Job Creation and Our Diminished Economic Engine: The Middle Class

Aug 10, 2011   //   Economy

Over the past 30 years the vast majority of income gains have gone to the wealthiest in our country. In an economy that is 70% personal consumption, we will continue to experience slow recovery and anemic job growth until we more broadly share prosperity and rebuild the purchasing power of our economic engine, the middle class

I became a fan of Robert Reich in the 1990′s when he made the case for a broad based liberal arts education.  His reasoning?  The average American would have at least 5 jobs during their life due to the rapidly evolving employment landscape and needed the skills to adapt.  A bit prophetic as a study conducted earlier this year out of Duke University’s Fuqua School of Business showed that US companies are shipping jobs overseas because of a shortfall of trained labor here (ref) and 15 year olds in our country scored well down the list amongst developed countries in reading, math and science test scores with China’s Shanghai topping the charts (ref) raising concerns that we will not be able to compete in the global economy.  Yet, some conservative ideologically-driven politicians such as Rand Paul have called for the abolishment of the Department of Education (ref)?

In recent years Reich has been championing another cause, the burgeoning income inequality in America since 1980 as a key contributor to our depressed economy and anemic job growth.  In short, with the income gains largely going to the top 1% of American families over the past 30 years, income for the middle class has not kept pace with the growth of the economy.  And as the largest single component of our economy is personal consumption (70%), the broad middle class, the American consumer and engine of our economy, can no longer create strong demand for goods and services which has resulted in higher unemployment and a sub-par economic recovery (ref).  As Reich points out, ‘Wall Street banditry’ was the proximal cause of the collapse; growing income equality is the structural issue in our economy that is hampering job creation and recovery.

The following graph (ref) plots share of income held by the top 1% of income earners in this country between 1913 and 2007.

Reich points out that it is no mere coincidence that America’s two biggest economic crashes occurred in the years following the twin peaks in 1929 and 2008 (ref) where the top 1% held almost 24% of our nation’s income in both instances.  He argues that when most of the gains from economic growth go to a small sliver of our population at the top, the purchasing power of the rest of America is diminished thus reducing demand for goods and services that in turn negatively affects job creation.

Both Reich and Paul Krugman (ref), our Nobel Laureate in economics out of Princeton University, have discussed how policy affects income distribution and thus our economy.   Krugman states that “the story of modern America is, in large part, the story of the fall and rise of inequality”.  He provides the following graph that displays the share of income held by the richest 10% of Americans over the past 90 years and has included labels for various periods.

During the Long Gilded Age that preceded the Great Depression, income remained about as unequally distributed as it had been in the late 19th century, or as it is today.  Political dominance by the wealthy during this period did little to address the extremes of wealth and poverty that existed at the time.  The rapid drop in share of income at the top during the Great Compression was created, and created in a very short period of time by FDR and his New Deal policies.  Krugman describes the Great Compression as a ‘seminal episode in American history’.  During the Middle Class period, America was a society without extremes of wealth or poverty, a society with broadly shared prosperity.  Strong unions, a high minimum wage, and a progressive tax system limited income inequality.  It was also an era where both political parties shared common values and engaged in bipartisanship. That America began unraveling since the late 1970′s during a period called The Great Divergence where “we’re no longer a middle class society”.  The median household income between 1979 and 2005 rose only 13 percent while the income of the richest 0.1% increased 296%.  And as Krugman points out, it was politics that drove both the Great Compression and the Great Divergence.

As income began concentrating at the top over the past 30 years, taxes on the wealthy were reduced from 70% pre-Reagan, to 28% under Reagan, and now 35% since the Bush tax cuts.  The increase in income at the top along with lower tax rates destabilized income inequality (ref).  And the Tea Party’s recalcitrance about raising taxes on the wealthiest while adopting a spending cuts only approach, places safety nets at risk that further exacerbates the plight of the middle class and the poor, and thus our economic recovery and jobs creation as well.

Larry Summers also issued opinion on the growing income inequality in America.  He noted that “conservative orthodoxies have become a vastly bigger threat to good economic policy than liberal ones”, a stance that “drives some conservatives nuts” (ref).  One way of looking at the point he made is that the income inequality we are experiencing today versus 30 years ago is the equivalent of every family in the bottom 80% of America (those making less than $120,000/yr) writing a $10,000 check to the top 1% every year.

And there is the “Krugman Calculation”  showing that 70% of the rise in average family income has gone to the top one percent of households over the past 30 years (ref).

Lest there be any doubt about the burgeoning income inequality that has occurred since 1980, the following graphs and charts are provided (ref).

Reich points out that the GDP of America increased from $5.908 trillion in 1980 to $13,441 billion in 2011 (ref), but that the median male worker earns less today today, adjusted for inflation, than he did 30 years ago (ref).  In the same article, he also notes that Americans kept spending as if their incomes had kept pace with the economy.  Middle class America developed several ‘coping mechanisms’.  The first was that women streamed into the workplace.  Second, everyone put in more hours; males 100 hours more per year and women 200 more hours per year.  And when this level of income was no longer sufficient they began accumulating debt; between 2002 – 2007 American households extracted $2.3 trillion from their homes.  This run up of personal debt, that increased over time to 130% of personal income, has been graphically depicted in a Krugman article (ref).

Household Debt as % of Personal Income

And then the debt bubble burst.  The economy between 2001-2007 was a false economy; an economy built on borrowing.  When The Great Recession hit, debt ridden middle America lost jobs leaving many  unable to re-pay their debt that further exacerbated the severity of the economic downturn.

Discussion

There are a couple of take away points from the above.

1. The Damaging Effect of Rising Income Inequality on the Economy was Reproducible

The ability of a study to be accurately reproduced is one of the main principles of the scientific method.  The damaging effect of burgeoning income inequality on the US economy was reproducible and at the same level.  In both 1929 and 2008, when almost 24% of this nation’s income was held by 1% of the population, a severe economic collapse followed.  It would be folly to ignore this after it occurred twice.  And the result makes sense.  If income gains are concentrated in a small sliver of our population, is it reasonable to assume that 1% of our population can be the driver of an economy that is 70% personal consumption?

2. Political Policy Can Rapidly Correct Income Inequality and Thus Job Creation

The fall and rise of income inequality in our country was driven by politics.  As Krugman noted, the rapid correction in income inequality that occurred during the Great Compression was created by the New Deal policies of FDR.  And Riech notes how policies in the post WWII era produced more widely shared prosperity with progressive tax rates, the ability of working America to bargain for better wages, the GI Bill, a vast expansion of public higher education, and civil rights and voting rights (ref).  We have the ability to turn things around, but the policies being promoted by ‘Tea Party’ politicians are actually moving in the opposite direction of what worked in the past.

Part of what worked well during the 1990′s was the redistribution to lower income classes, especially the poor that put the money back into the economy dollar for dollar and resulted in 7 million fewer Americans living in poverty (ref).  And I take exception to those who call ‘redistribution’ a dirty word.  I was subject to the Clinton surtax during the 1990′s and I viewed it as placing 3.6% of my upper level income as an ‘investment’ into our economy.  And what better way to invest in our economy than to support the driver of our economy, the American consumer.  I submit that is not socialism; rather it is smart capitalism.  That 3.6% extra I contributed from upper level income I got back in spades.  We all did quite well during those years and our country developed surpluses that were paying down our debt.

As Reich noted (ref) “The rich are better off with a smaller percentage of a fast-growing economy than a larger share of an economy that’s barely moving.  And that’s the…lesson we learned decades ago; until we remember it again, we’ll be stuck in the Great Recession”.

So Mr. President, go for it.  Create a bold New Deal and put America back to work repairing and modernizing our infrastructure and educational facilities.  Rebuild the purchasing power of our broad middle class to create demand and stimulate employment, defend the right of workers to negotiate good salaries, invest in America to create new industries (ref), and fight for a progressive tax policy (ref).  Regarding the bitter resistance and attack you will certainly encounter, remember the words FDR issued in his October 1936 campaign speech at Madison Square Garden where he rallied the masses against the forces of greed and self-interest: “They are unanimous in their hate for me – and I welcome their hatred” (ref).

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