Donald Trump was elected President a year ago because the white working class is angry about a lot of things, including slow wage growth. The tax burden in the U.S. is lower than in other developed countries and wages are higher in the U.S. even if they are not rising fast enough. The Brookings Institute has carefully analyzed the wage growth issue, here and here, and has delineated several reasons for wage stagnation:
Compensation has lagged behind productivity growth. This is largely due to globalization and technology which has put upward pressure on skills and downward pressure on wages.
Benefits have grown faster than wages, thus holding down wages. The skyrocketing cost of healthcare is mostly responsible for this.
Labor’s share of income, compared to capital’s, has been shrinking. Technology needs less low skill labor. Also, market concentration, i.e. monopoly power, has been increasing, which increases profits and therefore return on capital.
Wage gains have been higher in the higher wage quintiles. This is explained by the increasing wage benefit of more education and higher skill levels.
Manufacturing output is up and employment is down. High technology needs fewer low skill workers and high skill workers are in short supply.
Entrepreneurship, i.e. new business formation, has declined over the past several decades. This is caused by increased business consolidation and would also be relieved by more immigration of high skilled workers.
Labor market slack has declined since the Great Recession. This bodes well for wage increases which are now starting to occur.
Labor productivity growth since the Great Recession has been especially slow. What is needed is increased business investment which is the justification for the current push for lower corporate and business tax rates.
Conclusion. In short, what is needed to boost wages is better education and skills, more business investment, control of the surging cost of healthcare, better trust busting to break up monopolies, and more high level immigration.
“If stupidity got us into this mess, why can’t stupidity get us out?”
Will Rogers, 1879 – 1935
The Financial Crisis of 2008 and the subsequent Great Recession, from which we are still slowly emerging, is the greatest shock to our fiscal and economic health since the Great Depression of the 1930s. There are many explanations available for what happened, the most believable ones being written by the major participants themselves. My favorite reference for these events is the book, “Bull by the Horns,” written by the former Chair of the Federal Deposit Insurance Corporation, Sheila Bair, who held this post from 2006 – 2011. Ms. Bair could see the crisis coming. She interacted with all of the prime players but was too late on the scene, and with too little clout, to have a major effect on the outcome. Another persuasive account is provided by Richard Kovacevich, Chairman Emeritus of Wells Fargo, in a recent speech, “The Financial Crisis: Why the Conventional Wisdom Has It All Wrong.” According to Mr. Kovacevich:
Forcing all large banks to take TARP funds, in October 2008, even if they didn’t want or need the funds, was one of the worst economic decisions in the history of the U.S.
If Bear Stearns had been allowed to go bankrupt in March 2008, Lehman Brothers would have been sold and the subsequent financial crisis greatly reduced. A total of just 20 financial institutions caused the crisis, half investment banks and half savings and loans, yet 6000 commercial banks are being punished by Dodd-Frank.
Dodd-Frank does not address the major causes of the recent crisis and offers few approaches to prevent the next one.
Since regulatory agencies are not capable of using the authority they already have to prevent failures, we need a regulatory system which limits the damage of failures. In case of failure, all creditors, other than insured depositors, should take a “haircut”.
Requiring excessive levels of capital will only cause financial institutions to take on greater risks. If equity and long term debt, at both the bank and bank holding company levels, is required to be maintained at 30% of assets, it is unlikely that the FDIC will ever incur losses.
The quasi-private/public agencies Fannie Mae and Freddie Mac need to be abolished.
The Glass-Steagall Act, passed in 1933 and repealed in 1999, should not be reinstated because investment banking is far less risky than commercial banking, and therefore the two forms of banking need not be separated.
There are three warning signs when a financial institution is approaching the danger zone: concentration of risk, inadequate liquidity and significant exposure to capital markets. Competent regulators, not Dodd-Frank, are needed to address these risks.
Recoveries from past recessions have been much more vigorous than our anemic 2.2% rate of GDP growth for the past five years. Mr. Kovacevich believes that because of the Dodd-Frank legislation, and the current monetary policies of the Federal Reserve, the bottom 25% of Americans on the economic ladder have restricted access to mortgages and personal loans. This is inhibiting economic growth and contributing significantly to the inequality gap.
Why has the recovery from the Great Recession of 2007 – 2009 been so slow? Many mainstream economists blame structural problems in the economy such as more global competition for business and technological progress which replaces people by machines. Other economists blame greatly increased government regulation since 2009 such as the Affordable Care Act in healthcare, The Dodd-Frank Act for finance and many new regulations from the Environmental Protection Agency. The economist Casey Mulligan, writing in yesterday’s Wall Street Journal, “A Recovery Stymied by Redistribution”, makes a case that government programs designed to alleviate the effects of the recession have made it deeper and more prolonged. Such actions include:
Long-term unemployment insurance
Looser restrictions on food stamps which do not require recipients to seek work
Mortgage assistance programs which set mortgage payments at “affordable” levels
New rules for consumer bankruptcy with special emphasis on current earnings
Mr. Mulligan’s point is that all of these new programs, like taxes, reduce incentives to work and earn.
But, by definition, structural effects are endemic and can’t be overturned. Also, some government reaction to the financial crisis, in order to prevent recurrence, was inevitable. And it is natural for the government to be responsive to the human misery caused by the recession. All of these points of view help us understand what has happened but don’t provide much guidance for boosting economic growth going forward.
The Great Recession was fundamentally caused by the bursting of the housing bubble which destroyed trillions of dollars of wealth for tens of millions of Americans. The recovery won’t speed up until many more millions of consumers feel comfortable in spending more money. We need to put more money in their pockets.
A very good way to accomplish this, as I have been saying over and over again, is through fundamental tax reform. The idea would be to lower individual income tax rates for everyone, and pay for this by closing the loopholes and deductions which primarily benefit the wealthy. This will put big bucks in the hands of the two-thirds of Americans who do not itemize their deductions. Since these are the middle and lower income wage earners whose wages have been stagnant for many years, they will spend this new income in their pockets thereby giving the economy a big boost.
Let’s do it!
The occasion of the publication of Timothy Geithner’s book “Stress Test,” giving his version of the financial crisis, has led to a number of newspaper articles looking back at the Great Recession and its aftermath. The New York Times’ economics reporter David Leonhardt has such an analysis “A Rescue That Worked, But Left a Troubled Economy” in today’s NYT. “The Great Depression created much of modern American government and reversed decades of rising inequality. Today, by contrast, incomes are rising at the top again, while still stagnant for most Americans. Wall Street is flourishing again.”
“The financial crisis offered an opportunity to change this dynamic. But the (Dodd-Frank) law seems unlikely to transform Wall Street, and the debate over finance’s huge role in today’s economy will now fall to others. Should the banks be broken up? Should the government tax wealth? Should the banks face higher taxes?”
In my opinion, the real problem is not our financial system but the strong headwinds which are slowing down the economy.
Globalization of markets which creates huge pressure for low operating costs.
Labor saving technology which also puts downward pressure on wages.
Women and immigrants having entered the labor market in huge numbers, and therefore greatly increasing the labor supply.
The loss of wealth in the Great Recession also means that even people with good jobs have less money to spend. What we sorely need is faster economic growth to create more jobs and higher paying jobs. How do we accomplish this?
The best way to boost the economy is with broad-based tax reform to achieve the lowest possible tax rates to put more money in the hands of the working people who are the most likely to spend it. Such lower rates can be offset by closing the myriad tax loopholes and at least shrinking, if not completely eliminating, tax deductions which primarily benefit the wealthy.
Lowering corporate tax rates, again offset by eliminating deductions, providing a huge incentive for American multinational companies to bring their profits back home for reinvestment or redistribution.
With millions of unemployed and underemployed workers, reviving our economy with a faster rate of growth should be one of the very top priorities of Congress and the President. Survey after survey show that this is what voters want. Why isn’t it happening?
Two of my favorite columnists are the Brooking Institution’s William Galston, a social economist who has a weekly column in the Wall Street Journal and the economics journalist Robert Samuelson who writes for the Washington Post. Most people agree that income inequality in the U.S. is steadily getting worse. Mr. Galston make a good case (see my last post) that it is primarily caused by the large gap between the rising productivity of American workers and the stagnant level of their pay which has developed since 1973. He thinks that we need a fundamentally new social contract which links worker compensation to productivity. This, of course, is a tall order and it is not at all clear how such a new order would be achieved. Mr. Samuelson has a different perspective: “Myth-making about Economic Inequality”. For example:
The poor are not poor because the rich are rich
Most of the poor will not benefit from an increase in the minimum wage because only 6% of the 46 million poor people have full time jobs
All income groups have gained in the past three decades, even though the top 1% has gained the most (see the above chart from the CBO, December 2013)
Widening economic inequality did not cause the Great Recession
These two perspectives on inequality are quite different but not contradictory. Basically what Mr. Samuelson is saying is that we have to be careful in how we address this problem or we’ll just make it worse. Raising taxes on the rich is unlikely to help and might hurt if it slows down the economy. Raising the minimum wage will only raise a fairly small number of people out of poverty and may cause a lot of unemployment along the way.
My solution: focus on boosting the economy to create more jobs in the short run (tax reform, immigration reform, trade expansion) and improved educational outcomes for the long run (early childhood education, increasing high school graduation rates, better career education).
But I agree with Mr. Galston that it is imperative to lessen income inequality, one way or another. Otherwise as a society we’ll have big trouble on our hands.
Many political commentators have been complaining recently about the financial difficulties of the American middle class. For example, a recent report from Bill Moyers and Company, “By the Numbers: The Incredibly Shrinking American Middle Class”, has a chart showing that the median middle class salary, adjusted for inflation, is now no better than it was in 1989 and not much higher than in 1979: But there is another point of view, very well described by the two economists, Donald Boudreaux and Mark Perry, in the Wall Street Journal just about a year ago, “The Myth of a Stagnant Middle Class”. They make several pertinent points:
The Consumer Price Index overestimates inflation by underestimating the value of improvements in product quality and variety.
Wage figures ignore the rise over the past few decades in the portion of worker pay taken as (nontaxable) fringe benefits. Health benefits, pensions, paid leave, etc. now amount to almost 31% of total compensation according to the Bureau of Labor Statistics.
The average hourly wage has been held down by the great increase of women and immigrants into the workforce over the past three decades. Because the economy was (before the Great Recession) so strong, it created millions of jobs for the influx of often lesser skilled workers into the workforce.
Messrs. Boudreaux and Perry point out several other improvements in the quality of life which Americans enjoy:
Life expectancy has increased to 79 years for an American born today, five years longer than in 1980. And the gap in life expectancy between whites and blacks has narrowed.
Spending by households on the basics of food, housing, utilities, etc. has shrunk from 53% of income in 1950, to 44% in 1970 to 32% today.
Although income inequality is rising when measured in dollars, it is falling when measured in terms of our ability to consume. For another example, air travel is now as common as was bus travel in an earlier era. And another: the latest electronic products are available to even middle class teenagers.
Conclusion: We should stop complaining about inequality and thank our lucky stars for the free enterprise system which has been so successful in improving our quality of life.
The economist Joseph Stiglitz has an Op Ed column in today’s New York Times, “In No One We Trust”, blaming the financial crisis on the banking industry. “In the years leading up to the crisis our traditional bankers changed drastically, aggressively branching out into other activities, including those historically associated with investment banking. Trust went out the window. … When 1 percent of the population takes home more than 22 percent of the country’s income – and 95 percent of the increase in income in the post-crisis recovery – some pretty basic things are at stake. … Reasonable people can look at this absurd distribution and be pretty certain that the game is rigged. … I suspect that there is only one way to really get trust back. We need to pass strong regulations, embodying norms of good behavior, and appoint bold regulators to enforce them.” Mr. Stiglitz is partially correct. Although the housing bubble, caused by poor government policy – loose money, subprime mortgages, and lax regulation – was the primary cause of the financial crisis, nevertheless, poorly regulated banking practices made the crisis much worse. But this is all being fixed with Dodd-Frank, a just recently implemented Volker Rule, and a soon coming wind-down of Fannie Mae and Freddie Mac. Mr. Stiglitz concludes, “Without trust, there can be no harmony, nor can there be a strong economy. Inequality is degrading our trust. For our own sake, and for the sake of future generations, it is time to start rebuilding it. But how do we reduce the inequality in order to restore the trust which is necessary for a strong economy? Mr. Stiglitz doesn’t say! What we need is faster economic growth in order to create more new jobs. The last four years have demonstrated that the Federal Reserve can’t accomplish this with quantitative easing. It needs to be done by private business and entrepreneurship. Tax reform and the easing of regulations on new businesses is what we need. It’s too bad that ideological blinders prevent so many people from understanding this basic truth!
A recent article in Bloomberg View by Cass Sunstein, “How Did the 1 Percent Get Ahead So Fast?“, discusses the significance of new research by the economist Emmanuel Saez, ”Striking it Richer: The Evolution of Top Incomes in the United States”. Referring to Saez’s table and chart below, the conclusion is that income inequality has been getting steadily worse since the early 1980s and has been especially pronounced since June 2009 when the Great Recession ended. In particular, 95% of all income gain in the last four years has gone to the top 1%. This is a much greater disparity than during the so-called Clinton Expansion, from 1993 – 2000 (45% to the top 1%) or during the Bush Expansion, from 2002 – 2007 (65% to the top 1%). According to Mr. Sunstein, “one point is clear: through 2012 the gains from the current recovery were concentrated among the top 1 percent, and that pattern, extreme though it is, fits with a general surge in economic inequality over the last 40 years.” But there is more to the story! Looking at the final chart, just above, it is clear that the economy grew much faster during the Clinton Expansion than during the Bush Expansion, and, in turn, much more slowly during the Obama Recovery. In other words, the way to reduce inequality is to speed up economic growth. There are tried and true ways to speed up growth (e.g. tax reform with lower rates, emphasis on deregulation, boosting entrepreneurship, etc.). It is unfortunate that too many in Congress, as well as the President have ideological blinders which prevent them from moving in this direction!
Today’s Wall Street Journal has a story “Job Gap Widens in Uneven Recovery”, which shows how unbalanced the economic recovery is. For workers aged 25 and older, unemployment is only 6%, compared to the overall unemployment rate of 7.3%. But for the young, ages 16 – 24, unemployment is 15%. Since the end of the recession in June 2009, wages have risen by 12% for the highest paid 25% of all workers. For the lowest paid 25%, wages have only risen by 6% over this time period.
“Households earning $50,000 or more have become steadily more confident over the past year and a half. Among lower income households, confidence has stagnated. The gap in confidence between the two groups is near its widest ever. That isn’t only bad for those being left behind. It’s also hurting the broader recovery, because it means families are able to spend only on essential items. Consumer spending rose just .1% in September 2013, after adjusting for inflation.”
Unfortunately, this data is entirely consistent with other gloomy economic trends which I have been reporting on recently such as the threat of technology to the middle class, the increased competition from globalization, and the shrinking size of the labor pool because of baby boomer retirements.
The New York Times has a running series of articles on “The Great Divide” and how to address it. Here is a clear cut example of this divide: how older, better trained and more affluent Americans are recovering from the recent recession more quickly than the less well off. This evident unfairness is damaging to the health of our society. The question is how do we address it in an effective manner?
The basic problem is the overall slow growth of the economy, about 2% of GDP per year, since the recession ended in June 2009. There are many things that policy makers can do to speed up this growth if they were only able to set aside ideological differences. The best single action by far is tax reform, for both individuals and corporations, lowering overall rates in exchange for reducing deductions and loopholes which primarily benefit the wealthy.
Here is yet another reason why it is so important to speed up the growth of our economy. How exasperating that our national leaders cannot figure out a way to come to together and get this done!
My previous post, two days ago, introduced a new book by two economists, John Dearie and Courtney Geduldig, “Where the Jobs Are, Entrepreneurship and the Soul of the American Economy”. They make a very strong case that net job creation comes primarily from businesses less than one year old, true “start-ups”. But, unfortunately, there has been a huge drop off in the number of new businesses created each year since 2007 and, furthermore, the historical average of seven new jobs created by a firm in its first year has now fallen to less than five.
How do we reverse this alarming trend? Here is what the authors have learned from the many entrepreneurs they have talked to:
“Not enough people with the skills we need”
“Our immigration policies are insane”
“Regulations are killing us”
“Tax payments can be the difference between survival and failure”
“There’s too much uncertainty and it’s Washington’s fault”
Although there are 24 million Americans either unemployed or underemployed, there are also 3 million advertised high skill job openings going begging and many more potential jobs available for qualified individuals. A greater emphasis on STEM (Science, Technology, Engineering and Mathematics) education in the U.S. would help. But also immigration reform is urgently needed. The Senate has passed legislation to raise the annual cap on H1-B visas (for high skilled workers) from 65,000 currently to 110,000. Hopefully the House will concur.
A Preferential Regulatory Framework for New Businesses could be devised to help fragile new businesses in their first five years. A Regulatory Improvement Commission could be created to streamline the entire federal regulatory process. Likewise a Preferential Tax Framework for New Business should be created and could, for example, recommend taxing income for the first five years at a much lower rate than normal.
Regarding policy uncertainty the authors refer to the U.S. Economic Policy Uncertainty Index which is at a very high level since the Great Recession. Economic uncertainty obviously discourages business growth.
Conclusion: A very good way to boost the economy and create more new jobs is to put greater emphasis on supporting entrepreneurs who are trying to start new businesses. There are a number of concrete actions that the federal government can take to do this and doing so should be a very high priority for our national leaders.