What can be done to fill the demand gap caused by the end of the debt-driven spending of the middle classes after the Great Recession? In principle, other sources of demand could take over the growth-generating role played by household spending prior to 2008. Businesses could invest more; but why should they with a stagnant economy? Households at the top of the income distribution could consume more, but that would further magnify the social tension from inequality. Governments at all levels could raise spending, but state and local governments remain financially constrained and the political debate at the federal level seems to be only about how much austerity to impose.
We believe that the best way to fill the huge and growing gap in U.S. demand would be if the trend toward greater income inequality is reversed, or at least stabilized. Tax policy could help to meet this goal, by providing more funds to the lower and middle parts of the income distribution. The cut in payroll taxes in 2011 and 2012 was a modest step toward restoring incomes that fell behind economic growth due to stagnating wages and salaries of the middle classes. But this policy fell victim to fear, excessive in our view, about government debt. Another approach could focus on strengthening the social safety net. Health care reform is a step in this direction, although it falls far short of what is needed.
Any redistributive policy is politically contentious. An alternative more consistent with the ideology of self reliance in the U.S. is for wage growth to keep pace with productivity growth across the income distribution. Basic principles of fairness and social justice among much of American society imply that the benefits of higher productivity should be widely shared: a rising tide should indeed raise all boats. The concept of the “American Dream,” which is close to a defining idea for the social outcomes we aspire to in the U.S., posits that people who work hard and play by the rules should be able to have a good and secure economic life as the result of the rewards from their work, not from a handout or forced redistribution. We agree with this principle, but what is somewhat different in the analysis presented here is that we argue for more widely shared benefits of prosperity not just because this goal is consistent with our concept of a just society. Our perspective implies that shared prosperity across the income distribution is also necessary for strong economic growth. Without sustainable demand growth in the middle class based on rising incomes, not rising debt, firms will not be able to sell all the output that they could produce at full employment. This problem not only compromises the economic life of those whose incomes fall behind potential growth, it also compromises the well-being of the affluent, when the businesses that generate the profits and capital gains fail to prosper due to inadequate sales growth to the middle class.
Wages and salaries across the income distribution did rise together with labor productivity in the decades of broadly shared prosperity after World War II. It is far from obvious how to implement policies to achieve this goal in the early 21st century, but there may be no other way to generate the demand necessary to escape the stagnant aftermath of the Great Recession in a sustainable way.
The minimum wage in 2013 is $7.25 per hour. If the minimum wage had been indexed upward for both inflation and rising real labor productivity from 1980 (approximately when inequality began to rise) it would be about $15 in 2013. If one indexes for inflation and labor productivity back to 1960, the minimum wage would be about $22 per hour in 2013!
Perhaps the most important policy to encourage broad-based wage growth is a commitment to fiscal and monetary actions that keep demand growing at approximately full employment (see our discussion of fiscal policy and demand here). Low unemployment leads to fast wage growth both because it improves the bargaining power of workers and because it encourages firms to train scarce labor to move up the skill ladder.
Policy issues notwithstanding, a first step toward resolving the problem created for demand by stagnant wage growth in much of the income distribution is to have a clear understanding that inequality is more than an issue of social justice. The research discussed here shows that inequality also compromises the basic demand engine that the economy needs to grow at full employment.
Please continue to "Lessons from the Great Recession: A Summary."