Another path to recovery: higher incomes

By Philip Brewer on 4 May 2009 (Updated 17 July 2009) 27 comments
Photo: Dan Foy

Preventing a collapse of the financial system is part of preventing a depression. However, the shorthand term for this--getting the banks able and willing to lend--is misleading. There are plenty of banks that can lend. The problem is the borrowers: Those that could be counted on to repay their debts are mostly uninterested in borrowing, and those who want to borrow probably can't afford to take on more debt. That's the truth about the fix we're in. There are, however, two ways to fix it.

Spend less

First there's the long slow fix: Everybody spends less than they earn and either saves or pays off debts. This can be done. In fact, it always is done--it's the way this sort of situation is always fixed. However, it takes a long time. It's painful and disruptive. It's also unfair, in the sense that the pain falls disproportionately hard on different people depending on where they live and where they are in their life.

The slow fix is slow simply because even pretty serious frugality only opens up so much room between income and expense. WIth the amount of debt that's already baked into the system, too many households simply have no daylight between their daily expenses (including debt service) and their income.

At the same time, each household that bites the bullet and puts itself on the the slow path to a sound balance sheet--expenses less than income, debt service a small fraction of their income, an emergency fund, some retirement savings--shrinks the economy a tiny bit. A smaller economy means fewer jobs, less wages, less profits--meaning that it takes even longer to dig ourselves out of the hole we're in.

There are other pieces to the long slow fix. Assets will be sold and the cash used to pay off debt. Sales of productive assets can help everybody--the seller, who gets cash to settle overwhelming debt; the buyer, who gets something valuable for less than it would normally cost; workers associated with the asset, whose jobs now depend on someone who's not so broke; and consumers, who get more stuff because the productive assets can start producing at full capacity. (Of course, it doesn't necessarily help everybody--a productive asset dismantled and shipped overseas might leave local workers less well off. But the exercise can be a positive-sum game, with everybody better off.) Another part of the same process is bankruptcies--some debts are never going to be paid back. (Short of bankruptcy, some debts can be restructured to make them affordable.)

But, put it all together and it's still long and slow.

The other, quicker fix would be to boost incomes.

Earn more

The government is trying to do a piece of that--reduce the depth of the recession by replacing some of the missing household spending with government "stimulus" spending. That may help ease the downward spiral of households cutting spending leading to businesses laying off workers leading to more households that have to cut spending. But it doesn't help with the fundamental problem that household balance sheets are so badly out of balance that even years of frugal living won't restore a proper balance--if we go that route, it's going to take decades.

If we can boost household incomes, though, the whole thing could be speeded up considerably. Of course, any particular household might just spend its extra income, but that doesn't really matter: the economy can handle some number of households that live beyond their means; it always has.

Where, though, would this extra income come from? It's not like we can just gin up some money. (Well, the government can--and, in fact, has been--but that's not real value. Money created that way just dilutes the value of the existing money.) No, the only way to boost households' real income would be to reduce someone else's real income.

To get us out of this hole faster, what would have to happen would be for a greater share of income to flow to the people whose balance sheets are most tattered--the poor, the working class, middle class home-owners, etc. What would have to happen would be to change the way profits are divided between owners and workers. (This works because the owners' balance sheets aren't so out-of-balance.)

Of course, it isn't as easy as that. The division of the receipts of the enterprise is partially a matter of markets, and tampering with markets is always problematic. On the other hand, lots of other things play into the affair. Customs and traditions matter--salesmen get commissions, executives get bonuses, etc. These traditions can change--few people get paid piece rates nowadays--but they matter.

At its core, though, the division of profits is always a matter of power.

During long swaths of time the power rests with the owners, who claim all the profits as their right, setting workers against one another in competition for bare subsistence wages. At other times the workers scrape together some power, refusing to bid down their own wages, and claiming for themselves a greater share of the profits of the enterprise.

The last couple of decades have been something of a golden age for owners and managers.  Globalization has let employers put their workers in competition with poor people all over the world, giving them a huge market advantage.  At the same time, some of the traditional "rules of the game" were gradually slanted in favor of owners (in the form of the decline of labor unions, growth in lower paid service jobs, and vanishing traditions of loyalty to employees and to communities). 

If you're interested in this aspect, you might be interested in Robert Reich's book Supercapitalism.  I wrote a review of it for Wise Bread last year.

The main point of Reich's book is that you can't really expect anyone to behave differently unless they are forced to.  No owner or manager will pay more than the market rate for labor--anyone who even tries will quickly be replaced.

Generally, the workers only come out ahead when there's a genuine labor shortage--when war or plague has cut the work force so much that there simply isn't much competition for jobs. Other things factor into it, though. A huge surge in productivity can swell wages simply because owners are making money so fast it isn't worth it for them to push down the earnings of workers. Local customs and historical traditions have a strong influence. And, of course, government rules have a lot to say about the matter.

Real compensation per hour versus total output

In the United States, as the graph above shows, the relationship between compensation and business output was pretty steady all through the 1950s and 1960s. In the 1970s, though, and accelerating in the 1980s and 1990s, things changed: As output (i.e. income to businesses--shown by the blue line) surged, wages (shown by the red line) quit keeping pace.

Wages and salaries as a fraction of national incomeLooking at the data another way, as shown in the graph to the right, the average share of national income that went to compensation in the 1950s and 1960s was 57.1%. In the most recent quarter it was just 53.4% (and that was an increase from recent lows). 

Wages and salaries in 2008 totaled $26.2 trillion (versus a total national income of $49.7 trillion). If the division of the profits of the enterprise returned to the situation that prevailed in the 1950s and 1960s, household incomes would have been $28.4 trillion--that is, households would have received an extra $2.2 trillion in wages and salaries last year. An extra couple trillion dollars a year would go a long way to recovering household balance sheets. (Data for Wages and Salaries and National Income from the Bureau of Economic Analysis via the St. Louis Fed.)

Of course, that income would have been lost to someone else. To some extent, it would have been lost to the very same people--the bus drivers and school teachers who were bringing home bigger paychecks would have seen smaller gains in their 401(k)s over the years, if more income accrued to employees and less to owners. But the bulk of the difference would have shown up in the investment accounts of the very wealthy (because that's where the bulk of the income ends up).

So, there is a path for getting to recovery quicker: higher wages and salaries for workers at the expense of smaller profits to businesses. And it would not be a radical shift--just a return to the traditional proportion of income that went to labor in my parent's generation.

Of course, getting there is another story. Owners and managers are not going to voluntarily give up any of the profits and workers lack the market power to demand a larger share. There are some moves to increase the power of workers--proposed changes in the rules that determine whether workers can form a union, for example--but they're pretty tentative.

But that's okay. There's still the long slow path to recovery.

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Guest's picture
SJ

Wow. Really interesting post. Lots to think about, so no judgment.

But basically seems encouraging the class division right =)

I do like how it accepts money flows vis a vi zero-sum games.

Philip Brewer's picture

@SJ:

Yes, at the first approximation, I'd have to estimate that whatever money goes to workers does not go to owners (or managers).

On the other hand, it's probably not precisely zero-sum.  After all, part of the justification of the change in customs and traditions about the relationship between wages and salaries of the rank and file versus salaries (and bonuses) of senior management has been that great management "adds value" through all its various maneuvers to optimize the allocation of resources, spread risk, etc. 

Those operations look a bit less optimal these days.  Maybe paying management less would produce less maneuvering, to the benefit of us all.

Guest's picture
Guest

Sweeping generalizations are just that, if one does not acknowledge specifics.

1. Great technological advances aren't noted in the data. If jobs with great increases in productivity are due to tech, then those people pressing the "on" button, theoretically, would have had increases in wages for even less work. Take a fast food worker. Tech allowed a worker to only have to press a microwave button or a cash register button with a burger picture and the amount given by the customer. Thus, the job requirements are actually lower then in the past when one would have to know how to fry a burger, know the price of the burger, or calculate change. Should the button pushers be paid more because the company earns more, or should the investors (who put up their money for tech capital expenditure) be paid back in the form of dividends?

2. In recent decades, there has been a greater shift to partnerships, profit sharing, stock options, etc. for top earners. These owners/partners are usually not included in the "wages" data points.

Philip Brewer's picture

@ Guest:

The National Income and Product Accounts, where I got my data for wages and salaries, have a pretty expansive definition.  Wages and salaries include:

the monetary remuneration of employees, including the compensation of corporate officers; commissions, tips, and bonuses; voluntary employee contributions to certain deferred compensation plans, such as 401(k) plans; employee gains from exercising nonqualified stock options; receipts-in-kind; and miscellaneous compensation of employees.

Guest's picture
Guest

Anyone who thinks that management is underpaid is nuts. Look at the salaries of the cretins who destroyed the biggest banks in the world. That's their pay for doing the worst job imaginable.
Hey Chuck Prince! Enjoying those tens of millions....I thought so.

Guest's picture
Guest

The slow path with it's frugality and saving is the only way that's going to actually work in the longrun. Yes, I know that we modern Americans have no patience, but we need to learn it again. We need to spend less, save more, consume less and produce more. That's really the only way we get through this. Yes it will take a long time. What's the rush?

Guest's picture
Pat

Although you never explicitly say it in your article it sure sounds to me like you are advocating more government intervention to redistribute wages between managers and workers. I sure hope that is not the case. I would argue that business owners and managers are a more important part of the economy as they are the job creators. They generally have a much higher financial risk threshold and are therefore the pioneers that not only create more jobs but advance human civilization through their ventures.

History has long shown that the freer the market the more efficient it will be. This current financial mess could easily have been averted had the government not meddled so much in the market and economics of the US.

Guest's picture
Sam

Good article - got my brain going better then my morning coffee is :)

While I agree that people won't change unless they are forced to, I don't believe it's govt's job to force that change (please note I'm not talking about current safety laws when I say that - just talking about the flow of money). If govt had stayed out of it then we'd be fine now. Govt has caused so much of this current problem I think it'll be impossible to fix without 'em :(

Government is for controlling the military, currency, foreign affairs, tariffs, intellectual property (patents & copyrights) and mail. If they had just kept their nose there, the world would be in better shape.

Guest's picture

People who think government should stay out of the economy should play a game of Monopoly sometime. Is that really what you want? Government and unions potentially offer individuals some power to counterbalance the ability of wealth to completely dominate markets. Reagan began a push to shift the government into representing, not the interests of the people of the United States, but rather the interests of the super-wealthy all over the world. He broke the biggest unions and started reducing the high taxes on the super wealthy, while shifting the burden onto everyone else. He also allowed businesses to get much, much larger, which created a frenzy of acquisitions and forced businesses to make shorter-term decisions about profitability, at the expense of long-term stability. Bush took these positions to absurd extremes.

People who think government should stay out of the economy should look at the protections we still have thanks to the New Deal and think about where we would be without them. Without the Federal Reserve, the entire economic system would almost certainly have collapsed last fall. Think default. Think chaos. Think war, famine, and pestilence. Where would we be without Social Security and Medicare -- or if the Republicans had managed to privatize it? How many old folks would be out on the street after the market collapsed? Where would we be without unemployment insurance? How many more families would be selling apples and begging in the streets? Is that *really* what you want?

Guest's picture
Kelja

When you start quoting Robert Reich, I know there's going to be a problem. He's the most pro-big-government voice outside the old USSR politburo.

More power to the Unions? What a concept. The American Auto Industry is in shambles and will probably become a faint memory in the near future. One of the reasons - certainly not the only one - are the unions. Incredible pay/benefit packages out of whack with reality.

How about Municipal Unions? As state/local/federal revenues plunge, those unions are not giving an inch. Hey, be a fireman and retire after 20 years for 90% of your pay for life! But first game the system by working overtime the last couple years. Just one example.

Blame the managers and CEOs all you want, but there's plenty of blame to go around.

Guest's picture
Talheure

Socialism, anyone? From each according to his ability to each according to his needs...sound familiar?

Yeah, and no thanks. While there are some who've profitted obscenely, they are balanced by those who live above their means and insist they're "worth more" when they're not.

When "wise fools" like you start spouting the "wisdom" of forcing people to "share" what they have with those who don't have...God save us.

Guest's picture
tfan

take another look at the compensation v. output chart. see where the lines cross? it took government intervention to create that. So it is perfectly reasonable to use government to reverse this trend. The "free market" vs. "government intervention" argument is BOGUS. It is ALL government intervention, how you see it depends on whether you benefit or not. When owners benefit they call it free markets or deregulation, when their workers benefit they call it government interference. There is no deregulation, it is just re-regulation in favor of owners. If there were truly free markets, everyone who ran AIG, Bear Sterns, etc would be sleeping in a cardboard box right now.

Guest's picture
Edgar A.

Wow. The squeals reacting to such a mild and moderately stated post suggest that you hit a few people in the main trunk of their ideological nerve.

I wonder if they actually looked at the two graphs.

Guest's picture
Kelja

Anytime you quote a radical ideologue like Robert Reich, you are bound to get reactions.

It comes down to a difference in people. Some of us don't like self-appointed experts telling us what to do; others simply follow the path of least resistance.

Andrea Karim's picture

Anyone who thinks that Robert Reisch is a radical ideologue has clearly never had a conversation with an actual radical ideologue. I might disagree with Reisch on a number of issues, but 'radical'? 

You keep using that word. I do not think it means what you think it means.

-Inigo Montoya

Guest's picture
Kelja

Yes, I understand both 'radical' & ideologue ... & he's both.

He's a left wing economist who fervently believes that government is all-knowing and all-powerful - or should be. For that reason, he despises the constitution and our founding fathers.

I defy anyone to name another oft-quoted economist more liberal leaning.

Andrea Karim's picture

 Uh, Paul Krugman? Wow, that was really incredibly easy. 

Philip Brewer's picture

Reasonable people can differ on Reich's policy prescriptions, but the analysis of the current situation that he spells out in Supercapitalism is really spot-on. Well worth reading, even if you disagree about whether we need to do anything about the current situtation, it's worth understanding it.

Andrea Karim's picture

You're assuming we're reasonable, Philip. :)

I got sidetracked by comments, as usual, but what I wanted to do, in addition to thanking you for your thoughtful article, was share this article from the NYT - topical, in a way. Thought you might enjoy it, if you haven't read it already. 

http://www.nytimes.com/2009/05/03/magazine/03european-t.html?pagewanted=1

Philip Brewer's picture

@Andrea:

Yes, fascinating article on an American's perspective of the way things work in Holland--thanks for the link!

Guest's picture
Common Sense Will Not Kill You

There is no such thing as a totally free market. The Ayn Rand/Milton Friedman philosophy can be summed up as follows:

The poor complain, they always do
But that's just idle chatter
Our system brings rewards to all
At least to all who matter

Guest's picture
Guest

Spend Less! Earn More!
Wow!
Profound!

Guest's picture
Jim

A few of the comments are arguing about management versus workers. But the post is not pitting management against workers. In fact the managers and CEO's also get paid wages that are part of the totals listed. The post is about wages relative to corporate profits.

Question one might ask is : Where are all the profits going? Have corporate stockholders all become more and more wealthy in the past 4 decades? Where is that money? In Bill Gates giant safe or in the pension funds of retired little old ladies?

I'm curious if the corporate profits include the gains from overseas income? What about sale of goods produced with cheap overseas labor? I might guess that the more and more stuff that US firms manufacture overseas would lead to less of the money going to US based wages as a proportion of the corporate income.

Guest's picture
Mike in Portland

The free market works great...until it doesn't. Free markets naturally trend toward monopoly. If government did not intervene at the turn of the century we'd all be buying from the company store.

Capitalism is fundamentally the best economic system we have, but (as we've witnessed) religious adherence to free-market ideology can lead to economic ruin. The mess we're in right now is because government refused to recognize the house of cards the free-market was building in the arenas of loans and credit.

Government failed to do their job as watchdogs and stewards of the economy. They failed to regulate. The free-markets did what they always do...go where the fast money is. The market may have course corrected, but not after bankrupting the country.

I don't buy the argument that regulation to protect workers, consumers and the environment is socialism. Individuals have to conform to laws, I fail to see why corporations shouldn't. Capitalism is has a strong enough backbone to endure common sense regulations.

Guest's picture
Guest

Whether Reich is a "radical" ideologue or not, he is most certainly an ideologue. Listen on YouTube to his testimony in January before Charlie Rangel's committee and you will hear his clear call to using the current economic crisis to by-pass any democratic say-so on spending. He is also an ideologue who has not been averse in his writings to simply making things up. And as for his cute little charts and graphs, "Figures don't lie, but liars figure."

Just as an example: The graph that shows business output vs. compensation purports to show the decline of workers in relation to business owners, but completely ignores that since the creation of IRAs, defined contribution retirement plans (401ks) and funded defined benefit plans, large numbers of workers acquired owner status. In effect, part of their "compensation" should, to fairly state it, include the gains and earnings of their retirement plans. Reich's graph does not do that. (It may reflect the contributions to 401ks as compensation, but not the gains and earnings of the 401k.)

Look, though stated in far more moderate language, there is nothing different in Robert Reich's policy prescriptions from Robert Mugabe's: class warfare, empower the poor, redistribute the wealth, and make government all-powerful to accomplish these goals. The only part that ever comes true is the last part - government becomes all-powerful.

The notion that restricting profits is a path to prosperity is absurd. Profits are simply information. Restrict profits and you restrict information on where it is most useful to put capital to work, replacing that information with government directives. It hasn't worked out very well for Zimbabwe and it isn't working out very well for those states and localities in the U.S. that have gone overboard with it. It gives enormous power to government bureaucrats and politicians, but it doesn't make them any smarter than the market, or any less susceptible to corruption.

Philip Brewer's picture

@Guest:

First, the charts in this post are by me, not Robert Reich, so don't blame him for them.

Second, it's true that the stastics don't show 401(k) investment gains as employee compensation--but they also don't subtract investment losses from employee compensation, so I think that's the correct treatment.

Finally, my main point is simply that a change in the division of the profits of the enterprise, such that workers got more (even if it meant that bosses and owners get less) would speed recovery from recession.  (Because the workers are the people whose balance sheets are so out of balance.)  I also wanted to observe that this isn't such a radical change:  it would be a return to how things were in the 1950s--not, I think, our most radical era.  I certainly wasn't advocating a restriction of profits.

Guest's picture
Guest

Politicians and top government bureaucrats are drawn from exactly the same pool as AIG executives - smart, ambitious and self-interested human beings. The idea that taking power away from everyplace but government and enlarging the sphere of government control will protect us from the economic malfeasance of bad people is incredibly naive.