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by Kimberly Clausing

  At the same time, the levels of compensation considered acceptable for those at the top have never been higher. CEO pay is now three hundred times that of typical company workers, a ratio that has increased tenfold since 1980, when CEOs earned “only” thirty times the salary of typical company workers (fig. 2.16). CEO salaries have increased over 900 percent since the late 1970s, while worker wages have risen 10 percent.37 To precisely what degree these salaries reflect productivity is a matter for legitimate arguments, but it is unlikely that CEOs are ten times more productive than they were in 1980 relative to their workers. Likely, social norms, market power, and tax policy all contribute to these large ratios.

  Figure 2.16: US CEOs Earn Three Hundred Times Their Workers’ Salaries This Century. Are They Ten Times More Productive Than in 1980?

  Note: See Lawrence Mishel and Alyssa Davis, “Top CEOs Make 300 Times More than Typical Workers,” Issue Brief 399, Economic Policy Institute, June 2015. Data sources: Economic Policy Institute calculations from Compustat’s ExecuComp database, Current Employment Statistics program, and the Bureau of Economic Analysis NIPA tables.

  Tax Policy

  Tax policy plays a role in driving income inequality, the incomes at the very top of the income distribution, and the declining share of income that ends up in the hands of workers. Since 1900, the top 1 percent share of the income distribution has followed a u-shaped pattern in the United States.38 Between 1929 and the 1970s, the top 1 percent share fell steadily. Since the 1980s, it has increased (fig. 2.17).

  Tax rates have moved in the opposite direction. Top marginal income tax rates increased in the first half of the twentieth century, and they have declined steeply since 1980.

  This negative correlation between the share of the top 1 percent and the top marginal tax rates is striking.39 Tax avoidance provides one explanation for this pattern, since top incomes are more likely to be hidden when tax rates are high. But many argue that the bargaining process between workers and their managers is affected by tax rates. If tax rates at the top of the distribution decline, this provides more incentive for those at the top to aggressively increase their compensation.

  Figure 2.17: US Tax Rates and Income Shares for the Top 1 Percent

  Data sources: World Top Incomes Database; Thomas Piketty, Capital in the Twenty-First Century, (Cambridge: Harvard University Press, 2014).

  The era of increasing income inequality has also corresponded to lower tax rates on capital income, a source of income that is far more concentrated in the hands of high-income households. Capital gains tax rates were over 30 percent for most of the 1970s, fell to between 20 percent and 29 percent during the 1980s and the 1990s, and then fell to about 15 percent for most of this century, before increasing to 25 percent in 2013.40 Dividends were taxed as ordinary income until 2003, but have since been taxed at far lower rates, with a top rate of 15 percent before 2013, and a top rate of 20 percent since then.41

  Indeed, high tax rates serve as a brake, or speed limit, on earnings by high-income earners. Yet the restraint of higher tax rates was eased dramatically over recent decades, just as other forces were ramping up the pay packages for those at the top. The global economy and technological change have increased demand for capital and the most highly skilled workers and superstars. As top earners are also more aggressive in seeking higher pay, compensation at the top surges, and wages further down stagnate.42

  What to Do

  Beyond these six important forces, there are likely other factors at work, complicating matters further. Also, among these explanations, there is no clear way to unpack the precise contribution of each to the problems at hand. The six factors are deeply intertwined.

  International trade is spurred by changes in communications and technology, while new technologies are adopted in part due to the pressures of international competition. Lower tax rates reward individuals and companies that increase their compensation and profits, and higher profits and incomes at the top of the income distribution beget political power, which leads to tax and regulatory policies that are more favorable to high-income groups. Superstars earn more due to global markets and the easy distribution of their products—distribution facilitated by technological change. The success of superstars fuels changes in social norms about what level of compensation is “justified” by the marketplace.

  Still, different societies mediate these same economic forces in different ways. While many countries have experienced aspects of the trends described here (increased income inequality, surges in top 1 percent shares, reduced labor income shares), the United States’ experience of increasing income inequality, accompanied by middle-income economic stagnation, has been particularly dramatic and sustained. Common economic forces like trade and technological change create different consequences in different places, due to different institutions, social norms, and economic policies.43

  The remainder of this book will argue that global forces (namely, international trade, international capital mobility, international business, and immigration) are not the chief culprits behind the woes of the American middle class—and that, while these global forces certainly contribute to the economic insecurity facing American workers, clamping down on globalization would harm American workers more than it would help them.

  This is not to imply that the problems of American workers are not real. On the contrary, increasing income inequality combined with middle-class wage stagnation is the single largest economic problem of our era.44 The response to this challenge needs to be swift and bold.

  Chapters 9 through 11 will outline an agenda for moving toward a more equitable globalization. This agenda involves three key components, all of which directly target the problem at hand, avoiding the large collateral damage that results from erecting walls and raising trade barriers.

  First, we need better policies to equip workers for a modern, global economy: updated trade agreements, improved support for struggling workers and communities, and strong investments in fundamentals such as education, research and development, and infrastructure.

  Second, a grand bargain on tax reform would generate benefits along three lines: greater after-tax incomes for those left behind in prior decades; a simpler tax system to reduce distortions, avoidance, and complexity; and lower tax rates and a cleaner planet due to reliance on a carbon tax. Such reforms would satisfy goals of both those on the left (a more progressive tax system, a cleaner environment) and those on the right (lower tax rates, fewer distortions).

  Third, we need a better partnership between society and the business community. The goals of the business community can be met, but a mutually beneficial partnership would also entail more tax payments from some businesses, more business transparency on both tax and labor issues, and robust antitrust laws to counter undue market power.

  To make these important policy changes, we will also need a better politics—a vexing problem that is addressed in the concluding chapter. By boldly addressing the challenges of the modern economy, we can create a more equitable globalization that benefits all Americans—and we can retain the benefits of the world economy, fostering longstanding peace and prosperity.

  II

  International Trade

  The next three chapters discuss the role of international trade in the American economy. Chapter 3 explains why so many economists find international trade to be a compelling and even necessary ingredient to a country’s economic success. The US economy would be far less prosperous without the benefits of international trade.

  Chapter 4 discusses why international trade also poses vexing concerns for society. Evidence indicates that international trade has likely lowered wage growth for many US workers, aggravating income inequality. Because rising income inequality and middle-class wage stagnation are such large problems in the United States, these concerns are serious. Still, Chapter 4 argues that trade is not the dominant source of workers’ troubles. Technological change, market power, and other factors are more important.r />
  Chapter 5 turns to the policy implications of Chapters 3 and 4. International trade is not easily reversible without doing lasting damage to the economy and American workers. An ideal policy response to international trade likely involves more, not fewer, trade agreements. Even more important, we need to give workers the tools they need to succeed in today’s economy; we need stronger support for struggling workers and communities; and we must modernize economic policy to suit our global, technologically sophisticated economy.

  Three

  The Case for International Trade

  It is difficult to find a good economist who does not recognize the merits, and even the magic, of international trade for raising living standards and contributing to the felicity of humankind. At root, the case for international trade is not much different from the case for markets; the presence of international borders does not change the basic logic.

  Consider a person who, in an extreme show of self-sufficiency, tried to produce everything they planned to consume: food, clothes, tools, medicine, and all the rest. It is hard to imagine a quicker path to poverty. Even in the earliest, most basic societies, people swiftly began to trade items with each other, because trade generates great efficiencies relative to self-sufficiency.

  For many countries, going without trade would be analogous to a household trying to be self-reliant. Imagine Finland, a country of about five and a half million people, trying to be self-sufficient. Even with millions of people, it would be difficult for Finland to make a decent fraction of the goods and services that modern households crave. The scale of production would be too small to justify many types of cars, and the more types of cars Finland made, the more expensive each would be, since they would not be able to take advantage of economies of scale. Finland would have to go without many types of food that would not be practical to grow there, or such foods would need to be grown in hothouses at great expense. Food costs would rise enormously as each crop had fewer benefits of scale. The wide variety of clothes, shoes, pharmaceuticals, furnishings, and electronics that we all take for granted would not be remotely feasible, either.

  Indeed, many countries are closer to the economic size of US states, and going without trade for these countries would be similar to the state of Oregon (and its four million people) trying to live without trade. Eating nuts and berries (two excellent Oregon crops) would be fine for a while, and one could wash them down with Oregon’s excellent pinot noir, but it stretches plausibility to imagine that Oregon residents would be content to make do without the thousands of products they have grown accustomed to, or that they could make all these products themselves. How could Oregon possibly make its own cars, planes, perfumes, clothing, computers, books, shoes, and the like? Surely Oregon is a richer state, and its residents enjoy higher standards of living, if it specializes in what it is relatively good at (nuts, berries, pinot noir, shoe designing, semiconductor research, aircraft parts, and so forth) and then trades its output for other goods on the broader market.

  Intriguing early evidence suggests that trade may have even played a role in the evolution of humanity itself. Anthropologists and historians have puzzled about how Homo sapiens edged out the Neanderthals, despite the latter’s superior strength, which should have provided a key advantage in the hunting and gathering economies of yore. Although this puzzle may never be completely resolved, one compelling theory suggests that trade was essential to the dominance of Homo sapiens.1 Our ancestors had superior cognitive and social abilities, and this helped them develop trade networks. Through specialization and trade, early members of our species were able to conserve energy and better use their resources. Archeological evidence shows that Homo sapiens frequently possessed items that could only have been produced in regions far away from their communities, whereas Neanderthals relied solely on local products.

  Going without trade is quite harmful to a country’s well-being. For this reason, when the international community wants to punish a country for wrongdoing, it frequently withholds the benefits of international trade by imposing economic sanctions. If international trade were actually harmful to countries, then countries under sanctions might send thank-you notes to their antagonists! Instead, sanctions are often effective ways to alter governments’ behavior, or to bring them to the negotiating table, since they are eager to partake of the benefits of unfettered trade.

  Economic sanctions have been highly inconvenient, for example, for Russia’s consumers. After Russia annexed Crimea in March 2014, the United States and the European Union used sanctions to freeze the assets of Kremlin-connected individuals and companies, and curtailed exports of military technology as well as key goods for Russia’s oil industry. The sanctions, coupled with a fall in world oil prices in summer 2014, proved crippling to Russia’s economy: per capita GDP shrank, the ruble’s value swiftly declined, and the poverty rate increased. Russia refused to be cowed and enacted counter-sanctions that banned imports of beef, pork, fish, fruit, vegetables, and dairy products. This led to huge increases in food prices and a thriving black-market economy. (Even the Russian government couldn’t avoid sanction-related suffering: the Ministry of Defense placed an order for homegrown “Russian iPads” at $6,000 a piece.)

  One study calculates the collective impact of past economic sanctions to have been more deadly than the entire history of weapons of mass destruction, including large-scale acts of nuclear, chemical, and biological warfare.2 The atomic bombs dropped on Hiroshima and Nagasaki killed about 125,000 people; chemical weapons have killed a similar number. Yet the United Nations found that Iraqi sanctions alone killed at least 239,000 children under the age of five. The sanctions placed on Iraq from 1990 to 2003 disproportionately affected the country’s most vulnerable populations, increasing the price of food by 25,000 percent and holding syringes and other basic medical equipment hostage at Iraq’s borders. As a result, thousands of Iraqis died of malnutrition, from infectious diseases, and due to the absence of essential drugs. Weapons of mass destruction generate universal fear and revulsion, yet the loss of human life due to these weapons does not approach the toll of sanctions.

  Still, one might argue that the United States is such a big country that it does not need other countries. Going without globalization might be an option for the United States, even if it is not an option for countries closer in size to Oregon. Yet the case for international trade is also strong for large economies.

  The United States could attempt to replace the goods we now import with domestic production, but that would give up the valuable benefits associated with trade, whereby we export the goods that we produce relatively efficiently in exchange for those goods that other countries make relatively efficiently. We could make our own coffee beans, winter fruits, and winter flowers, and we could limit ourselves to domestic sources of production for wine, steel, pharmaceuticals, and cars, but these decisions would have serious negative consequences, ultimately lowering living standards of all Americans. Next, let’s see why.

  Jobs, Jobs, and Jobs

  If you wander through the aisles of Walmart, IKEA, or the Gap, you will see many, many imported products; in fact, it can be relatively rare to see American-made products in some US stores. Many Americans wonder: Why do we have to import these products? Why not instead produce T-shirts, jeans, furniture, and household items right here in the United States of America? Surely if we made these goods, there would be more factory jobs, more demand for those workers seeking such jobs, and resulting improvements in income equality.

  First, consider the effect on the total number of jobs if we began to manufacture all the products that we now import. In June of 2018, the unemployment rate was 4.0 percent. Most economists believe this unemployment rate represents full employment. What does “full employment” mean? In a dynamic economy, some workers will always be between jobs, and some workers may be living in places where job opportunities are too few, but nationwide unemployment much lower than 4 percent would create upward pressure on wa
ges and prices, resulting in inflation rather than additional job creation. Lower unemployment rates are simply not sustainable. Historical data support this idea; there are few years in the United States (or elsewhere) where unemployment has been lower than 4 percent.3 Therefore, there is probably not much room to lower the unemployment rate further.

  Some argue that labor force participation could be changed. Many people who are not in the labor force, however, have reasons for their nonparticipation. They are in school, or have retired early, or have chosen to stay home with children. These workers are unlikely to be lured into the labor force by the prospect of jobs making T-shirts or home furnishings.

  Still, labor force participation is not constant over time. Over the period of 1980 to 1995, it rose about 2.5 percent in the United States (from about 64 percent to about 66.5 percent), in part due to women’s increasing participation in the labor force. Since 2000, labor force participation has dropped by more than 4 percent (from about 67 percent to under 63 percent), with the steepest part of that decline happening during the Great Recession, and a more level trend in recent years (fig. 3.1).

  It is clear that the Great Recession drove some workers out of the labor force, but demographic factors also contributed. Much of the recent decline in labor force participation is due to the aging of the population, since older workers are more likely to retire early. One factor that does not, however, appear to be a meaningful driver of labor force participation is international trade.4 In years of rapid import growth, labor force participation has often grown, whereas labor force participation has fallen most in years of flatter import trends.

  Thus, considering our low unemployment rate as well as the insensitivity of labor force participation to trade, even draconian reductions in imports would be unlikely to increase the number of jobs in the economy by more than a percent or two.