The Truth About the American Economy

Robert Reich – Chancellor’s Professor of Public Policy, University of California at Berkeley; Author, ‘Aftershock’ – Posted: 05/31/11 10:48 AM ET

The U.S. economy continues to stagnate. It’s growing at the rate of 1.8 percent, which is barely growing at all. Consumer spending is down. Home prices are down. Jobs and wages are going nowhere.

It’s vital that we understand the truth about the American economy.

How did we go from the Great Depression to 30 years of Great Prosperity? And from there, to 30 years of stagnant incomes and widening inequality, culminating in the Great Recession? And from the Great Recession into such an anemic recovery?

The Great Prosperity

During three decades from 1947 to 1977, the nation implemented what might be called a basic bargain with American workers. Employers paid them enough to buy what they produced. Mass production and mass consumption proved perfect complements. Almost everyone who wanted a job could find one with good wages, or at least wages that were trending upward.

During these three decades everyone’s wages grew — not just those at or near the top.

Government enforced the basic bargain in several ways. It used Keynesian policy to achieve nearly full employment. It gave ordinary workers more bargaining power. It provided social insurance. And it expanded public investment. Consequently, the portion of total income that went to the middle class grew while the portion going to the top declined. But this was no zero-sum game. As the economy grew almost everyone came out ahead, including those at the top.

The pay of workers in the bottom fifth grew 116 percent over these years — faster than the pay of those in the top fifth (which rose 99 percent), and in the top 5 percent (86 percent).

Productivity also grew quickly. Labor productivity — average output per hour worked — doubled. So did median incomes. Expressed in 2007 dollars, the typical family’s income rose from about $25,000 to $55,000. The basic bargain was cinched.

The middle class had the means to buy, and their buying created new jobs. As the economy grew, the national debt shrank as a percentage of it.

The Great Prosperity also marked the culmination of a reorganization of work that had begun during the Depression. Employers were required by law to provide extra pay — time-and-a-half — for work stretching beyond 40 hours a week. This created an incentive for employers to hire additional workers when demand picked up. Employers also were required to pay a minimum wage, which improved the pay of workers near the bottom as demand picked up.

When workers were laid off, usually during an economic downturn, government provided them with unemployment benefits, usually lasting until the economy recovered and they were rehired. Not only did this tide families over but it kept them buying goods and services — an “automatic stabilizer” for the economy in downturns.

Perhaps most significantly, government increased the bargaining leverage of ordinary workers. They were guaranteed the right to join labor unions, with which employers had to bargain in good faith. By the mid-1950s more than a third of all America workers in the private sector were unionized. And the unions demanded and received a fair slice of the American pie. Non-unionized companies, fearing their workers would otherwise want a union, offered similar deals.

Americans also enjoyed economic security against the risks of economic life — not only unemployment benefits but also, through Social Security, insurance against disability, loss of a major breadwinner, workplace injury and inability to save enough for retirement. In 1965 came health insurance for the elderly and the poor (Medicare and Medicaid). Economic security proved the handmaiden of prosperity. In requiring Americans to share the costs of adversity it enabled them to share the benefits of peace of mind. And by offering peace of mind, it freed them to consume the fruits of their labors.

The government sponsored the dreams of American families to own their own home by providing low-cost mortgages and interest deductions on mortgage payments. In many sections of the country, government subsidized electricity and water to make such homes habitable. And it built the roads and freeways that connected the homes with major commercial centers.

Government also widened access to higher education. The GI Bill paid college costs for those who returned from war. The expansion of public universities made higher education affordable to the American middle class.

Government paid for all of this with tax revenues from an expanding middle class with rising incomes. Revenues were also boosted by those at the top of the income ladder whose marginal taxes were far higher. The top marginal income tax rate during World War II was over 68 percent. In the 1950s, under Dwight Eisenhower, whom few would call a radical, it rose to 91 percent. In the 1960s and 1970s the highest marginal rate was around 70 percent. Even after exploiting all possible deductions and credits, the typical high-income taxpayer paid a marginal federal tax of over 50 percent. But contrary to what conservative commentators had predicted, the high tax rates did not reduce economic growth. To the contrary, they enabled the nation to expand middle-class prosperity and fuel growth.

The Middle-Class Squeeze, 1977-2007

During the Great Prosperity of 1947-1977, the basic bargain had ensured that the pay of American workers coincided with their output. In effect, the vast middle class received an increasing share of the benefits of economic growth. But after that point, the two lines began to diverge: Output per hour — a measure of productivity — continued to rise. But real hourly compensation was left in the dust.

It’s easy to blame “globalization” for the stagnation of middle incomes, but technological advances have played as much if not a greater role. Factories remaining in the United States have shed workers as they automated. So has the service sector.

But contrary to popular mythology, trade and technology have not reduced the overall number of American jobs. Their more profound effect has been on pay. Rather than be out of work, most Americans have quietly settled for lower real wages, or wages that have risen more slowly than the overall growth of the economy per person. Although unemployment following the Great Recession remains high, jobs are slowly returning. But in order to get them, many workers have to accept lower pay than before.

Starting more than three decades ago, trade and technology began driving a wedge between the earnings of people at the top and everyone else. The pay of well-connected graduates of prestigious colleges and MBA programs has soared. But the pay and benefits of most other workers has either flattened or dropped. And the ensuing division has also made most middle-class American families less economically secure.

Government could have enforced the basic bargain. But it did the opposite. It slashed public goods and investments — whacking school budgets, increasing the cost of public higher education, reducing job training, cutting public transportation and allowing bridges, ports and highways to corrode.

It shredded safety nets — reducing aid to jobless families with children, tightening eligibility for food stamps, and cutting unemployment insurance so much that by 2007 only 40 percent of the unemployed were covered. It halved the top income tax rate from the range of 70 to 90 percent that prevailed during the Great Prosperity to 28 to 35 percent; allowed many of the nation’s rich to treat their income as capital gains subject to no more than 15 percent tax; and shrunk inheritance taxes that affected only the top-most 1.5 percent of earners. Yet at the same time, America boosted sales and payroll taxes, both of which took a bigger chunk out of the pay the middle class and the poor than of the well off.