If you have any doubts about how easy it is for someone who works hard in the US to get ahead, consider this factoid from Martin Wolf’s latest comment in the Financial Times, on Raghuram Rajan’s new book (see Satyajit Das’ review here:
Thus, Prof Rajan notes that “of every dollar of real income growth that was generated between 1976 and 2007, 58 cents went to the top 1 per cent of households”.
It isn’t merely stunning, it’s destructive.
Rajan isn’t the first to put together the story line recounted by Wolf, but it is likely that his book does it in a more comprehensive fashion. We noted that Thomas Palley (along with others) was writing about the change in economic policy and the drivers of growth in 2007. He argued that policy-makers retreated from full employment as a goal, since it allows workers to demand higher wages, which in turn causes inflation. Reducing worker bargaining power led to disinflation, lower interest rates led to rising asset prices, which in combination with financial innovation, created an until-recently reinforcing cycle whereby rising asset prices funded consumption. Palley further contended that this was inherently a self-limiting paradigm, and we had reached the end of the road. A host of others, such as Steve Waldman in 2008, described the dangers:
Credit was the means by which we reconciled the social ideals of America with an economic reality that increasingly resembles a “banana republic”. We are making a choice, in how we respond to this crisis, and so far I’d say we are making the wrong choice. We are bailing out creditors and going all personal-responsibility on debtors. We are coddling large institutions of prestige and power, despite their having made allocative errors that would put a Soviet 5-year plan to shame. We applaud the fact that “wage pressures are contained”, protecting the macroeconomy of the wealthy from the microeconomy of the middle class.
Yves here. Wolf’s comment is forceful, yet it contains enough econ-speak that its sense of urgency might be missed by generalist readers. He focuses on deep seated political issues that will make it hard to blaze a path out of our financial stress. The first is that social contracts are breaking down in the US and Europe:
I think of it as the end of “the deal”. What was that deal? It was the post-second-world-war settlement: in the US, the deal centred on full employment and high individual consumption. In Europe, it centred on state-provided welfare.
Yves here. Now some readers may simply snort and say, “Well we can no longer afford that.” But that’s simplistic and misleading. We DID afford it. What led to the change in the deal was the staflationary 1970, which was driven both by a commodity prices (most notably the oil crisis) AND labor baragaining power (workers were able to demand that wages keep pace with inflation, which when inflation got beyond a modest level, meant it started to become self-reinforcing).
So the new program was to reduce workers’ bargaining power, both by combating unions, and by tolerating un and underemployment. Rising worker wages had been seen as crucial to greater prosperity; it was quietly abandoned as a policy goal. But this has profound implications. As rising income inequality demonstrates, the benefits of growth accrued substantially to those at the very top. But absent a few wastrels, people with that level of income are not going to spend as much of their income on consumption as those less well off. Thus (in very crude terms) Keynes’ problem of the paradox of thrift, that the understandable desire of households to save can result in insufficient demand, becomes even more acute when it it pretty much only the rich who are getting richer.
Wolf describes the results:
…a number of significant economies have built their economies around exports. The resultant dependence on foreign demand means the credit-dependence they proudly avoid at home emerges abroad. The constraint upon them is what Prof Rajan describes as a “politically strong, but very inefficient domestic-oriented sector”. The problem is that the countries that used to provide the demand – the US, at world level, or Spain, in the eurozone – have over-indebted private sectors. So we see a zero-sum battle over shares of structurally deficient global demand. This is a threat to survival of the eurozone and even the open world economy…..
The west is not the power it was; its debt-fuelled consumers are not the source of demand they were; the west’s financial system is not the source of credit it was; and the integration of economies is not the driving force it proved to be over the past three decades. Leaders of the world’s principal economies – both advanced and emerging – will need to reform co-operatively and deeply if the world economy is not to suffer further earthquakes in years ahead.
Yves here. I am not terribly optimistic about the survival of the “open world economy”. I believe that (absent measures like Keynes’ Bancor proposal) large trade flows over time produce destabilizing international capital flows. Citizens are not prepared to suffer sudden, dramatic losses of savings and high odds of unemployment or reduced income in the name of world trade. Containing the downside would require a considerable loss of national sovereignity, which again few are prepared to accept.
Moreover, much of America seems blithely unaware of our diminished role in the world. Likewise, financiers, having wrested massive concessions from national governments (bailouts with almost no concessions demanded of them) if anything view themselves as even more influential than before the crisis. In other words, both the distorted self image of key players and a reluctance to admit the deep seated nature of the problems make a happy resolution unlikely.