Aftershock

by Robert B. Reich

Why did we fail to raise taxes on the rich and fail to cut them for poorer Americans? Why did we fail to attack overseas tax havens by threatening loss of U.S. citizenship to anyone who keeps his money abroad in order to escape U.S. taxes? America could have expanded public investments in research and development, and required any corporation that commercialized such investments to create the resulting new jobs in the United States. And we could have insisted that foreign nations we trade with establish a minimum wage that’s half their median wage. That way, all citizens could share in gains from trade, setting the stage for the creation of a new middle class that in turn could participate more fully in the global economy.

  In these and many other ways, government could have enforced the basic bargain. But it did the opposite. Starting in the late 1970s, and with increasing fervor over the next three decades, it deregulated and privatized. It increased the cost of public higher education, reduced job training, cut public transportation, and allowed bridges, ports, and highways to corrode. It shredded safety nets—reducing aid to jobless families with children, and restricting those eligible for 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 25 to 39 percent; allowed many of the nation’s rich to treat their income as capital gains subject to no more than 15 percent tax; and shrank inheritance taxes that affected only the topmost 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 of the middle class and the poor than of those who were well-off.

  We allowed companies to break the basic bargain with impunity—slashing jobs and wages, cutting benefits, and shifting risks to employees, from you-can-count-on-it pensions to do-it-yourself 401(k)s, from good health coverage to soaring premiums and deductibles. Companies were allowed to bust unions and threaten employees who tried to organize (by 2010, fewer than 8 percent of private-sector workers were unionized). We stood by as big American companies became global companies with no more loyalty or connection to the United States than a GPS device. By 2009, Intel, Caterpillar, Microsoft, IBM, and a raft of other so-called American firms derived most of their revenues from outside the United States, and were hiring like mad abroad.

  And nothing impeded CEO salaries from skyrocketing to more than three hundred times that of the typical worker (up from thirty times during the Great Prosperity), while the pay of financial executives and traders rose into the stratosphere. Increasingly, the ranks of America’s super-rich were made up of top business and financial executives. More than half of all the money that the top one-tenth of 1 percent of American earners reported on their 2001 taxes represented the combined incomes of the top five executives at the five hundred largest American companies. Almost all the rest were financial traders and hedge-fund managers.

  Significantly, Washington deregulated Wall Street while insuring it against major losses. In so doing it turned finance—which until then had been the servant of American industry—into its master, demanding short-term profits over long-term growth, and raking in an ever-larger portion of the nation’s profits. Between 1997 and 2007, finance became the fastest-growing part of the U.S. economy. The gains reaped by financial executives, traders, and specialists represented almost two-thirds of the growth in the gross national product. By 2007, financial and insurance companies accounted for more than 40 percent of American corporate profits and almost as great a percentage of pay, up from 10 percent during the Great Prosperity. Before and after the bubble burst, the biggest Wall Street banks awarded tens of billions of dollars in bonuses. In 2009, the twenty-five best-paid hedge-fund managers together earned $25.3 billion, an average of $1 billion each. Henry Ford’s legacy was a company that no longer made its money exclusively from selling cars; in 2007, Ford’s financial division accounted for more than a third of the company’s earnings.

  As the financial economy took over the real economy, Treasury and Fed officials grew in importance. The expectations of bond traders dominated public policy. And the stock market became the measure of the economy’s success—just as it had before the Great Depression.

  Why did the pendulum swing back? Why didn’t America counteract the market forces that were shrinking the middle class’s share of the American pie? Answers to these questions offer clues about when and how the pendulum will swing in the other direction.

  Some argue that there was simply no need for government intervention. The economy did better on its own, those people say, without so much government and with lower taxes on the rich. They point to the great expansion of the 1980s and the long recovery of the 1990s, and to the wildly exuberant bull market of the era. (They blame the Great Recession on the fact that too many people got mortgage loans who had no business getting them, and on too much middle-class debt overall.)

  This argument is bunk. It equates the stock market with the economy, and turns a blind eye to the revocation of the basic bargain. The argument does not acknowledge the consequences for an economy when the middle class lacks the means to buy what it produces.

  Others see the reversal of the pendulum as the inevitable result of declining confidence in government. In their view, the era that began with the Vietnam War and continued with the Watergate scandal culminated in the tax revolts and double-digit inflation of the late 1970s—which, according to presidential candidate Ronald Reagan, occurred not because Americans were living too well but “because the government [was] living too well.”

  Confidence in government did drop, but proponents of this view have cause and effect backward. The tax revolts that thundered across America starting in the late 1970s were not so much ideological revolts against government—Americans still wanted all the government services they had had before, and then some—as against paying more taxes on incomes that had flattened. When government services consequently deteriorated and government deficits exploded, the public’s growing cynicism was confirmed. Furthermore, the inflation of the 1970s wasn’t due to government spending. It was the result of a twelvefold hike in world oil prices (engineered by the oil cartel), and a drop in value of the dollar. When inflation began to accelerate, federal spending was only one percentage point higher as a proportion of gross domestic product than it had been in the first half of the 1960s.

  The real reason for the reversal of the pendulum had to do with power. As income and wealth became concentrated in fewer hands, politics reverted to what Marriner Eccles described in the 1920s when people “with great economic power had an undue influence in making the rules of the economic game.” With hefty campaign contributions, and platoons of lobbyists and public relations flacks, the rich helped push through legal changes that enabled them to accumulate even more income and wealth—including tacit permission to bust unions, slash corporate payrolls, and reduce benefits; lower taxes for themselves; and deregulate Wall Street. With so much of their wealth depending on the performance of the stock market, they especially wanted to free up the Street to put greater pressure on companies to perform—for example, by making it easier for investors to mount “leveraged buyouts,” pay with high-risk (junk) bonds, pump up the profits by firing workers, and then dump the company back on the market at a higher price. The plan worked. The Dow Jones Industrial Average took off, rising tenfold between 1980 and 2000. (To be sure, the market’s meteoric rise also boosted the values of middle-class pensions, which were now dependent on the stock market rather than guaranteed to pay out a certain sum each month. But the average market holdings of middle-class Americans remained tiny compared to those of wealthy Americans.)

  The rich and powerful also had substantial influence “in conditioning the attitude taken by people as a whole toward [the] rules,” as Eccles wrote in describing the pre-Depression years. They generously financed think tanks, books, media, and ads designed to persuade Americans that free markets always know best. Ronald Reagan, Margaret Thatcher, Alan Greens
pan, Milton Friedman, and other apostles of free-market dogma reiterated a simple story: The choice was between a free market and big government. Government was the problem. Free markets were the solution.

  But how could the public have been so gullible as to accept this story? After all, America had gone through a Great Depression, suffering the consequences of an unfettered market and unconstrained greed. Even Marriner Eccles, business tycoon and chairman of the Federal Reserve Board, saw that left to its own devices, the market concentrates wealth and income—which is disastrous to an economy as well as to a society. America had also experienced the Great Prosperity, which depended so obviously on public improvements, safety nets, and public investment. Now that the basic bargain was coming apart once again, the need for them was even greater.

  One way to understand the paradox is loss of generational memory. While the trauma of the Great Depression echoed in the memories of people who came to adulthood in the 1930s (and who carried its lessons into the 1940s and ’50s), their children became adults during the Great Prosperity, and took it for granted. And their grandchildren, born during the Great Prosperity, had no actual, palpable memory of their grandparents’ experience of a fallible and unreliable market offset by a strong and reliable government. When this last generation became adults (from around the end of the 1970s onward), all they recalled was the failure of government and the apparent success of the market. This made them particularly susceptible to the seductive rants of the free marketeers, who wanted to blame government for the economy’s failings. Moreover, they had no clear memory of a society whose members were all in it together. They witnessed instead an economy in which, increasingly, each of us was on his own.

  8

  How Americans Kept Buying Anyway: The Three Coping Mechanisms

  Americans also accepted the backward swing of the pendulum because they mitigated its effects. Starting in the late 1970s, the American middle class honed three coping mechanisms, allowing it to behave as though it was still taking home the same share of total income as it had during the Great Prosperity, and to spend as if nothing substantially had changed. Not until these coping mechanisms finally became exhausted in the Great Recession would the underlying reality become evident. (And not until the federal government ended its stimulus and the Fed tightened the money supply would that reality be exposed as more enduring than the Great Recession’s downturn.)

  Coping mechanism #1: Women move into paid work. Starting in the late 1970s, and escalating in the 1980s and 1990s, women went into paid work in greater and greater numbers. For the relative few with four-year college degrees, this was the natural consequence of wider educational opportunities and new laws against gender discrimination that opened professions to well-educated women. But the vast majority of women who migrated into paid work did so in order to prop up family incomes, as households were hit by the stagnant or declining wages of male workers. Fortunately, the changing nature of work—from heavy manufacturing to services—opened jobs that demanded less brute strength; and the use of the contraceptive pill gave women more control over when they would have children and how many they would have, thereby allowing them to put more time and energy into making money.

  This transition of women into paid work has been one of the most important social and economic changes to occur over the last four decades. It has reshaped American families and challenged traditional patterns of child rearing and child care. In 1966, 20 percent of mothers with young children worked outside the home. By the late 1990s, the proportion had risen to 60 percent. For married women with children under the age of six, the transformation has been even more dramatic—from 12 percent in the 1960s to 55 percent by the late 1990s.

  Families seem to have reached the limit, however, a point of diminishing returns where the costs of hiring others to help in the running of a household or to take care of the children, or both, exceeds the apparent benefits of the additional income.

  Coping mechanism #2: Everyone works longer hours. What families failed to get in wage increases, they made up for in work increases. By the mid-2000s it was not uncommon for men to work more than 50 hours a week, and for women to work more than 40. Professionals put in more “billable” hours. Hourly workers relied on overtime. A growing number of people took on two or three jobs, each demanding 20 or more hours. By the 2000s, before the Great Recession, the typical American worker put in more than 2,200 hours a year—350 hours more than the average European worked, and more hours even than the typically industrious Japanese. All told, the typical American family put in 500 additional hours of paid work, a full twelve weeks more than it had in 1979.

  How did women and men work such long hours and also take care of their families, maintain their homes, pay their taxes and their bills? Not easily. Many did it in shifts. I have an acronym for such families—DINS, “double income, no sex.” Here, too, though, Americans seemed to have reached a limit. Even if they could find more work, they couldn’t find any more time.

  Coping mechanism #3: We draw down savings and borrow to the hilt. After exhausting the first two coping mechanisms, the only way Americans could keep consuming as before was to save less and go deeper into debt. During the Great Prosperity, the American middle class saved about 9 percent of their after-tax incomes each year. By the late 1980s that portion had been whittled down to about 7 percent, and it dropped to about 6 percent in 1994. The slide continued until it reached 2.6 percent in 2008. Meanwhile, household debt exploded. During the Great Prosperity, debt had averaged 50 to 55 percent of annual after-tax income (including what people owed on their mortgages). But starting in 1980, debt took off. In 2001, Americans owed as much as their entire after-tax income. But the borrowing didn’t even stop there, especially after the Federal Reserve Board lowered interest rates and made borrowing easier. By 2007, as I said earlier, the typical American household owed 138 percent of its after-tax income.

  Americans borrowed from everywhere. Credit card solicitations flooded mailboxes; many American wallets bulged with dozens of cards, all amassing larger and larger debt loads. Auto loans were easy to come by. Students and their families went deep into debt to pay the costs of college. Mortgage debt exploded. And as housing values continued to rise, homes doubled as ATMs. Consumers refinanced their homes with even larger mortgages and used their homes as collateral for additional loans. As long as housing prices continued to rise, it seemed a painless way to get money (in 1980 the average home sold for $64,600; by 2006 it went for $246,500). Between 2002 and 2007, American households extracted $2.3 trillion from their houses, putting themselves ever more deeply into the hole.

  Eventually, of course, the debt bubble burst. With it, the last coping mechanism disappeared.

  It has been easy to place blame ever since. Some observers blame consumers for borrowing too much. Others fault banks for lending so carelessly. Others blame foreign lenders—especially the Chinese—who were happy to send so much money our way because we’d use some of it to buy their exports. Or they blame the Federal Reserve, which made borrowing easy by lowering interest rates too much. Or they blame regulators, who didn’t adequately oversee the banks that did the lending. On it goes, a blame game much like a merry-go-round, on which every villain chases every victim, and every victim becomes a villain to another victim.

  Much of this blame is justified, but it misses the point. Middle-class consumers took on the huge amount of debt as a last resort. Median wages had stopped growing, and the proportion of total income going to the middle class continued to shrink. The only way most Americans could keep consuming as if wages hadn’t stalled was to run through the coping mechanisms. But each of these mechanisms reached its inevitable limit. And when the debt bubble burst, most Americans woke up to a startling reality: They could no longer afford to live as they had been living; nor as they thought they should be living relative to the lavish lifestyles of those at or near the top, nor as they expected to be living given their continuing aspirations for a better li
fe, nor as they assumed they could be living, given the improvements they had experienced during the Great Prosperity.

  9

  The Future Without Coping Mechanisms

  November 6, 2008. Barack Obama has just been elected president and has invited a dozen or more of us who informally advised him during the campaign to talk about the big economic challenges of the future. Paul Volcker, the former chairman of the Federal Reserve, eighty-one years old (and almost two feet taller than I am), tells the president-elect the underlying problem is that Americans have been living beyond their means. My colleague Laura Tyson, the former chair of Bill Clinton’s Council of Economic Advisors, disagrees. “The real problem is their means haven’t been growing.”

  Laura was right. The fundamental economic challenge ahead is to lift the means of middle-class Americans and reconstitute the basic bargain linking wages to overall improvements—providing the vast American middle class with a share of economic gains sufficient to allow them to purchase more of what the economy can produce. The nation cannot achieve nearly full employment, a higher median income, and faster growth without a reorganization of the economy that spreads the benefits of growth on a scale similar to that which occurred during the Great Prosperity. It is both an economic challenge and a moral challenge; concentrated income and wealth will threaten the integrity and cohesion of our society, and will undermine democracy. But the conversation with the president-elect that fateful day in November never got this far. There was no opportunity to talk about how the increasing concentration of income and wealth had destabilized the economy. The meeting quickly shifted back to the massive debts Americans had taken on, especially mortgage debt, and from there it moved to the fragility of the nation’s largest banks. This was understandable. At that moment, the immediate challenge appeared to be rescuing the financial system.