In anticipation of 2008, a potentially historic debate is shaping up within the Democratic Party. On one side are progressive Democrats whose lineage reaches back to FDR and the New Deal. On the other side are new Democrats, who emerged in the 1980s and embraced Ronald Reagan’s critique of big government.
The economy is the central point of contention between the two groups. Thus, New Democrats maintain the economy is headed in the right direction, and they deny progressive Democrat claims about income stagnation and corporate excess. This denial was recently on display in a report (The New Rules Economy) issued by Third Way, an influential new Democrat think-tank in Washington DC. The report denies America’s working families have been short-changed. In doing so, it misrepresents economic reality, under-cuts working families and gives comfort to supporters of corporate excess. That makes the Third Way the wrong way. Here are the facts.
Denial #1: family income has not stagnated. The report begins by claiming America’s middle class has been doing well. According to Third Way, incomes for married couple households half way up the income ladder (the fiftieth percentile) rose twenty-two percent between 1979 and 2004. That seems pretty good – except tucked away in a footnote is the fact that adjusting for increased hours worked by wives, income only rose nine percent. Over a twenty-five year period that translates into an average increase of about one-third of one percent per year – which is not the economy American families once knew.
The situation is far worse for those lower down the income ladder. Families near the bottom (the tenth percentile) saw their incomes rise just one percent over twenty-five years. If hours worked had not increased, their incomes would have fallen. For families at the thirtieth percentile (America’s historic blue-collar middle class), the twenty-five year income gain was fourteen percent. Strip out increased hours worked and we’re talking income stagnation.
Sizeable family income gains only kick in higher up the ladder: a thirty-one percent increase at the seventieth percentile and forty-two percent at the ninetieth percentile. But claiming these top-end families represent the middle-class is like believing we all have above average income.
Denial #2: executive pay not a problem. A second denial concerns the CEO pay explosion, which Third Way describes as “maddening†but just a “drop in the bucket†and of no major economic consequence. Reality says otherwise, with corporate executive excess now reaching such proportions that it is like a tax on all of us.
Harvard Law School Professor Lucian Bebchuk and Yaniv Grinstein of Cornell report that between 2001 and 2003 the aggregate compensation paid by public companies (about 2000 of them) to their top-five executive officers equaled ten percent of company profits. In a sense, these executives are implicitly claiming their productive contribution equals the contribution of ten percent of their companies’ net equity capital.
The raw numbers show that between 1993 and 2003 total top-five executive compensation paid by public companies totaled 350 billion dollars. That averages 35 million dollars per executive, or 3.5 million dollars per executive per year. This is not a drop in the bucket; it’s a hole.
Even worse, executive excess is a like cancer that ripples down and distorts organization pay structure, creating massive top-heavy pay inequality and leaving less for ordinary workers.
Denial #3: trade deficits not a problem. Next, Third Way casually dismisses the trade deficit as not a cause for concern. The trade deficit has caused job loss, and while it is true that the economy eventually creates new jobs, those replacement jobs tend to pay significantly less. Displaced workers therefore first suffer the injury of unemployment, and then find inferior jobs.
Moreover, it is widely known that companies use the threat of job off-shoring to suppress pay and benefits. This helps explain why family incomes have stagnated. Jobs don’t need to be lost for current trading arrangements to do harm.
The trade deficit has also contributed to the erosion of the U.S. manufacturing base. Unable to compete because of unfair foreign trade practices and our own flawed policies, many manufacturing firms have either shut shop or moved offshore. That has shrunk manufacturing, which threatens future living standards because manufacturing is key to productivity growth.
It has also made the U.S. dependent on imported manufactured goods to accompany our dependence on imported oil. That is an economic and national security threat, which is compounded by the financial vulnerability that goes with growing foreign indebtedness. The trade deficit is the funnel through which these effects stream, yet Third Way recommends turning a blind eye.
Denial #4: no household debt or saving problem. Lastly, the report claims families have no debt problem because most debt is mortgage debt. However, data shows that households are paying a record share of income as interest, and debt is at record levels relative to income.
This has increased household financial vulnerability but that has been obscured by rapid house price inflation. Should house prices start falling or merely stall, as speculation evaporates or adverse demographics and income stagnation grind away, mortgage debt could quickly become a problem, Moreover, any problem will be amplified by increased income volatility since debt makes families more vulnerable to income shocks, be they due to sickness, outsourcing, or parenthood.
As for retirement saving, here too Third Way tries to hide behind house price inflation. The claim is that increased house prices have solved the saving problem. That is like saying we can take care of saving through inflation.
Higher house prices have benefited those who bought early enough, but prices must be sustained. Even if they are, owners’ gains come at the expense of buyers whose own saving is eaten up by large mortgage interest payments. And if someone sells their home because they need retirement income, where do they live? On top of that, what about the thirty-plus percent of people who do not own?
House price inflation is a one-time wealth transfer that at best solves the saving problem of one generation of owners. Put bluntly, price inflation that robs Peter to pay Paul does not solve families’ long-term problem, which is one of wages and income.
Copyright Thomas I. Palley
What can I say except ‘Bravo’?
Have the Dem candidates lined up behind this ‘Third Way’ ? Hard to believe this “think tank” can read the last election result and the current economic realty this poorly.
I want to believe that Dems are not only for small responsible government but for the smaller citizens, the ones who thought there was a lot of corruption in Congress, the ones who are getting tired of the lack of a real/perceived difference in the candidates, the ones who no longer vote.
Obama seems to be making a difference. Hope he’s not with ‘the third way’.
http://www.thomaspalley.com/?p=69#more-69
Hi Dr. Palley,
I enjoy reading your blog even though I’m not an economist. The American New Democrat v. Old Democrat debate interests me a great deal, and accordingly, this post too. If you have time to respond, I’d like to pose a few questions by a novice.
a) It is unclear to me whether this post is directed soley at the report produced by the think-tank, the Third Way, or if it also indirectly addresses attempts to find another way between labour and free-market ideologies. If the latter, then I curious about how one is to fix the economic woes of countries like France.
b) Additionally, I’m curious about your outlook. Do you sympathize with labour? Or do you believe that a third way may be conceived, but that the current ideas of the Third Way think-tank and the New Democrats are off the mark?
c) It would seem, at least from a political view-point, that the world has undergone a few paradigm shifts since the end of the Cold War. As such, do the problems you addressed in this post result in some degree to the increase of connectedness and globalisation? And, do we need to rethink our previous economic views?
I understand that these are somewhat loaded questions, but I hope that you might be able to provide some direction.
Thanks
(BTW, I’m somewhat familiar with your previous remarks re New Dems v. Old Dems.)
Dear Tar Heel,
Thanks for your good questions. The post is aimed at the New Democrat paradigm, of which Third Way is representative.
The progressive vs. New Dem debate operates at two levels. The first level is empirical, and concerns the state of the economy & the middle class (which is the focus of the current article). That sets the stage for the second level debate concerning policy.
New Dems are comfortable with the state of the economy, and therefore recommend “helping hand” policies such as assisting displaced workers & tax credits for saving and education. In a sense, they are the “true” compassionate conservatives.
Progressive Dems read the economy as needding deeper structural reforms to globalization policy, labor market policy, monetary policy, public investment, etc.
In the U.S., the Third Way paradigm is a distraction that helps keep debate where conservative market fundamentalists have positioned it. What we should be talking about is how progressive Democrats and labor can modernize themselves. For me, that means taking economic policy seriously. What’s the point of labor helping win elections and then having nothing to contribute or getting nothing after the election? If labor tackles economic policy at a deep level, it will automatically modernize itself & start sounding extremely relevant and attractive to people.
Best,
Tom Palley