Thomas Palley runs the Economics for Democratic and Open Societies Project. He is the author of Plenty of Nothing: The Downsizing of the American Dream and the Case for Structural Keynesianism. His weekly economic policy blog is at www.thomaspalley.com.
In anticipation of 2008, a potentially historic debate is shaping up within the Democratic Party. On one side are progressive Democrats whose lineage reaches back to FDR and the New Deal. On the other side are new Democrats, who emerged in the 1980s and embraced Ronald Reagan’s critique of big government.
The economy is the central point of contention between the two groups. Thus, New Democrats maintain the economy is headed in the right direction, and they deny progressive Democrat claims about income stagnation and corporate excess. This denial was recently on display in a report, "The New Rules Economy ," issued by Third Way, an influential new Democrat think tank in Washington. The report denies America’s working families have been shortchanged. In doing so, it misrepresents economic reality, undercuts working families and gives comfort to supporters of corporate excess. That makes the Third Way the wrong way. Here are the facts.
Denial #1: Family income has not stagnated. The report begins by claiming America’s middle class has been doing well. According to Third Way, incomes for married couple households halfway up the income ladder (the 50th percentile) rose 22 percent between 1979 and 2004. That seems pretty good—except tucked away in a footnote is the fact that adjusting for increased hours worked by wives, income only rose 9 percent. Over a 25-year period that translates into an average increase of about one-third of 1 percent per year—which is not the economy American families once knew.
The situation is far worse for those lower down the income ladder. Families near the bottom (the 10th percentile) saw their incomes rise just 1 percent over 25 years. If hours worked had not increased, their incomes would have fallen. For families at the 30th percentile (America’s historic blue-collar middle class), the 25-year income gain was 14 percent. Strip out increased hours worked and we’re talking income stagnation.
Sizeable family income gains really kick in higher up the ladder: a 31 percent increase at the 70th percentile and 42 percent at the 90th percentile. But claiming these top-end families represent the middle-class is like believing we all have above average income.
Denial #2: Executive pay is not a problem. Third Way describes the CEO pay explosion as “maddening” but just a “drop in the bucket” and of no major economic consequence. Reality says otherwise, with corporate executive excess now reaching such proportions that it is like a tax on all of us.
Harvard Law School Professor Lucian Bebchuk and Yaniv Grinstein of Cornell report that between 2001 and 2003 the aggregate compensation paid by public companies (about 2,000 of them) to their top five executive officers equaled 10 percent of company profits. In a sense, these executives are implicitly claiming their productive contribution equals the contribution of 10 percent of these businesses' total capital stock.
The raw numbers show that between 1993 and 2003 total top-five executive compensation paid by public companies totaled $350 billion. That averages $35 million per executive, or $3.5 million per executive per year. This is not a drop in the bucket, it's a hole.
Even worse, executive excess is like a cancer that ripples down and distorts organization pay structure, creating massive top-heavy pay inequality and leaving less for ordinary workers.
Denial #3: The trade deficit is not a problem. Third Way casually dismisses the trade deficit as not a cause for concern. The trade deficit has caused job loss, and while it is true that the economy eventually creates new jobs, those replacement jobs tend to pay significantly less. Displaced workers therefore first suffer the injury of unemployment, and then find inferior jobs.
Moreover, it is widely known that companies use the threat of job off-shoring to suppress pay and benefits. This helps explain why family incomes have stagnated. Jobs don’t need to be lost for current trading arrangements to do harm.
The trade deficit has also contributed to the erosion of the U.S. manufacturing base. Unable to compete because of unfair foreign trade practices and our own flawed policies, many manufacturing firms have either shut shop or moved offshore. That has shrunk manufacturing, which threatens future living standards because manufacturing is key to productivity growth.
It has also made the U.S. dependent on imported manufactured goods to accompany our dependence on imported oil. That is an economic and national security threat, which is compounded by the financial vulnerability that goes with growing foreign indebtedness. The trade deficit is the funnel through which these effects stream, yet Third Way recommends turning a blind eye.
Denial #4: There is no household debt or saving problem. Lastly, the report claims families have no debt problem because most debt is mortgage debt. However, data shows that households are paying a record share of income as interest, and debt is at record levels relative to income.
This has increased household financial vulnerability but that has been obscured by rapid house-price inflation. Should house prices start falling or merely stall, as speculation evaporates or adverse demographics and income stagnation grind away, mortgage debt could quickly become a problem. Moreover, any problem will be amplified by increased income volatility since debt makes families more vulnerable to income shocks, be they due to sickness, outsourcing or parenthood.
As for retirement saving, here too Third Way tries to hide behind house-price inflation. They claim that increased house prices have solved the saving problem. That is like saying we can take care of saving through inflation.
Higher house prices have benefited those who bought early enough, but prices must be sustained. Even if they are, owners’ gains come at the expense of buyers whose own saving is eaten up by large mortgage interest payments. And if someone sells their home because they need retirement income, where do they live? On top of that, what about the 30-plus percent of people who do not own?
House price inflation is a one-time wealth transfer that at best solves the saving problem of one generation of owners. Put bluntly, price inflation that robs Peter to pay Paul does not solve families’ long-term problem, which is one of wages and income.
