Were Clintonites wrong about the economy?; Freakoutonomics

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NOVEMBER 6, 2006

Were Clintonites wrong about the economy?; Freakoutonomics

In 1993, mere months into the Clinton era, the new administrationwent to war with itself. Liberals in the Cabinet argued that thecentral problem of the U.S. economy was the vast middle class thatwas not seeing its income improve--a problem, they said, that couldonly be addressed through massive public investment. Moderates,including Robert Rubin, then the chairman of the National EconomicCouncil, replied that the central problem was restoring economicgrowth, which could only come about by slashing the budget deficit.The moderates won. Their triumph was chronicled memorably in BobWoodward's The Agenda and bitterly mourned in Locked in the Cabinet,the memoir of liberal Labor Secretary Robert Reich. PresidentClinton's first major economic address "mentions education, and jobskills," lamented Reich, "but the real heart of the message is theimportance of reducing the deficit."

By the end of the Clinton years, the centrist ideology that emergedvictorious from this skirmish came to be known as "Rubinomics," amoniker that took hold after Rubin was elevated to Treasurysecretary and became the ideology's most prominent advocate. Thiseconomic vision encompassed several elements: fiscal responsibilitymarried to controlled progressive investment, a belief in theimportance of cultivating Wall Street's confidence, and a suspicionof populism. But, at its deepest level, it reflected an assumptionthat economic growth could be harnessed to the benefit of allAmericans, not just the rich.

When Clinton left office, the Rubinites looked like prophets.Everything they hoped for had come true. Businesses invested more.Incomes grew, and not just for the rich. Families at the middle ofthe income distribution saw their incomes grow by more than

$7,000. The poverty rate fell by one-quarter, and the typical blackfamily saw its income grow by one-third. Even in the early Bushyears, the victory of Rubinomics within the Democratic Party seemedcomplete. Democrats arguing against George W. Bush's tax cutsinsisted that they preferred to use the money not on socialspending but on debt-reduction.

Today, however, the Rubinites have been thrown into doubt. It is notthat their policies have failed. (They have been abandoned:Clinton's economic policies meant fiscal responsibility combinedwith downward redistribution, while Bush has embraced fiscalirresponsibility and upward redistribution.) Rather, what has beenshaken is something even deeper: their faith in the possibilitiesof economic growth.

The cause of their doubt is the disturbing performance of the U.S.economy over the last five years. What's happening is very simple:The economy is growing smartly, but, essentially, all the gains aregoing to the rich. It is almost a dystopian Marxist vision come tolife. Corporate profits have soared, incomes at the very top haveshot through the stratosphere, and, yet, the vast majority ofAmericans have not seen their living standards rise at all. Thisdevelopment does not offer much of an intellectual challenge toeither the right (which is not particularly troubled) or the left(which is not particularly surprised). But the center is bothtroubled and surprised. And, for the Rubinites, figuring out justwhy this is happening, and what to do about it, has begun tounravel their confidence in the moderate remedies that not long agoseemed unassailable.

For 25 years after World War II, widespread prosperity was a bedrockassumption among liberals. The Port Huron Statement, issued by theStudents for a Democratic Society in 1962, famously began, "We arepeople of this generation, bred in at least modest comfort... ."There was good reason for such economic optimism: From 1947 to1973, the median family income more than doubled. And so, with themiddle class flourishing, economic liberalism concerned itself withthe plight of those left behind--inner-city minorities, the ruralpoor, and so on. Since the economic pie was growing on its own,liberals' chief concern was ensuring it was divvied up fairly.

But, starting with the oil price shock of 1973, the spectacularpostwar boom ground to a halt. For the next two decades, livingstandards barely rose at all. Wages would grow during an expansion,but only enough to recapture the ground that had been lost duringthe previous recession. (This period was neatly captured by thetitle of Paul Krugman's 1990 book on the subject, The Age ofDiminished Expectations.) The reason everything went bad all at oncecould be boiled down to a single word: productivity. Productivity,which is a measure of how much workers produce per hour, is theessential ingredient for higher material living standards. Afterall, the two ways to create more wealth are to work more hours orto be more productive in the hours we work--whether throughtechnological advances, improved skills, organizationalstreamlining, or whatever. Since the number of hours in a day isfinite--and, anyway, few people want to spend every waking hourslaving away--the only way for a society to enjoy greater materialcomfort over the long run is to increase productivity. As Krugmanwrote, "Productivity isn't everything, but in the long run, it isalmost everything."

During the postwar boom, productivity surged at an average rate of2.5 percent a year. But from 1973 to 1995, by contrast, it grew ata paltry 1.5 percent. The economic pie had stopped growing, andslicing it up more fairly was no longer enough. So a generation ofliberals, and especially moderate liberals, began focusing on howto restore rising productivity and get the pie growing again. Thiswas one reason the Clinton administration made it a priority toreduce the budget deficit, which drained savings that couldotherwise be tapped by business for investments in new plants andequipment that could raise productivity. "The whole focus was ongrowth," Rubin recalled in an interview with The Nation's WilliamGreider last June. The focus on growth worked. Starting in 1995,productivity began to climb rapidly once again. And, just as theyhad after World War II, wages rose up and down the income ladder.

This is what has made the current economic expansion--which beganafter the brief 2001 recession--such a mystery. On one level, itresembles the expansion of the '90s--high growth, high productivitygains, low unemployment. But, on another level, it resembles theAge of Diminished Expectations: The median income has not grown atall. Workers are helping create enormous fortunes, but not sharingin them. The average hourly wage has actually declined 2 percentsince 2003. The crisis of scarcity has been solved, only to bereplaced by a crisis of maldistribution.

This seems to run in the face of economic theory. If workers growmore productive, logic suggests, they're making more money fortheir employers, which means businesses will find it profitable tohire more of them. The more workers get hired, the more businesseshave to bid up their price to hire them, which means that theirwages will rise. Yet that final step is not happening. The vast newwealth being created by U.S. business is going to owners of capitaland nobody else.

In a widely noted 2005 paper, Northwestern economists Robert Gordonand Ian Dew-Becker concluded that, for some time now, productivitygains have gone entirely to the top one-tenth of the workforce. "Abasic tenet of economic science is that productivity growth is thesource of growth in real income per capita," they wrote. "But ourresults raise doubts, that we find surprising and even shocking,about the validity of that ancient economic paradigm." Ever sincethe Gordon and Dew-Becker paper, economists--especially those on theleft- -have been obsessed with the phenomenon, discussing it inthe mystified tones astronomers might use for a previouslyundetected black hole in our region of space. "Part of the answeris, we don't really know," confesses Peter Orszag, a former Clintoneconomic adviser.

The full weight of what is happening, in other words, has not yetsunk in. Before the current expansion, it had always seemed to bethe case that growth translated into higher living standards formost workers. For that reason, those who follow the economy had,understandably, gotten into the habit of treating top-line economicnumbers as a good gauge of broader economic health. Since thecurrent state of affairs (with rapid growth sitting alongsidestagnant incomes for most workers) is so unprecedented, economicjournalists have had little idea how to treat it. The generalreaction has been to puzzle at the public's sour disposition. Arecent story in the Associated Press is typical:

Overall, the economy grew at a 2.6 percent pace from April throughJune, compared with a 5.6 percent pace over the first three monthsof the year, which was the strongest spurt in 21/2 years. Still,voters remain uneasy even though gasoline prices have starteddropping, the stock market is hitting record highs, and interestrates on credit cards and adjustable mortgages are leveling off.

Just this week, The New York Times published a story on the frontpage of the business section marveling at voters' inexplicablydownbeat assessment of the economy. "Republican candidates do notseem to be getting any traction from the glowing economicstatistics with midterm elections just two weeks away," reportedthe Times. The author proceeded to puzzle at length about why thiscould be, without ever considering the possibility that, for mostpeople, the economy was not doing well.

Conservatives, for their part, have grown enraged that the publicdoes not adequately appreciate the economic bounty it is enjoyingunder Bush. The Wall Street Journal editorial page dubbed thecurrent recovery the "Dangerfield economy" (meaning it gets "norespect") and speculated that people only believe the economy isbad because they have been fed misleading reports by the biasedliberal press. Columnist George F. Will has fulminated against the"economic hypochondria" of the ungrateful masses. Conservativecommentator Larry Kudlow has endlessly touted the Bush boom as "thegreatest story never told."

It is certainly true that the economy is performing well bytraditional standards. But it ought to be apparent that, in thiscase, traditional standards are not the most relevant ones. Fasteconomic growth, after all, is a means to an end--namely, higherliving standards for most people. By any decent moral calculation,an economy that does not produce higher living standards for mostpeople is not a good one.

The most obvious mystery is: Why is this happening now? What makesthis economic cycle so different from the ones that came beforeit?

One convenient answer is that Bill Clinton was president during thelast expansion, and George W. Bush is president during this one.It's an appealing theory for Democrats. The problem is that nobodycan point to any specific policies Bush has put into place thatcould have had such a massive effect. Bush's tax cuts--whichdisproportionately benefit the rich--have, of course, aggravatedthe situation. But the change that economists have troubleexplaining is what's happening to before-tax incomes. Bush simplyhasn't done enough to account for the huge difference between thiseconomy and the Clinton economy. "I wish I could say Bill Clintonwas the reason everything was better in the 1990s," Jason Furman, aClinton economic adviser, confessed to me. Alas, he conceded, it'snot true.

Some economists point out that the unemployment rate is deceptivelylow: If you look at other measures, like the share of thepopulation who are not working (a measure that takes into accountretirees and people not actively looking for work), you can seethat the job market is not quite as tight as it seems. There's alsothe fact that rising health care costs have gobbled up some of themoney that should be going to wages. But none of these factorsexplain all, or even most, of the huge gap between productivity andwages.

And so, in setting about to unravel the mystery, economists(especially those on the center left) have looked closely at adeeper trend, one that has been going on much longer than thecurrent administration: rising inequality. Although the post-1973decline in productivity growth was long considered the primaryeconomic problem facing the nation, lurking in the background was amore or less concurrent trend of widening inequality. Put simply,the fortunes of the very rich and the fortunes of everybody elsehave been diverging sharply. Over the last quarter century, theportion of the national income accruing to the richest 1 percent ofAmericans has doubled. The share going to the richest one-tenth of1 percent has tripled, and the share going to the richest one-hundredth of 1 percent has quadrupled.

During the last half of the Clinton administration, the issue ofinequality receded somewhat. In part, this was due to theparticularly beneficent conditions of the moment. With workers ofall income levels enjoying rising incomes, the fact that someworkers enjoyed higher gains than others seemed less crucial. Inlight of present circumstances, though, the 1990s boom seems morelike a fluke. We enjoyed cheap gasoline, peace and prosperity, anda temporary lull in rising health care costs, thanks to the spreadof health maintenance organizations. Operating under near-perfectconditions, the job market heated up and workers reaped thebenefit. In retrospect, those halcyon days seem like more of ahistorical blip--one that temporarily obscured the massive,continuing undertow of rising inequality.

There is a second reason that inequality has commanded renewedattention in recent years. The more we learn about its causes, themore pernicious it seems, and the more it seems to require radicalsolutions.

For a long time, economists have had a hard time pinning down whythe rich have pulled so far away from the rest of us. The leadingtheory initially put forward by economists was something called"skill-biased technological change." The theory, in a nutshell, isthat the development of new technologies, especially computers, hasmade mental skills more important. In the old industrial economy,there was high demand for brawn, which pumped up the wages ofblue-collar workers. The new economy puts a premium on education.Therefore, the theory goes, workers with college educations havethrived, and those without have suffered. It's a nice theory, andone that seems intuitively correct. It also vindicates the basicfree-market model, in which rising wages for those at the top aresimply a natural reflection of their rising relative economicvalue.

But confounding evidence has piled up in recent years. First,Europe, which is exposed to the same changes in global trade andtechnology, has not seen anything like the increase in inequalityfound in the United States. Second, the salaries of those workerswho ought to be best positioned to gain from technological changehave not risen much at all. From 1989 to 1997, occupations relatedto math and computer science saw only modest income growth (4.8percent), while the income of engineers actually dropped slightly.During that time, however, CEO compensation doubled. Third, thewhole pattern of rising inequality does not suggest a split betweenthe educated and the uneducated. The rise in inequality isn'tbetween the top one-fifth and everybody else; it's between the topone-hundredth and everybody else. As a matter of fact, over thelast five years, college graduates have watched their wages drop,while high school graduates' wages have held steady.

If the skill-biased technological change theory were true, then theanswer to rising inequality would be to make your workers moreskilled. That is exactly what the Clinton administration did,devoting billions of dollars to re- train blue-collar workers inthe hope of making them more competitive for the global economy.And, despite mounting evidence to the contrary, that continues tobe the Bush administration's answer to inequality. Whenevereconomists associated with the administration are asked about therising gap between the very rich and the not very rich, theyinevitably cite skill-biased technological change, offer up someanodyne musings about the need for education, and quickly changethe subject.

If, on the other hand, you reject the theory of skillbiasedtechnological change, you are left with an altogether morediscomfiting explanation. Rising inequality must not be the logicaloutcome of the free market, the invisible hand working its magic.Instead, it must reflect the rising social, economic, or politicalpower of the rich.

Economists, especially those on the center left, have lately beenpaying renewed attention to explanations for rising inequality thatcenter around the lack of bargaining power for labor. First, thepurchasing power of the minimum wage has withered away, reducingwages for workers at or near the bottom. In the late '70s, wheninequality first began to explode, a minimum-wage worker made wellover one-third as much per hour as the average worker. That figurehas crept slowly lower and is currently less than 25 percent.Second, labor unions have shriveled. Less than 8 percent of theprivate-sector workforce belongs to a union, down from more than 20percent three decades ago. And, third, globalization has thrownmuch of the workforce into competition with low- paid overseaslabor.

These last two factors represent terra nueva for the Rubinites.Until recently, the ideological fissure between the economic leftand the center left has always been over the question of at whatpoint the government should step in to redress inequality.Moderates--that is, policy types associated with the Clintonadministration, the Brookings Institution, or most universityeconomics departments--believe that the market is generally themost efficient mechanism for distributing wealth. Government shouldredress inequality, but it should usually do so only after thefact--let the market work, then tax the rich and use some of theproceeds to help the poor. Moderate liberals have historically beenrestrained in their enthusiasm for the minimum wage and unions, andthey have been downright hostile to any limits on internationaltrade.

Economists from the liberal wing of the Democratic Party (thoseassociated with labor unions, say, or groups like the EconomicPolicy Institute) have always attacked the moderates' prescriptionsas naive. If the rich control a growing share of the nationalincome, they will turn their financial power into political powerto protect their holdings. Untrammeled economic inequality willinevitably lock itself into place as the rich buy politicalinfluence and propagate policies that safeguard their wealth. Andso, the liberals have always argued, government must foster greaterlevels of equality before the fact, not merely after.

It would be an exaggeration to say that the Rubinites have accededto the labor-liberal worldview. But there are a lot of straws inthe wind. Take Alan Blinder, a Princeton economist. Blinder is thevery embodiment of technocratic moderate liberalism. He is a formergovernor at the Federal Reserve and a confirmed critic of economicpopulism. Yet, last spring, Blinder wrote a much- discussed essayin Foreign Affairs predicting that tens of millions of U.S. jobscould be outsourced in the coming years and pondering thepotentially devastating implications.

The Democratic Leadership Council--once thought of as labor'sarch-foe within the Democratic Party--has embraced the idea of a"card-check" system to make it easier for workers to form unions.And moderate liberal economists have, in sundry ways, temperedtheir enthusiasm for free trade with deeper worries about thedislocating effects of trade. A recent paper by the HamiltonProject, a Rubin-led group that is ground zero for formerClintonite economists, offered up a far more measured endorsementof free trade than would have been on display a dozen years ago,conceding, "International trade also has slightly exacerbated theunderlying trend in the United States to greater income inequalityand increased levels of income volatility." Former Clinton economicadviser Gene Sperling wrote last year that his fellow moderatesshould admit that "accelerated market opening in nations with weaksafety nets and poor labor rights can at least temporarilyexacerbate inequity." More anecdotally, Jared Bernstein, a liberaleconomist with the Economic Policy Institute, told me that theHamilton Project requested 20 copies of his latest book.

Even Rubin himself has begun saying some highly unRubin-like things.In his interview with The Nation last summer, he mused about the"global convergence of wages"--a favorite phrase of labor liberalsthat refers to the ways global trade can bring down incomes forunskilled workers in advanced economies. He cited John KennethGalbraith's observation that a true labor market does not existwhen business acquires too much power in setting wages. He broughtup the idea again, unprompted, in an interview with me. "I'm notsure where that leads you," he admitted.

I'm not sure either, but the overall direction seems clear. Sincethe outset of the Clinton administration, the party's economicpopulist wing has been on the defensive. Democrats have foughtagainst the most plutocratic and fiscally irresponsible Republicanplans, but they have done so from a standpoint of resolutecentrism. They had strong confidence in an economic model that was,at its core, conservative: unfettered free trade, fiscal restraint.They believed these ideas would benefit all Americans, and theydid. But something has changed in the way the U.S. economy works.And, even if it's not yet entirely clear what has happened or howwe can best address it, the intellectual balance of power inDemocratic circles is already shifting. Today, all the confidenceis on the populist side, and it is the centrists who aren't quitesure what to make of the world around them.

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