Tuesday, September 28, 2010

Aftershocked by Reich

Shortly after yesterday's post about a recent Robert Reich interview, I purchased the book he's currently out pimping, Aftershock: The New Economy and America's Future.  I have not read the whole thing yet, but I have read the key chapters in which he sets forth his vision of the problem and his solution to it.

Here's what I can say definitively: this is a book written for economic elites by an economic elite.  What's more, it was not written for economic elites like me, who already believe that having a vibrant middle class is crucial for America's long term success as a nation, but for economic elite who need convincing (i.e., the "let them eat cake!" types). 

Here's what I cannot tell: is Reich really as clueless as he seems, or is he playing dumb to make sure his intended audience (the "cakers") will read the whole book?

Reich's central thesis is that income inequality is the source of America's economic doldrums:
Geithner . . .  misstated the underlying problem, of which the Great Recession was a symptom.  The problem was not that Americans spent beyond their means but that their means had not kept up with what the larger economy could and should have been able to provide them.  The American economy had been growing briskly, and America’s middle class naturally expected to share in that growth.  But it didn’t.  A larger and larger portion of the economy’s winnings had gone to people at the top.
This is the heart of America’s ongoing economic predicament.  We cannot have a sustained recovery until we address it.  It is our social and political predicament.  We risk upheaval and reactionary politics unless we solve it.  The central challenge is not to rebalance the global economy so that Americans save more and borrow less from the rest of the world.  It is to rebalance the American economy so that its benefits are shared more widely in America, as they were decades ago.  Until this transformation is made, our economy will continue to experience phantom recoveries and speculative bubbles, each more distressing than the one before.

Reich explains how the middle class was able to mask the effects of income inequality through three coping mechanisms:Of these measures, only the last one-- taking the money out of politics-- seems to address the underlying system (the tilted playing field) that led to income inequality, but it does so in a purely cosmetic way that cannot address the influence exerted over lawmakers by the largest employers in a congressional district, for example.

Americans also accepted the backward swing of the pendulum because they mitigated its effects. Starting in the late 1970s, the American middle class honed three coping mechanisms, allowing it to behave as though it was still taking home the same share of total income as it had during the Great Prosperity, and to spend as if nothing substantially had changed. Not until these coping mechanisms finally became exhausted in the Great Recession would the underlying reality become evident. (And not until the federal government ended its stimulus and the Fed tightened the money supply would that reality be exposed as more enduring than the Great Recession’s downturn.)

Coping mechanism #1: Women move into paid work . . .
Coping mechanism #2: Everyone works longer hours . . .  
Coping mechanism #3: We draw down savings and borrow to the hilt . . .

Eventually, of course, the debt bubble burst. With it, the last coping mechanism disappeared . . . 
Reich then explains how the disappearance of these coping mechanisms has awakened the middle class to a reality that is very different from what they expected, a reality that appears to be a "rigged game" to make the rich richer even as they are made poorer.  Reich at no time argues that the game is NOT rigged.  Indeed, he admits that it is, and that the income gap will continue to widen unless something is done.

All of this, Reich says, is giving rise to "the politics of anger," something that is a threat to everyone, including the wealthy and the nation as a whole:
So, does Reich offer solutions to level the playing field, to clean up the game so it is no longer rigged but fair?  No.  Reich's proposal merely aims to make "a tilted playing field . . . tolerable" to the middle class through:
I could have grounded my argument in morality: It is simply unfair for a handful of Americans to take home such a large share of total income when so many others are struggling to make ends meet. Or I could have based it on traditional American values: Such a lopsided distribution is at odds with the nation’s history and its ideal of equal opportunity—especially when the deck seems stacked in favor of those at the top. I could have talked about how this degree of inequality undermines the nation’s moral authority and its standing in the world.
I have chosen instead to base my argument on two tangible threats that such inequality poses to everyone—including even the wealthiest and most influential among us. One is economic: Unless America’s middle class receives a fair share, it cannot consume nearly what the nation is capable of producing, at least without going deeply into debt. And debt on this scale is unsustainable, as we have seen. The inevitable result is slower economic growth and an economy increasingly susceptible to great booms and terrible busts. The other threat is political: Widening inequality, coupled with a growing perception that big business and Wall Street are in cahoots with big government for the purpose of making the rich even richer, gives fodder to demagogues on the extreme right and the extreme left. They gain power by turning the public’s economic anxieties into resentments against particular people and groups. Isolationist and nativist, often racist, and willing to sacrifice overall prosperity for the sake of achieving their ends, such demagogues and the movements they inspire can cause great harm. As I’ve shown, the Great Recession has accelerated both troubling trends. With the bursting of the housing bubble, many middle-class homeowners who can no longer use their homes as piggy banks must face the reality of flat or declining wages. The downturn also has forced—or given a ready excuse for—firms to increase profits by shrinking their payrolls, laying off millions of workers and reducing the pay of millions more. It has simultaneously induced firms to ratchet up the pay of their “talent”—the executives and traders who drive the profits. At the same time, the Great Recession has starkly revealed the political power of big business and of Wall Street. Both have been able to enhance their profits by exacting money and other favors from government—even from one under the nominal control of the Democratic Party.
Unless these trends are reversed, the financially stressed middle class will not have the purchasing power to keep the economy growing. This will hurt even those who are well-off. A political backlash could generate a similar result, or worse. Margaret Jones and her Independence Party are fictional, but the anger on which she bases her appeal is not.
I cannot pretend that the following measures would remedy these problems altogether, but they represent important steps. They would help restore the basic bargain. As such, they would fill the gap in aggregate demand, and would preempt a politics of resentment. Some of these reforms would be costly, but I suggest ways to pay for them so they would not increase the national debt. To the contrary, they are likely to produce a budget surplus. And because they would generate stronger and more sustainable growth than the policies we now have, they would shrink the debt as a proportion of the national economy in years to come. The costs of inaction are far greater. An economy functioning well below its capacity is a terrible waste of all our resources, especially of our people; a society riven by resentment is potentially unstable.

A reverse income tax  (welfare for the working poor)
A carbon tax(recouping subsidies in production at the point of consumption)
Higher marginal tax rates on the wealthy.
A reemployment system rather than an unemployment system(worker training)
School vouchers based on family income. 
College loans linked to subsequent earnings.
Medicare for all.
Public goods(free parks, museums and public transportation)
Money Out of Politics.

Everything else seeks to address income inequality through redistributive taxes and by shifting costs to the government.   While some of the proposals are necessary (e.g., Medicare for all and higher marginal tax rates on the wealthy), none of them are sufficient, alone or together, to address thre real problem, of which income inequality is only a symptom.

Again, Reich's central thesis is that the Great Recession is a symptom of income inequality.  That's not correct. 

The Great Recession was not caused by income inequality but by a major financial crisis, which was itself caused by debt-financed financial speculation.   

The Great Recession is being prolonged by debt inequality, not by income inequality.  The American middle class in these uncertain times feels compelled to pay down what debt it has (which is a good thing because the banks aren't lending).  But paying down existing debt doesn't add to the GDP.  If the American middle class were not so weighed down with debt (i.e., if its debt-to-wage ratio were not so high), it would be out there spending right now, even with the same levels of income inequality. 

Note: Reich asserts that the American middle class turned to debt as a "coping mechanism," but the fact is that debt was pushed on the consumer like a drug.  Starting in the 1980s, the financial sector greatly expanded access to credit and began marketing it like product that everybody had to have.  "What's in your wallet?"

Addressing income inequality will not prevent boom-bust cycles, which are always caused by debt-financed financial speculation. 

Addressing income inequality also will not address debt inequality.  Giving people more money to start just gives the banks more money to siphon off through debt service. 

And giving the middle class a taste of the things the elite take for granted and believe to be important won't change the fact that not everybody comes from the same mold or has the same interests or abilities.  Making college more affordable won't help people who can't or don't want to go to college.  Providing worker training won't create jobs.  Offering private school education won't help kids who struggle to learn in a less challenging curriculum.  Free museums and other cultural experiences don't matter much to most people.

The current system is fundamentally broken, and shuffling money around won't fix it.  The fact is that the only thing America "produces" any more is debt.  Debt is what has fueled our economy for the last thirty years and has masked an ongoing depression for the last ten years.  The only answer the Obama administration sees is more debt, but it isn't going to happen.

The current system is so broken that the playing field can't be leveled.  As long as our private sector, which is dominated by financial institutions, must demonstrate perpetual growth to satisfy shareholder expectations, it will find more and more ways to layer debt on to those willing to accept it (which is everybody but the top decile of American households).

The only way out of our current predicament is to eliminate the dominance of the FIRE sector over our economy, which will require an official industrial policy that encourages investment in what America produces and provides blue collar jobs that provide a living wage.  At the moment, it is possible to make American manufacturing competitive without rejecting globalization through politically expedient tarriffs, but the window of opportunity is closing, and tarriffs will be required if something significant isn't done.

Economist Pat Choate has a much more compelling (and correct) vision than Reich, who seems to be wearing neoliberal blinders (i.e., the very kind of "free market absolutism" that people like Pat Choate and Paul Craig Roberts reject).