaper effect appears strongest wherever interest groups are highly active at the state level and/or where federal grants require matching state funds.

From a political economy perspective, this outcome is predictable. Policymakers respond to incentives embedded in institutional rules. Conditional funding allows Congress to expand influence without a direct mandate, while states adjust policies to secure federal dollars.

Federal transfers also create a transactional form of governance. “There’s a very great danger,” Philip Hamburger comments, “that all institutions will end up being aligned under centralized control” due to the influence of federal transfers with conditional funding.

When federal aid comes into the picture, decision-making becomes distorted. Federal transfers allow states to export some of their burden of funding their own budgets to taxpayers across the country. The cost of spending a dollar is now much less than a dollar for state taxpayers. As a result, states will overspend on federally subsidized activities (especially those that support interest groups) and underspend on other budget priorities, regardless of how state residents value that spending.

The goal of increasing spending to maximize federal dollars also invites a lapse in program security, inviting fraud and abuse. At the beginning of 2026, the federal Department of Health and Human Services froze childcare and family assistance in five states over fraud concerns. Additionally, when federal transfers to the states discourage states from auditing programs for waste, fraud, and abuse, taxpayer dollars get wasted while dependence on the federal government increases. This scenario occurred while the federal COVID-19 stimulus packages were passed, particularly with unemployment insurance and Medicaid. This gave the federal government greater control over these programs and their respective sectors of the economy (i.e., healthcare) while taxpayers must sacrifice additional income to cover the losses these programs incurred.

It also encourages state policymakers to shift costs from their own budgets onto federal balance sheets. This results in many states having the appearance of strong fiscal health while being propped up by federal funds. If federal transfers decrease, many states and cities are likely to experience budget crises.

Jonathan Rodden’s analysis of fiscal federalism finds that this is a predictable outcome of institutional design. Rodden finds that when subnational governments depend on transfers while retaining borrowing and spending autonomy, they can expand programs without fully bearing the cost, also known as a “soft budget constraint.”

Political incentives reinforce this behavior. Policymakers respond to the fiscal rules they operate under as actors that want to maximize resources and avoid hard tradeoffs. When spending decisions are made locally but financed nationally, each state will try to draw as much as possible from federal funds while spreading the costs across the national tax base.

The result is a system that quietly builds fiscal distress beneath a veneer of stability.

The Twenty-First Century: An Era of Federal Dependence

“A Brief History of Federal Transfers to the States” covered the history of federal transfers from the Founding to 1980, but the story continues after the Great Society. A brief respite from ratcheting federal transfers, known as the “Devolution Revolution,” consolidated 77 categorical grants and two block grants into 9 block grants under the Omnibus Budget Reconciliation Act of 1981. Despite this consolidation, federal transfers, particularly for entitlements, continued relatively unabated.

In 1995, the Unfunded Mandate Reform Act brought hope to limiting federal unfunded mandates on state and local governments and the private sector, but its scope was extremely limited, excluding most federal grant conditions and preemptions. By 2000, 653 aid programs to the states existed. Throughout the presidencies of George W. Bush, Barack Obama, and Donald Trump, these programs and their spending steadily increased in the years leading up to the pandemic in 2020.

In 2020 and the years following, state dependence on federal funds increased 63 percent from 2019 to 2021 (the peak of federal transfers during the COVID-19 economic contraction). Even after these programs were reduced, federal spending on state and local governments in 2023 is still $200 billion (constant 2017 dollars) greater than in 2019. Projections from the Congressional Budget Office also anticipate federal transfers to state and local governments to resume a steady increase from 2026-2036. Increased strains on the federal budget, however, will inevitably lead to cuts to state transfer payments (as is being heavily debated in discussions of Medicaid reform) resulting in state governments scrambling to cover billion-dollar funding shortfalls. State policymakers will then likely finance those budget shortfalls with debt to avoid political backlash. Figure 1 shows the average state expenditures as a percentage of total spending since Fiscal Year 1991.

Figure 1: State Expenditures by Type as a
Percentage of Total State Expenditures (50 State Average)

Note: These totals include capital spending. Shaded areas indicate periods of recession.

Source: National Association of State Budget Officers (NASBO) State Expenditure Report Historical Data, FRED Database (for inflation indicator), and Author’s Calculations

Hopes of reducing federal influence over states were dashed as both FY 2023 and 2024 state budgets saw a severe decline in revenues. This has meant prolonged dependency on federal taxpayer dollars, which federal policymakers are happy to provide in exchange for submission. While federal funding returned to second place in 2023, nearly one third of the average state spending comes from federal transfers. This gives the federal government a large influence over state policy and softens budget constraints for state policymakers.

Such demands for state submission may occur at unexpected times. In late 2025, Indiana legislators discussed redistricting efforts, with many rejecting a plan proposed by President Trump. In response, a rumor spread of a federal funding freeze (originating from a non-profit outside of the government) if Indiana failed to pass the redistricting map. The mere rumor of such a threat stoked fierce debate in the Indiana legislature. The redistricting map was rejected, and the rumored threat never materialized. The clear lesson, though, is that states are so dependent on federal funding that they can be scared into compliance.

Breaking the Addiction to Federal Transfers

Fiscal discipline will be the best means for states to prepare for the coming cuts. One successful example is the Financial Ready Utah plan. Implemented in 2013, the plan created the state Federal Funds Commission to monitor the effects of federal grants on the state and required state agencies to develop emergency action plans in anticipation of a 5- to 25-percent cut in federal funding.

Additionally, state policymakers can begin tracking the number and type of federal transfers coming into the state. Recently, Indiana Comptroller Elise Nieshalla began a campaign highlighting how excessive national debt comes from overspending, which has drawn many state legislators and organizations to rally to the cause. Comptroller Nieshalla has also highlighted the dangers in her own state with a data transparency portal, noting that 43.48 percent of Indiana state expenses were paid from federal transfers.

Making the extent of state federal dependence on federal funds clear to the public, and the dangers of such dependence, can help states break free from federal funds.

Conclusion

The growth of federal transfers pushes America further from the ideal federalism rooted in competition and autonomy and emboldens a federalism defined by dependence and centralized control. What began as limited fiscal assistance evolved into a powerful mechanism through which the federal government shapes state and local policy, distorts local priorities, and weakens accountability. As fiscal pressures mount in DC, states face a critical choice: continue down the path of dependency or restore their fiscal independence. Reclaiming autonomy and preserving the decentralized system Tocqueville admired starts with ending the dependence on the federal government.