EconoMonitor

Why the Economy Can’t Get Out of First Gear

Rarely in history has the cause of a major economic problem been so clear yet have so few been willing to see it.

The major reason this recovery has been so anemic is not Europe’s debt crisis. It’s not Japan’s tsumami. It’s not Wall Street’s continuing excesses. It’s not, as right-wing economists tell us, because taxes are too high on corporations and the rich, and safety nets are too generous to the needy. It’s not even, as some liberals contend, because the Obama administration hasn’t spent enough on a temporary Keynesian stimulus.

The answer is in front of our faces. It’s because American consumers, whose spending is 70 percent of economic activity, don’t have the dough to buy enough to boost the economy – and they can no longer borrow like they could before the crash of 2008.

If you have any doubt, just take a look at the Survey of Consumer Finances, released Monday by the Federal Reserve. Median family income was $49,600 in 2007. By 2010 it was $45,800 – a drop of 7.7%.

All of the gains from economic growth have been going to the richest 1 percent – who, because they’re so rich, spend no more than half what they take in.

Can I say this any more simply? The earnings of the great American middle class fueled the great American expansion for three decades after World War II. Their relative lack of earnings in more recent years set us up for the great American bust.

Starting around 1980, globalization and automation began exerting downward pressure on median wages. Employers began busting unions in order to make more profits. And increasingly deregulated financial markets began taking over the real economy.

The result was slower wage growth for most households. Women surged into paid work in order to prop up family incomes – which helped for a time. But the median wage kept flattening, and then, after 2001, began to decline.

Households tried to keep up by going deeply into debt, using the rising values of their homes as collateral. This also helped – for a time. But then the housing bubble popped.

The Fed’s latest report shows how loud that pop was. Between 2007 and 2010 (the latest data available) American families’ median net worth fell almost 40 percent – down to levels last seen in 1992. The typical family’s wealth is their home, not their stock portfolio – and housing values have dropped by a third since 2006.

Families have also become less confident about how much income they can expect in the future. In 2010, over 35% of American families said they did not “have a good idea of what their income would be for the next year.” That’s up from 31.4% in 2007.

But because their incomes and their net worth have both dropped, families are saving less. The proportion of families that said they had saved in the preceding year fell from 56.4% in 2007 to 52% in 2010, the lowest level since the Fed began collecting that information in 1992.

Bottom line: The American economy is still struggling because the vast American middle class can’t spend more to get it out of first gear.

What to do? There’s no simple answer in the short term except to hope we stay in first gear and don’t slide backwards.

Over the longer term the answer is to make sure the middle class gets far more of the gains from economic growth.

How? We might learn something from history. During the 1920s, income concentrated at the top. By 1928, the top 1 percent was raking in an astounding 23.94 percent of the total (close to the 23.5 percent the top 1 percent got in 2007) according to analyses of tax records by my colleague Emmanuel Saez and Thomas Piketty. At that point the bubble popped and we fell into the Great Depression.

But then came the Wagner Act, requiring employers to bargain in good faith with organized labor. Social Security and unemployment insurance. The Works Projects Administration and Civilian Conservation Corps. A national minimum wage. And to contain Wall Street: The Securities Act and Glass-Steagall Act.

In 1941 America went to war – a vast mobilization that employed every able-bodied adult American, and put money in their pockets. And after the war, the GI Bill, sending millions of returning veterans to college. A vast expansion of public higher education. And huge infrastructure investments, such as the National Defense Highway Act. Taxes on the rich remained at least 70 percent until 1981.

The result: By 1957, the top 1 percent of Americans raked in only 10.1 percent of total income. Most of the rest went to a growing middle class – whose members fueled the greatest economic boom in the history of the world.

Get it? We won’t get out of first gear until the middle class regains the bargaining power it had in the first three decades after World War II to claim a much larger share of the gains from productivity growth.

This post originally appeared at Robert Reich’s Blog and is posted with permission.

21 Responses to “Why the Economy Can’t Get Out of First Gear”

SchofieldJune 13th, 2012 at 2:46 pm

For sustainable demand history seems to be saying the time has come round yet again to squeeze the rich until the pips squeak or less prosaically it's time for them to share some of their ill-gotten gains, well at least unaccountable gains.

StuJune 13th, 2012 at 2:52 pm

Well right now organized labor is out of control and social security is broke so I'm not sure we can learn from those. Glass-Steagall would definitely help though.

There is no mention of the fact that governments are refusing to let bad debt be restructured in an orderly manner. Instead they are using taxpayer (including middle class) dollars to bail out bondholders instead of making the ones who took the risk take the loss. That is where the government needs to learn its lesson

LCRJune 13th, 2012 at 9:33 pm

"American consumers, whose spending is 70 percent of economic activity, don’t have the dough to buy enough to boost the economy – and they can no longer borrow like they could before the crash of 2008."
The entire expansion of the US economy since the early 70's was debt-based. By borrowing for their (government and household) consumption (things they actually did not need) and sending productive jobs overseas, we have a self inflicted wound. Don't blame the rich. Blame the Fed that changed "price stability" in to "stable inflation". You know inflation is the worst regressive tax out there yet most continue to "play along" as if it is necessary. Inflation is only necessary in a debt-based leveraged society. Hence, we have to deflate. Yes, it will be painful but it provides a nice firm base from which to rebound. Then the middle class can grow once we end the FED.

LCRJune 13th, 2012 at 9:40 pm

From Nobel Prize:
"The decision to lower the prize sum, from SEK 10.0 to 8.0 million, is related to the assessment that the Board of Directors makes today of the potential for achieving a good inflation-adjusted return on the Nobel Foundation’s capital during the next several years. Another part of the picture is that during the past decade, the average return on the Foundation’s capital has fallen short of the overall sum of all Nobel Prizes and operating expenses. The costs of the Nobel Foundation’s central administration and the Nobel festivities are therefore being reviewed.

“The Nobel Foundation is responsible for ensuring that the prize sum can be maintained at a high level in the long term. We have made the assessment that it is important to implement necessary measures in good time,” says Lars Heikensten, Executive Director of the Nobel Foundation.

We can thank the central Bankers for this. Households are no different.

Aegean1972June 14th, 2012 at 7:46 am

The article hit the nail on the head.

As long as the middle-class is not spending and even shrinking fast, dont expect a light at the end of the tunnel.

Same applies to europe. Europe will not get out of the hole it dug itself in, unless they cut down on taxes and austerity. The economy doesnt grow with austerity. It grows with middle class spending. When you tax them through the roof and put hard austerity on top of that, what you get is "a Greece". A country in the brink of collapse with 50% unemployment (ages 24-35) 25% official unemployment and 50% of small to md sized business closed in the last 2 years.

Is that the recipe that europe wants to enforce to the the rest of the south (Spain, Italy, Portugal, etc)? Hasnt europe learned anything from the Greek "guinea pig"? Dont they see that this recipe is totally wrong?

30 years of globalization has seriously affected the worlds middle class. Took us a while to figure that out…Now its gonna take at least a decade for some light at the end of the tunnel. Add to that the euro-crisis and you can see how fragile the whole system is…All it takes is one domino for world panic to start unfolding in both sides of the atlantic and in china. Cause everything is linked.

sierra7June 14th, 2012 at 10:33 am

"The answer is in front of our faces. It’s because American consumers, whose spending is 70 percent of economic activity, don’t have the dough to buy enough to boost the economy – and they can no longer borrow like they could before the crash of 2008."
DUHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHHH!!!!!!!!

My, My! Has some form of "critical thinking" taken over!!!!!!!?????

Denis ProsperiJune 14th, 2012 at 11:24 am

The article presumes that we live in a closed economy. There is a world out there that isn't going to allow for our middle class to get a bigger bite of the pie without losing more business to overseas producers.

benleetJune 14th, 2012 at 1:17 pm

Half of American workers, 75 million of 150 million, have an average income of $15,000 in an economy that generates $47,000 per human or $188,000 per family of four. These 75 million workers receive only 7% of all personal income. That is, Social Security Administration wage income report shows that 48.2% of workers had income below $25,000, and collectively their income was $734 billion, and in the same year the total personal income was $11,468 billion or $11.5 trillion. Half had 7% of total personal income. These low-income people have been losing their share, the balance of distribution has shifted, the size of the income pie for 80% of the nation has been shrinking. CBO report Trends in the Distribution of Household Income Between 1979 and 2008 proves that the after-tax and after-government-transfer income to the top 1% grew from 8% to 17%, a 9% shift in about 30 years. If we had the same distribution of income as 1979 each of the 94 million households in the lower 80% would have $11,000 more income each year. When workers are unable to buy the products and services they produce, the employers lay them off, and the entire economy shrinks.
Marriner Eccles, Chief of the Fed 1934-1948, said the same: "But by taking purchasing power out of the hands of mass consumers, the savers denied to themselves the kind of effective demand for their products that would justify a reinvestment of their capital accumulations in new plants." —– This is too simple, as Reich says, it is staring us in the face. Shift income and wealth imbalance — then the economy will grow again. Did you know that there were more private sector jobs in July 2000 than today? Even though the working age population has increased by 25 million, from 217 million to 242 million. No private sector job growth. Why? No one could buy the stuff they were producing, except the very rich. My blog: http://benL8.blogspot.com

JMA1787June 14th, 2012 at 2:46 pm

Have you ever thought that the real fundamental problem is that 70% of our economy depends on consumer consumption, much of it financed by debt? And that a large portion of the other 30% depends on government consumption, 40% of that also financed by debt. Maybe if our economy focused more on capital investment, savings and exports, things would be quite so bad.

LCRJune 14th, 2012 at 8:15 pm

You describe symptoms of a disease without diagnosing the correct disease. The disease is the debt-based consumerism backed by government shouldering of massive debt. This tumor started in the 70's and is growing exponentially. The US allowed its economy to be funded by government expenditure and borrowing while basically sending labor/manufacturing overseas. We also decided to subsidize the healthcare of other countries with our healthcare inflation footed by private and government premiums and payments. The distribution of wealth was always destined to skew to the wealthy when the Fed creates inflation to support increasing debt.

R. CoutinhoJune 14th, 2012 at 8:27 pm

If you truly believe what you just wrote, then blame Nixon for taking the U.S. off of the gold standard (a really good idea, imho).

PronghornJune 14th, 2012 at 9:10 pm

Consumption is not the only thing that pushes the economy, Robbie. Why not talk about investment, which creates long-term growth? Wouldn't that be better than simply getting people to buy more crapola they don't need?

LCRJune 15th, 2012 at 6:55 pm

Of course I blame Nixon, what's your point? He was manipulated by the banksters and knew the other countries were calling our financial bluff. The entire debt-based economy since 1970's is a government Ponzi scheme. Now we have to see it unwind, likely through default on the citizens and massive inflation.

DavidJune 18th, 2012 at 7:05 pm

Coincidence is not causation. The "rich" are not getting "richer" because the poor and middle class are getting poorer; this is not a finite pie economy and neither the "rich" nor "big corporations" make people poor…that would be counter-productive even if they had that ability. The poor and middle class suffer disproportionately from excessive government control, regulations and taxes, which are the primary cause of our economic malaise. For the poor and middle class to prosper, we need more jobs and economic activity, which will only come from eliminating the excessive impediments and incompetence of government. Politicians blocking high paying jobs in the energy sector as a pay-off to their enviro-wacko constituents, or wasting half a billion hard-earned tax dollars on a failed "green energy" company kick-back, are just two of the thousands of examples of our current government's debilitating incompetence and negative impact on our economy and psyche. We need transaction "velocity" which comes from a freer and more efficient economy full of confident entrepreneurs and consumers. Our current system of big controlling government full of arrogant bureaucrats with little to no practical business experience is the main impediment to economic growth, velocity and confidence. The Obama-Reid-Pelosi regime is far too controlling and hostile toward economic freedom and unwilling to commit to a budget, tax policies and regulatory relief that would give businesses the freedom and visibility needed to plan, hire and invest. Government really is the problem; we need to get it out of the way.

Deva SagayamJune 23rd, 2012 at 1:39 am

No jobs even if economy improves.
New successful companies can not be automatically expected to create jobs. The old successful ones themselves are not able to create jobs for the following reasons:
1) Manufacturing is going high tech. Now even warehousing and online distribution centres have gone High Tech. This translates to fewer jobs.
2) Virtual economy created by Facebook, Google or Microsoft which creates wealth without creating corresponding jobs, as the old economy did.
So look elsewhere for jobs.

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