Rewriting the Rules of the American Economy (part 2)

March 10, 2016

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The central message of Stiglitz’s latest book is this: “The American economy is not out of balance because of the natural laws of economics. Today’s inequality is not the result of the inevitable evolution of capitalism. Instead, the rules that govern the economy got us here.”

We have been operating under a set of rules that were inspired by the largely discredited “supply-side” economics. The aim was to free up capital by cutting taxes, regulation, and wasteful social spending. That would promote more investment and economic growth, with the benefits flowing to all levels of society (what critics call “trickle-down” economics). This was in contrast to the traditional Keynesian approach preferred by liberals, which stressed the importance of maintaining aggregate economic demand through government spending beneficial to the middle class and the poor. Stiglitz and his co-authors regard the supply-side approach as a failure. “These policies increased wealth for the largest corporations and the richest Americans, increased economic inequality, and failed to produce the economic growth that adherents promised.”

Greater wealth at the top does not necessarily translate into greater productive capacity for the economy. Wealth becomes capital only when it is invested in productive activity, but wealth that is not so invested can still produce an economic gain. Property owners in a hot real estate market can collect rents and/or capital gains without making anything or creating any jobs. If the rules of the game encourage it, those with wealth and power will devote too many resources to “rent-seeking,” that is, “obtaining wealth not through economically valuable activity but by extracting it from others, often through exploitation.” The rule changes inspired by supply-side economics shifted the balance of power toward the wealthy and made it easier to make money without serving society very well.

Deregulation of industries such as airlines, railroads, telecommunications, natural gas, and trucking, as well as legal rulings limiting regulation in general, made it easier for big companies to accumulate market power and ultimately limit competition. Some public policies have contributed directly to that accumulation, such as intellectual property rights laws that favor the rights of pharmaceutical companies to profit from a drug over the rights of other companies to make it and sick people to obtain it at a reasonable cost. International trade agreements that failed to include proper safeguards made it too easy for corporations to locate their operations wherever worker bargaining rights and environmental laws were weakest.

The rapidly growing financial sector was allowed to shift “away from its essential function of allocating capital to productive uses and. . .toward predatory rent-seeking activities.” Never had so many people become so rich by producing so little of real value. Market power became enormously concentrated, with the share of assets held by the top five banks increasing from 17% to 52%. The complexity of modern finance puts ordinary consumers at a disadvantage to begin with, but the lax regulatory environment made it worse, allowing predatory lending, fraud and discrimination to run rampant. Meanwhile, the financial industry became less efficient at performing its basic function of providing credit, since the cost-per-dollar of credit actually went up.

Within corporations, the “Shareholder Revolution” increased the pressure on CEOs to generate quick profits. CEO compensation was increasingly tied to rising company stock prices. “The idea that corporations exist solely to maximize current shareholder value and that all other goals are secondary reversed decades of management theory that prioritized firm longevity and saw corporations as more broadly advancing societal interests.” This encouraged several unfortunate corporate practices: favoring shareholder payouts over long-term investments, taking excessive risks (since executives with stock options could profit from financial bubbles), paying executives much more than their productivity could justify, and treating employees “as short-term liabilities rather than as long-term assets.” The bottom line: “Corporate profits are at record highs, with no increase in investment.” Here, corporate culture is as much to blame as public policy, a reminder that the relevant rules of the game include private social norms, not just public policies and laws.

The Reagan and Bush tax cuts favored the wealthy by reducing both the upper-bracket income tax rates and the taxes on dividends and capital gains. This contributed not only to greater after-tax inequality, but surprisingly, to greater pre-tax inequality as well. It increased the pressure on companies to pay out more in executive compensation and dividends, since the payments would be more lightly taxed. International comparisons show that such tax cuts increased economic inequality but failed to boost per capita income. US Federal Reserve policy also contributed to inequality by prioritizing fighting inflation over reducing unemployment, although both goals are mandated by law. The impact of unemployment on family income varies by social class, reducing income by a higher percentage at the lower end of the income scale. In addition, “episodes of below-full employment do lasting damage to productivity, equity, and opportunity.”

During this period, US employers were generally successful in resisting any expansion of worker rights. Within the 30 democracies in the OECD, “an average of 54 percent of the workforce is covered by union collective bargaining agreements, 4.5 times more than in the US.” Companies increasingly used outsourcing and franchising to circumvent labor laws, while continuing to set the terms of employment. Wage growth fell far behind productivity growth (19% vs. 161% between 1973 and 2013), and the federal minimum wage failed to keep up with inflation. To make matters worse, one study found that about a quarter of low-wage workers were getting paid less than the minimum wage, and three quarters weren’t receiving the overtime pay they were due. One major goal of public policy was to reduce dependency on government by creating jobs and cutting social welfare payments. Instead, spending on programs like Medicaid and food stamps remained high as more working families found themselves unable to make it on their own. Conservatives deplore this, but generally oppose efforts to raise wages or strengthen the bargaining position of workers.

The final post will cover the book’s recommendations for rewriting the rules.

Continued

 

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Rewriting the Rules of the American Economy

March 3, 2016

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Joseph E. Stiglitz. Rewriting the Rules of the American Economy: An Agenda for Growth and Shared Prosperity, with Nell Abernathy, Adam Hersh, Susan Holmberg and Mike Konczal. New York: W. W. Norton & Company, 2015.

This book began as a report from the Roosevelt Institute directed at policy makers. The general public should find it useful as well, since it clearly and simply lays out a new way of thinking about economic problems, especially economic inequality.

The general approach is “institutionalist,” based on the assumption that “rules matter and power matters.” In other words, what happens in the economy is not just a result of natural economic laws, but of larger social processes such as rule-making and jockeying for power. “Rules include all the regulatory and legal frameworks and social norms that structure how the economy works.” Power is important because markets rarely conform to an idealized model of perfect competition, in which no one actor can control outcomes. In reality, markets can be dominated by one or only a few actors; they can be closed to entry by additional actors; and actors who are “in the know” can take advantage of those with less information. Just think of how marketers of esoteric financial instruments took advantage of investors before the financial crash. Rules and power are closely related, since the prevailing rules can either favor or limit the accumulation and exercise of market power.

Obviously this perspective can shed some light on one of the major economic concerns of our time, rising inequality. Rule changes and power shifts are relevant both to the dramatic increase in wealth at the top and income stagnation at the middle and below. Stiglitz uses the metaphor of an iceberg to distinguish three aspects of the problem. At the tip of the iceberg are the everyday experiences that people have with inequality, such as small paychecks and insecure futures. At the base of the iceberg are large-scale economic forces like globalization, new technologies, and demographic changes. But in-between, above the base but beneath the surface (where have I heard that?) lie the rules and power structures that most interest the authors:

These are hard to see but vitally important: the laws and policies that structure the economy and create inequality. These include a tax system that raises insufficient revenue, discourages long-term investment, and rewards speculation and short-term gains; lax regulation and enforcement of rules to make corporations accountable; and the demise of rules and policies that support children and workers.

I find the iceberg metaphor really helpful in avoiding two theoretical and practical mistakes. One is treating the large-scale economic forces as having inevitable economic effects, effects that lie beyond the reach of policy. Sorry, globalization and technological change are just leaving many workers behind, so they’ll just have to get poorer while others grow richer. But international trade agreements don’t have to permit a race to the bottom in which countries compete for jobs primarily by cutting labor costs. “The premise of this report is that we can reshape the middle of the iceberg–the intermediating structures that determine how global forces manifest themselves.”

The other mistake is focusing too heavily on the tip of the iceberg, trying to correct economic inequality just by redistributing wealth from the top to the bottom. A more effective approach is to steer the economy toward productive participation by economic actors at all levels. That means good jobs for most workers, as well as the most productive use of capital by businesses. Don’t play the game by the same rules and then try to redistribute the prizes, but change the rules of the game themselves. “This means that we can best improve economic security and opportunity by tackling the technocratic realms of labor law, corporate governance, financial regulation, trade agreements, codified discrimination, monetary policy, and taxation.”

In the rest of the book, Stiglitz explains what is wrong with the rules that have governed the economy in recent decades and lays out his proposals for reform.

Continued

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A Living Wage (Glickman, part 2)

February 11, 2015

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The previous post discussed how Lawrence Glickman links the demand for a living wage to the historical transformation of the US economy. As independently owned and managed farms and businesses became less common, American workers had to rethink their hostility to working for wages. Increasingly they pinned their hopes for freedom and independence on better wages instead of on control over their own labor. The labor movement called for a high American standard of consumption supported by a living wage, at least for white males.

An idea whose time had come

By the end of the nineteenth century, this idea was gaining support beyond the labor movement itself. “Religious reformers were the first group outside of the labor movement to call for a living wage, beginning with Pope Leo XIII’s encyclical of 1891.” The Pope declared it a “dictate of nature more imperious and more ancient than any bargain between man and man.” In 1906, the Catholic priest and social activist John Ryan, published A Living Wage, which also made a distinction between prevailing market wages and ethical wages based on natural moral law. Prevailing wages were partly determined by the relative power of capital and labor, so were unlikely to reflect the true value of workers or their work. [On a personal note, my father told me that when he studied economics at a Catholic college in the 1930s, his ethics professor argued for the moral responsibility of employers to pay a living wage.]

States began passing minimum-wage laws in 1912, and the platform of the Democratic Party began calling for a federal minimum wage in 1916. From organized labor’s point of view, the minimum wage was exactly that, only the lowest point on the “spectrum of conceivable living wages,” but it was a start.

Opposition to higher wages was still intense in the early 1900s. The opposing arguments were partly economic, based on the idea that the wage set by the market represented the real value of labor. But this easily became a moral argument: since the worker’s labor was only worth what the market said it was worth, any demand for more was an immoral attempt to get something for nothing. Another argument was that any interference with the labor market violated the principle of freedom of contracts. A market wage represented an agreement between two free parties, but a legally mandated minimum deprived employers of their right to bargain freely with workers. It was this last argument that most impressed the Supreme Court when it declared minimum-wage laws unconstitutional in 1923. [It probably didn’t occur to justices to worry about whether the individual worker really had much freedom to bargain with a powerful employer.]

By the 1930s, support for a living wage became stronger, as economists, politicians and the general public came to associate low wages with economic depression. President Roosevelt stated it bluntly in 1938: “We suffer primarily from a failure of consumer demand because of lack of buying power.” With the productive capacity of the nation expanding, not to raise wages made it impossible for workers to buy enough goods to keep the factories humming and the labor force employed.

I don’t recall Glickman telling this part of the story, but the Supreme Court reversed itself in 1937 and upheld a state minimum-wage law. Interestingly, this happened because a certain Justice named Roberts departed from his usual practice of voting with the four most conservatives justices (perhaps setting a precedent for the Affordable Care Act!). This decision marked the end of an era in which the Court had generally resisted government efforts to regulate industry.

In 1938, Congress passed the Fair Labor Standards Act, which set a national minimum wage and a standard work week of forty hours beyond which overtime must be paid. Perhaps just as important, although not discussed by Glickman, the National Labor Relations Act of 1935 gave workers the right to organize and bargain collectively. A combination of union organizing and government support helped millions of workers achieve a higher standard of living and move into the middle class.

An idea whose time has gone?

Because Glickman is concerned primarily with the rise of the living wage as an idea, he ends his story in the early twentieth century with its partial implementation. He does not address the question of why the struggle for higher wages became so much harder in the latter part of the century, or why the very term “living wage” went out of fashion. I’ll just mention a few of the many developments that impeded or even reversed the progress that workers had been making:

  1. Runaway inflation not only eroded the buying power of wages, but it also reduced popular support for wage increases, since high wages could be blamed for inflation.
  2. Globalization undermined the argument for a distinctly “American standard” of wages. Employers could justify low wages in order to keep their companies globally competitive, or replace well-paid US workers with lower-paid foreign workers.
  3. New technologies reduced the demand for unskilled labor and the market price of that labor.
  4. Globalization and automation led to job losses in the highly unionized manufacturing sector, while employment in the less unionized service sector expanded. The decline of unions reduced the workers’ political clout too, since the labor-friendly Democratic Party had relied heavily on unions for its grass-roots organizing.
  5. The decline of the patriarchal, male-breadwinner family undermined the argument for a “family wage.” In theory, wages could be lower if families were accustomed to relying on multiple earners, but households with only one earner lost ground.
  6. The struggle for higher wages focused increasingly on racial minorities and women, who had been largely excluded from high wages in the past. Many white males felt threatened, however, and became more interested in holding on to what they had than advancing the cause of labor in general. They abandoned their traditional Democratic allegiance and voted Republican in large numbers, especially in the South, helping insure that public policy would tilt toward business and away from labor. The labor movement eventually paid a price for once thinking of the living wage as only a white man’s wage.

A new interest?

The recent attention focused on economic inequality suggests that the issue of just wages may once again move center stage. At the low end of the income scale, increases in the minimum wage have failed to keep up with inflation. In today’s dollars, the original minimum of about $4 an hour increased to over $10 in the 1960s before falling back to $7.25 since then. Meanwhile, incomes in the middle have largely stagnated while incomes at the top have increased dramatically (especially after-tax incomes because of large tax cuts for the wealthy).

Thomas Piketty observes that in the US recently, “income from labor is about as unequally distributed as has ever been observed anywhere,” with the top tenth of workers receiving 35% of the total and bottom half of workers only 25%. Income from investments is even more uneven, since the share of wealth controlled by the richest tenth has risen to over 70% in recent decades. The distribution of total income is a combination of the distributions of both labor income and investment income. The share of total income going to the top tenth fluctuated in the range of 30-35% between 1950 and 1980, but has gone up to 45-50% since 2000. So 15% of the national income has been transferred to the top tenth from everybody else. (See my discussion of Piketty’s Capital in the Twenty-First Century, especially part 3.)

In our new Gilded Age, with the rich living in increasing luxury while so many others can barely scrape by at all, the stage may be set for a new national discussion of a living wage.

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The New Geography of Jobs (part 2)

October 17, 2014

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Enrico Moretti makes a good case that where a worker lives still matters, and that job opportunities are unevenly distributed across metropolitan areas of the United States. The best jobs in the innovation sector of the economy are to be found primarily in a small number of thriving metropolitan areas.

I find Moretti less convincing when he addresses more general economic questions, such as how many good jobs the new economy can create. He presents a rather rosy view of job creation that would be contested by other authors.

How much opportunity?

Moretti cites the spectacular growth rates of certain kinds of jobs, such as in software, scientific research and development, and pharmaceuticals. But even in these areas, the absolute numbers of jobs are not as impressive as the growth curves (which tend to rise steeply when they are starting from close to zero). Moretti says that the innovation sector can be the main engine of economic growth without providing a majority of the jobs, but one would still like to know how much it can grow beyond its estimated 10% of jobs today, considering that manufacturing jobs used to employ 30% of the labor force.

Moretti asserts that “2.6 jobs are typically created for every one destroyed,” but he doesn’t suggest a time frame for that process or explain why job creation has been so sluggish and unemployment so high during this particular transition.

Consistent with his rosy view of job creation, Moretti regards the concentration of good jobs in certain metropolitan areas as a temporary state of affairs:

Just like people, industries have life cycles. When they are infants, they tend to be dispersed among many small producers spread all over the map. During their formative years, when they are young and at the peak of their innovative potential, they tend to concentrate to harness the power of clusters. When they are old and their products become mature, they tend to disperse again and locate where costs are low. Thus it is not surprising that the innovation sector— the part of the economy that is now going through its formative years— is concentrated in a handful of cities.

Cities that have fallen behind can catch up by means of a “big push: a coordinated policy that breaks the impasse and simultaneously brings skilled workers, employers, and specialized business services to a new location.” Apparently this is only theory, however, since “looking at the map of America’s major innovation clusters, it is hard to find an example of one that was spawned by a big push.”

I would suggest that the jury is still out on whether the information society can create as many well-paid, full-time jobs as the manufacturing society in its heyday. The last book I reviewed, Jeremy Rifkin’s The Zero Marginal Cost Society, argues that it cannot. Rifkin believes that the information age is calling into question the whole idea of the paid job as defined by capitalism. The fact that knowledge is so easily shared may place a limitation on how much it will be bought and sold in the marketplace. When people can access the ideas of the most renowned scholars on the Internet for free, how many intellectuals will be paid to think?

I accept the assumption that as machines do more of the routine work, people will be liberated to engage in more creative activity. The question is how much of that creative activity will take the form of paid work. Maybe we will do less paid work in the aggregate, but distribute what paid work there is more evenly.

Why inequality?

Moretti’s take on inequality is consistent with his belief that the demand for qualified employees is ample, and the problem is on the supply side. In other words, the system is a meritocracy, with low pay and unemployment resulting from inferior qualifications. The way to remedy that is to invest more in education and/or admit more educated immigrants. (He notes that highly skilled immigrants can be job creators rather than job stealers because of their contribution to innovation and its economic multiplier effects.)

This meritocratic view is contested by other economists, notably Thomas Piketty in Capital in the Twenty-First Century. (See my review, especially Part 3.) In his view, the distribution of income depends not just on merit but on institutional factors, such as the organization and bargaining power of unions and the influence of executives over their own compensation. The widening pay gap between executives and other workers cannot be accounted for by a widening education gap. The distribution of income also depends on the share of national income going to owners of capital, which has been rising recently (from a range of 15-25% in rich countries in 1970 to a range of 25-30% recently). This happens when the return on capital remains high although the rate of general economic growth has slowed. Getting ahead through wage growth becomes harder compared to profiting from accumulated wealth.

Moretti makes a contribution to economic geography, but his general view of the job market never gets beyond the conventional wisdom to address the more interesting controversies.

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The New Geography of Jobs

October 16, 2014

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Enrico Moretti. 2013. The New Geography of Jobs. Boston: Houghton Mifflin.

Economist Enrico Moretti has a surprise for those who think that advanced means of communication and transportation have rendered the geographic location of work unimportant. The world is so connected, so the theory goes, that the same activity can be carried on almost anywhere. A factory can be located in Birmingham or Bangkok, and a software designer can work in a downtown office or a rural cabin. Moretti, on the other hand, contends that location matters, that the innovative work that drives today’s economy clusters in geographic centers of innovation. As a result, “Your salary depends more on where you live than on your resume.”

Moretti starts his book with the story of a young engineer who made a very consequential move in 1969. Seeking a more peaceful environment, he moved from Menlo Park in Silicon Valley to Visalia in a more agricultural area. In those days, the two places were statistically rather similar, but after forty years of change, they represent the geographic diversification Moretti is discussing. While Menlo Park exemplifies the thriving, high-tech, high-education center of innovation, “Visalia has the second lowest percentage of college-educated workers in the country, almost no residents with a postgraduate degree, and one of the lowest average salaries in America,” along with a high crime rate.

This is not an isolated phenomenon. Moretti calls it the “Great Divergence”:

A handful of cities with the “ right” industries and a solid base of human capital keep attracting good employers and offering high wages, while those at the other extreme, cities with the “wrong” industries and a limited human capital base, are stuck with dead-end jobs and low average wages. This divide— I will call it the Great Divergence— has its origins in the 1980s, when American cities started to be increasingly defined by their residents’ levels of education.

Moretti acknowledges that some forms of convergence are occurring as well. As poorer countries develop, many of them are becoming more similar to richer countries. Traditionally poorer regions such as the American South are also converging with other regions in many respects. But within countries and regions, some cities–such as Austin, Atlanta, Dallas, Durham and Houston in the South–are emerging as the affluent and educated centers of innovation, while others are being left behind.

From production to innovation

“Over the past half century, the United States has shifted from an economy centered on producing physical goods to one centered on innovation and knowledge.” Moretti notes that even in hi-tech areas such as computers, production jobs are declining, and job opportunities are mostly in the more professional, technical and managerial areas. We haven’t stopped making things–US manufacturing output is actually increasing, and locally made goods are often very fashionable–but manufacturing can no longer provide employment for tens of millions of people.

According to a study of companies in twelve industrialized countries, some firms are much more successful than others in finding a place in the new economy. The more successful ones “buy more computers, spend more on R & D, take out more patents, and update their management policies.” They don’t just produce what any number of other companies could produce; they lead in innovation, creating the jobs in what Moretti calls the “innovation sector.” He estimates that it currently includes only 10% of the jobs, but it is increasingly the “driver of our prosperity.” That’s because it is the major source of productivity gains, and it has a powerful multiplier effect that creates other jobs, especially in both professional and nonprofessional services. He calculates that five additional local jobs are created by each new high-tech job. Not only that, but the presence of many highly educated, highly paid workers in a metropolitan area boosts the productivity and wages of other workers in that area. As a result, even workers without college degrees are better off living in an area where many residents are well educated.

Geographic concentration

Why are the innovative companies and jobs clustered in a such a small number of metropolitan areas? A striking example is Seattle, which has benefitted greatly from Microsoft’s decision to move there from Albuquerque in 1979. The presence of one big hi-tech firm attracted others, such as Amazon, and had many other unforeseen consequences. For example, former employees of Microsoft have started 4,000 new businesses, most of them in the local area. Before the move, the percentage of college-educated workers in Seattle and Albuquerque differed by only 5%; today the difference is 45%!

Traditionally, the location of cities has depended on natural advantages such as harbors or access to natural resources. Since centers of innovation depend more on human capital, their location depends more on creative interactions among human beings. Once someone starts the creative ball rolling–a major university helps–then innovative activity feeds on itself in many ways. Moretti identifies three “forces of agglomeration” that foster the growth of an innovative center:

  • Thick labor markets: A labor market that already contains a lot of highly educated labor attracts more employers who need that labor, and vice versa. The more specialized the skills needed, the harder it is to find them outside of a major innovation center.
  • Specialized service providers: Innovative companies need specialized services such as “advertising, legal support, technical and management consulting, shipping and repair, and engineering support.” As those develop, they help create an entire “ecosystem” supporting innovation.
  • Knowledge spillovers: New ideas foster other new ideas to create a stimulating cultural environment that benefits all. In that way, education has a “social return” that benefits many others besides the holder of a degree. Moretti notes that this is a strong reason for society to share the costs of education, since it shares the benefits.

In the United States today, Silicon Valley is the #1 innovation cluster, followed by Austin, Raleigh-Durham, and Boston. The ten metropolitan areas with the largest share of college-educated workers are Stamford (CT), Washington, Boston, Madison, San Jose, Ann Arbor, Raleigh-Durham, San-Francisco-Oakland, Fort Collins-Loveland (CO), and Seattle-Everett.

One downside to living is these areas is the cost of housing, which is driven up by the competition of well-paid workers for proximity to good jobs and schools. This is another factor maintaining the geographic divergence between areas with different educational levels. Today the educated are more mobile, since they have the money, skills, and information to go where the opportunities are. Less educated workers can also benefit from the higher wages of thriving metropolitan areas, but only if they can reside there in the first place.

The divergence of places extends to many aspects of public and private life. Metropolitan areas that differ in educational and income level also differ in average life expectancy, family stability, political participation and resources for charitable giving. For example, men in some poorer metropolitan areas in the U.S. have life expectancies comparable to those of poor countries.

Continued

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