Tuesday, March 6, 2012

Searching for Policy Solutions in 6 Major Areas

In order to restore balance to the economy, we submit that there are six critical and related areas that have to be addressed, adding up to a necessary shift of income from wealthy individuals, banks and other corporations (who have more money than they are able to spend) to working people and to government (who have less money than they need).  We will discuss these areas after describing how this shift would unblock the circular flow of income in the economy by releasing funds to spending and thereby increasing final demand, especially consumer demand. This would stimulate employment and investment, which in turn would further increase demand.
            In the current situation of pervasive unemployment, and with this great imbalance in mind, policy proposals should be subjected to this litmus test: do they increase the flow of income in the near term? Second, however, are they compatible with a balanced federal budget in the long term? Increased effective taxation on corporations and high-end incomes to finance state and local government spending is an obvious example of a sound policy proposal.  Reduction of federal support of state and local government spending, by contrast, jeopardizes the economic recovery.  Increases in such support that are not coupled with increased taxation are justified in the near term but would contribute to the federal deficit in the longer term.
The case for a large reverse shift of earnings from wealthy individuals and corporations to ordinary working people – and to the government in the form of higher tax revenues – is obviously remote from the current budget debate in Congress. However, this is a good time to raise fundamental ideas because it is clear that something is fundamentally wrong with the economy. At a time like this, people are likely to be more receptive. Here are six areas that should be addressed.
            1. The problem of low basic wages.  At the heart of the economic imbalance is the problem of low wages. Paradoxically, the setting of wages at their current low levels is bad for business because it depresses demand. Of course, individual companies try to keep wage costs as low as they can, and the immediate impact of lower wages is to increase their profitability. But if you add together the effects of low wages in all the enterprises in the country, the result is that the sum total of wages is insufficient to buy the goods and services produced by those enterprises. When Henry Ford, in a similar epoch, was criticized for his high-wage policy, he said he wanted his workers to be able to buy the cars they produced. Mass production cannot exist without mass consumption.
Today, the circular flow of income is being unduly constricted by the tightness of the wage-setting process. It is remarkable that the average wage for non-supervisory personnel in the private sector has barely kept up with inflation since 1973, and is currently still under $20 an hour or $40,000 a year. And middle-class pay and benefits are under increasing pressure. The setting of wage rates, the most important set of prices in the economy, is not being reliably guided by Adam Smith’s omniscient “invisible hand,” which is supposed to optimize prices across the economy. In America in the early 2000s, just as in the 1920s, the invisible hand has been too tight-fisted to enable most Americans to sustain a middle-class lifestyle. Families have coped by taking on debt, most notoriously in the form of sub-prime mortgages, as depicted in the diagrams above. In 2008, the chickens came home to roost.
            We will not have a sustainable economic recovery – or sustainable economic growth in the longer term – unless and until basic pay levels are increased along with the general growth of the economy over time. There is no single solution to this problem of low wages, no magic bullet, but clearly the political economy of wage-setting needs to be changed. Elements of the solution probably include the spread and strengthening of labor unions, the toughening-up of labor laws such as enforcement of penalties for wage theft, labor bureaus to help workers find the best jobs, minimum wage laws set at living-wage levels, skill training, and the reduction of payroll taxes. 
            Let us deal head-on with the likely objection to higher wages, namely that they will make American companies unprofitable and uncompetitive, particularly in relation to cheap imports from other countries. (Part of income “leaks” out of the U.S circular flow of income and expenditure into cheaper imports, which is one reason why U.S. wages are not finding their way back into sufficient purchases of U.S. goods and services.) There are two broad ways to enhance the labor-competitiveness of U.S. manufacturers and other companies. One is to remove heavy cost burdens that are placed on employers and employees in the U.S. economic system. In particular, there are the burdens of payroll taxes and health care costs currently imposed on employers and employees as part of the labor cost package. (This is discussed below.)
            The other broad solution is to allow the U.S. dollar to decline in an orderly fashion against other currencies through the workings of the currency market, to the extent that wages in the U.S. are higher than those of competitive countries such as China.
            2. Excessively high upper-end incomes.  Secondly, in contrast to the low-wage policies for ordinary workers, the corporate sector in recent decades has increasingly been awarding astronomical salaries, bonuses, stock options and fees to top corporate officers and outside consultants such as financial advisers, advertising agents, and accountants.
            Professional salaries also evidence extreme inequality. While it would be hard to address this issue, perhaps a process for the selective review of price-setting may be in order in certain professions like medicine and law. To the extent that professions operate like “guilds” with restrictive membership, barriers to entry could be considered. In any event, it is hard to believe that salaries and fees running into the millions of dollars a year can be justified, while average wages languish.
            The other factor at work here is that profits as a share of national income are at a high level. Again, this is good for the individual firm, but to the extent that in aggregate those profits lie unused in the coffers of corporations and the wealthy, they are being blocked from performing a useful function.
            As is clear from the Congressional Budget Office study discussed above, almost all the growth in incomes in recent decades has accrued to the top few percent of income earners. Inequality is, in other words, a growing problem, which implies that the political economy underlying income-setting has changed at the upper level in the opposite direction to that in the basic wage-setting process for the mass of workers.  The present system at the upper level is a kind of crony capitalism in which corporate committees and consultants pat each other on the back by awarding each other ever higher salaries and fees.
            “But it’s our money,” the corporate insiders and advisers might object. “It’s ours to do with what we will.” Not so. If you look out across the whole country, across all Americans, it is clear that we are all stakeholders in the “private sector” and are all contributing to it – as consumers, ordinary workers, shareholders, taxpayers – and the rewards as between different stakeholder groups must be assessed, and modified if necessary, by all of us through the political process as well as the marketplace. The relatively unregulated marketplace of the 2000s has let us down.
            Various political and corporate measures could be introduced to reduce the excesses of insider earnings. For instance, greater transparency of salary- and fee-setting could be supplemented by greater rights for investors to challenge the way in which corporations are spending their money.
            A complementary and simpler way of getting the top end of the income distribution back into balance is by reversing some of the tax changes that have favored corporations and the rich. Higher effective high-end income taxes and corporate tax rates are undoubtedly justified
            The current implicit solution to the economic imbalance caused by the excess earnings of corporations and the rich is for the rich to increase their personal consumption, in the form of additional and larger dwellings, automobiles, yachts, airplanes, corporate perks, whatever. And it is no doubt true that in technical economic terms, if the rich were to succeed in consuming a larger share of their income, while investing less, a macro-economic balance between spending and investment could be reached, consistent with full employment, without addressing the distribution of income. To the wealthy and their pundits and politicians that might seem to be a satisfactory solution.
            However, the entrenchment of a small class of people literally and metaphorically in gated communities, with the rest of the population restricted to a low-wage environment providing goods and services to the wealthy directly or indirectly, is not consistent with democracy. Nor does it address the legitimate concerns of Occupy Wall Street.
            3. Burdens on employment costs.  There is no logic in treating social security and health care costs as part of the costs of employment. I repeat: there is no logic in treating social security and health care costs as part of the costs of employment. But for historical reasons both types of costs are currently recovered from employers and employees and at this point have become a crushing burden. It is no wonder that employers are reluctant to take on more workers, and it is not surprising that the wages left over after these costs have been paid are squeezed by employers. Consider the calculations made by automobile manufacturers about the costs per car of assembling cars in this country and the resulting competitive handicap.
            As hard as it is to imagine the American economy without the burdens of social security and health care costs on private sector employers, it seems necessary – if we are to achieve and sustain full-employment – to make this break and to recover these costs out of general tax revenues. At one stroke, manufacturing in this country – even with higher cash wages – would become more competitive than it currently is.
            4. Changes in Taxation.  The pair of changes discussed above – the elimination of payroll taxes and the removal of health costs from employers and employees – would significantly shift the burden of taxes. Additional or enhanced sources of tax revenues would be required to recover the additional costs. These would include the increases in income and corporate taxes mentioned above.
            What is necessary is not only to return nominal tax rates closer to levels that prevailed before the Reagan-Bush tax cuts, but to reduce tax breaks so that effective tax rates are returned to more reasonable levels. The point, again, is to unblock the flow of expenditure in the economy by, in effect, recycling additional income from the groups that can easily afford it to the government and consumers, who desperately need it.
            These sources might prove to be adequate, but if not, some additional form of taxation would be needed. (A general carbon tax would be a good candidate, because it would at the same time help address global climate change issues.)  Obviously, any major changes of this nature would be highly contentious and hotly debated, but the justification for them would be a huge reduction in the cost of employing labor.
            5. High health-care costs.  A solution must be found to the problem of high health care costs. While the focus of this paper is macroeconomic, one or two sectors are so large and so burdensome on the economy as a whole that it is worth singling them out for special mention.
            Health care is such a sector. Not only does it absorb approximately one out of every six dollars spent in the economy, it also is directly implicated in the budget problems of the federal government because of the large and rising costs of Medicare and Medicaid. Other things being equal, these costs will continue to rise as health care inflation continues and the population ages.  In the framework of a single-payer health care system or public option, however, there would be many opportunities to reduce the level of costs per capita, as is clear from comparison with all the other countries that have universal health care systems in place.
            6. The problem of the bloated financial sector.  Finally, the financial sector absorbs about 8 percent of the GDP, and although this is somewhat less than half the share of health care, the sector is directly implicated in the episodes of repeated bubbles and busts that have destabilized the economy.
            Adult supervision of the financial sector is required. Finance has doubled its share of GDP in recent decades, while the country’s economic performance has deteriorated. It is fair to label it as dysfunctional and to require fundamental financial reform if the country is to get back onto an even keel.

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