February 23, 2015
Robert Samuelson was inspired by a graph in the new Economic Report of the President to tell readers that the real problem for the middle class is not inequality but rather productivity growth. His point is that if we had kept up the Golden Age (1943-1973) rates of productivity growth it would have mattered much more to middle income families living standards than the rise in inequality since 1980.
This is true in the sense of if I were six feet five inches, I would be taller than I am, but it’s not clear what we should make of the point. We don’t know how to have more rapid productivity growth (at least not Golden Age rates), so saying that we should want more rapid productivity growth is sort of like hoping for the second coming. As Samuelson notes, we do have policies that would likely improve growth, more spending on infrastructure, education, and research and development, but no one seriously thinks such policies would get us back to the golden age growth rates of 3.0 percent a year. (Samuelson includes tax reform on his list. While a cleaner tax code probably would boost growth, it’s worth noting that tax rates were much higher and the tax code contained more loopholes in the golden age.)
As a practical matter we may not be able to boost productivity growth, but we can change the policies driving inequality. At the top of this list, if we maintain low levels of unemployment as we did in the late 1990s, then middle income and lower income wages will rise in step with productivity growth. This would require generating demand through fiscal policy and lower trade deficits from a lower valued dollar. It also means not having the Fed cut off growth with higher interest rates.
If we also structured labor laws so that it was possible for workers to organize unions, had a minimum wage that kept pace with productivity growth (as it did in the golden age), and didn’t protect high-end professionals (e.g. doctors, dentists, and lawyers) from domestic and international competition, then it would be reasonable to expect middle class incomes to keep pace with the economy’s productivity growth. If we can only sustain the 1.5 percent annual productivity growth of the slowdown years (1973-1995) this would still imply income gains of almost 60 percent over three decades. While it would of course be better to have golden age productivity growth, since we don’t know how to get back such rapid growth, why not pursue the policies that we know will be effective in restoring middle class income growth?
It is also worth noting that these equality enhancing policies are also likely to provide some boost to productivity. We know that the most important determinant of investment is growth in demand. This means that if we push the economy, rather than have the Fed slam on the brakes with higher interest rates, we will likely see more investment in new plant, equipment, and software, and therefore more productivity growth. In addition, in a tighter labor market workers will leave low productivity jobs for jobs with higher productivity that offer higher wages. A reason that many workers, including many with college degrees, have taken jobs in restaurants is that there are not better paying jobs available. If the economy were stronger, better jobs would be available causing productivity to rise due to a shift in composition.
It is also worth briefly correcting Samuelson’s history. After telling us about the post-World War II boom Samuelson gives readers the following breakdown:
“? The Great Inflation, 1965-1982: We couldn’t let well enough alone. Economists argued that deft policies could keep the economy close to “full employment” (defined as a 4 percent unemployment rate). The experiment backfired. Inflation — virtually nonexistent in 1960 — hit 6?percent in 1969 and 13 percent in 1979. This led to four recessions (1969, 1973, 1980 and 1981). Because no one seemed capable of subduing inflation, people lost faith in national leaders. Rising foreign competition deepened pessimism.
“? The Great Moderation, 1983-2007: A period of brutally tight money, engineered by Federal Reserve chairman Paul Volcker, crushed inflationary psychology and started a 25-year boom. There were only two mild recessions (1990, 2001). As inflation fell, so did interest rates; and as interest rates fell, stocks and home prices rose. People spent or borrowed against newfound wealth. The personal savings rate dropped from 10.6 percent of disposable income in 1980 to 2.5 percent in 2005.
“? The Big Scare, 2008-????: The boom’s confidence turned self-destructive. People overborrowed; lenders over-lent. What was scary about the ensuing crisis was that it was supposedly made impossible by modern economics and financial regulation. The fact that it happened anyway made consumers and business managers extra cautious. ..”
This one doesn’t fit well with the data. The sharp break between the inflation of the “Great Inflation” and the prior period when it was “virtually nonexistent” is not quite right. There were several years of moderate to high inflation in Samuelson’s shortened golden age. Inflation was 3.4 percent in 1956 and 3.5 percent in 1957. It was 5.6 percent in 1948, 6.8 percent in 1951, and 11.2 percent in 1947. If Samuelson’s point is that high inflation was not sustained, this is true, but it is wrong to imply there were no issues with inflation prior to the efforts of the low unemployment do-gooders of the 1960s.
This is also reflected in the recession story. He tells us that the high inflation led to four recessions. That is true, but we also had four recessions from 1948 to 1960 during Samuelson’s golden age. It is also worth noting that the high inflation of the 1970s and early 1980s (which peaked at less than 10.0 percent using the GDP deflator) was driven in large part by surges in oil prices that had nothing to do with U.S. macroeconomic policy. The price of oil quadrupled following a round of OPEC price increases and oil boycott directed at the United States in 1973. There was a second round of price increases in 1979 following the Iranian revolution. Since the economy was far more dependent on oil than it is today, these price hikes were certain to cause major disruptions regardless of what macroeconomic policy we pursued.
The notion that the recessions of the Great Moderation period were mild also is not entirely accurate. While they were moderate in terms of GDP loss, there were quite severe measured in terms of their impact on the labor market. The 2001 recession was especially harsh. We did not get back the jobs lost in the downturn until January of 2005. Until the current downturn, this was by far the longest period without net job growth since the Great Depression.
Finally, the story of the “Big Scare” doesn’t quite fit the data either. Saving as a share of disposable income is now lower than at any point except the peaks of the stock and housing bubbles. By the measure of how much consumers are spending, they do not appear scared. Similarly, the investment share of GDP is back to its level of 2005-2006, a period in which firms were not obviously scared.
The most obvious reason for a shortfall in demand is the $550 billion annual trade deficit (@ 3.0 percent of GDP). In the late 1990s and the last decade the shortfall in demand created by the trade deficit was filled by the stock bubble and the housing bubble, respectively. In the absence of another bubble, there is no obvious way to fill this shortfall in demand (apart from large budget deficits).
Addendum:
Samuelson tells readers:
“At every juncture in the chronology, people — including “experts” — did not foresee the next major change. In the early 1960s, they didn’t anticipate high inflation; in the late 1970s, they didn’t expect its demise. In this respect, the surprise 2008-2009 financial crisis was typical.”
Actually, the housing bubble, and the recession that would result from its collapse, was easy for experts who understood the economy to see.
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