Tuesday, 6 May 2014

The future for America's stagnant incomes: How the US must react to global convergence and technology

The following piece originally appeared on GeopoliticalMonitor.com

It took five years, but the US has finally recovered all the jobs lost following the 2008 recession. Indeed, the economy has been growing since June 2009; its fifth longest expansion in history. House prices have jumped sharply and the unemployment rate has tumbled. Yet it hardly feels like boom times for many Americans.

While stock markets reached record highs and large companies amassed record profits over the last few years, wage growth stagnated. And it is not a recent phenomenon; the inflation-adjusted median household income peaked in 1999 at $56,080. It is now $51,017. Listless wage growth has become such a norm that manufacturing corporation Caterpillar, despite announcing bumper profits, was able to implement a six-year wage freeze on many of its blue collar workers in 2012.

It seems an anomaly that so many important economic indicators have shown such strength while incomes remain static. In the post-recession years consumption has grown about 2% annually, well below its 3.5% long-term rate. That doesn’t bode well for an economy that relies on consumption as its engine. The gravity of the problem was masked in the pre-crisis years as consumers availed of easy credit and could afford to cut back on savings. But with many households now drowning in debt, stagnant incomes will become a bigger drag on economic activity.

An improving job market may bring some relief, but not much. The unemployment rate has reached its lowest rate since September 2008, but the number is flattering. It isn’t so impressive when the labor force participation rate is at a 35-year low due an increase in discouraged jobseekers, retirees, college returners and disability claimants; all categories that are typically boosted when an economy is weak.


But even if more employment is available, entering the workforce may not be attractive when so many jobs provide depressed incomes. The stagnation in wages does not appear to be part of a normal business cycle; it was evident long before 2008. The causes are more than just credit availability and a short-term drop in demand.

Median household incomes rose steadily between 1970 and 1999, but the pace was considerably slower than the 1950-1970 period. The picture gets even worse when the increased participation of women is considered; a strong trend that took off in the 1980s. The full extent of the problem is evident when it’s considered that the median male worker earned an inflation-adjusted 8% less per week in 2013 than in 1979. 

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The forces contributing to wage suppression have been surging for more than two decades and show little sign of abating. Globalization and technology have brought much prosperity to the world economy, narrowing the gap between rich and poor nations. Yet their influence seems to be doing the opposite in America. An interconnected world powered by technological advances means that many labor-intensive jobs have moved to countries with cheaper costs, leaving behind a large supply of lower-skilled workers. It has also provided jobs that bring demand for highly-skilled workers, but there isn't a sufficient supply at home.

The share of American employment in manufacturing has declined precipitously since the 1950s. It housed 30% of the workforce then, but that has now dropped below 10%. The share of services jobs has jumped sharply, but they too are coming under threat from technological advances and alternative markets. As a result the superior wage gains are going to those who can afford exorbitant college fees. The share of wages going to the 1% has more than doubled since 1976.

Such a skewed distribution of income isn’t just bad for the average worker; eventually it will impact the economy as a whole. Theory indicates that the marginal propensity to consume decreases as income levels rise, meaning that wealthy people have a greater tendency to save and invest income, thus spending less per dollar earned than do the less well-off. Moreover, the Federal Reserve’s response to the financial crisis with large-scale quantitative easing has allowed asset prices to balloon, benefiting wealthy owners, but providing little comfort to the average American. Growing inequality can generate social instability too, polarizing political ideologies s and limiting the potential for those not born into wealth to join the powerful elite.

Consumers seem desperate to maintain spending habits, as evidenced by a declining savings rate and sizeable withdrawals from retirement funds (the IRS said about $57 billion was taken out in 2011). But such measures cannot be done for much longer. Moreover, if the 1% continue to eat into the income pie, the corporations that rely on consumer spending will suffer. Corporate profits have been strong in recent years, but much of the gains have come from cost-cutting measures rather than robust revenue growth. Cutbacks can only be reduced so much. Many corporations will soon need to boost revenue and sell more to the consumer if they want to maintain profit margins. Stagnant incomes won’t be much help then.

The ability of American multinational companies to readily move operations between countries poses another risk to US employment. In recent years several corporations, especially high-tech pharmaceutical firms, have sought to relocate their headquarters overseas to take advantage of lower tax rates. A continuation of this trend will lead to the loss of more high-paying jobs and billions in tax revenue. The US will be forced to change its corporate tax structure to prevent the practice from escalating.
Many argue that the overall benefits brought by technology and globalization to modern lifestyles more than offset declining incomes. It is true that the ability to import goods from anywhere in the world and efficiencies from of high-powered machinery instead of back-breaking manual labor have untold benefits to society. Moreover, the cost of home appliances and automobiles has become more affordable in recent decades. But many things have not. College fees have soared and many graduates are suffocated by student loan debt. House prices remain elevated. And the US remains only a political crisis away from a spike in food and fuel prices. 

It may be tempting to propose measures to slow the rapid changes that pose risks to American employment and incomes. Trade barriers could keep jobs at home, while a pause in adopting new high-tech equipment would preserve roles that might otherwise become redundant. Such initiatives may slow the advances of globalization and technology, but they won’t be applicable to the rest of the world and US corporations will simply move their operations to nations that allow greater efficiency. Instead, the global changes must be embraced and the US must adapt to the changes in global wealth.

In recent times, its share of the economy has been reduced by the expansion of China and India, but two hundred years ago those countries were the world’s superpowers. Changing political systems and debilitating wars later saw their shares of global wealth decline, resulting in generations of obscurity. History shows that once-powerful economic leaders lose influence as their attention turns from boosting productivity to enacting laws that focus on preserving wealth, excessive borrowing to finance wars and tighter labor regulations that reduce competitiveness.

Great Britain took over from China and India around the 1850s as the Industrial Revolution drove productivity, but a hundred years later, two World Wars and immense reconstructive spending resulted in over-indebtedness, allowing the comparatively lean US become the global leader. Enjoying debt levels that were low relative to rising income, the US rode the wave of prosperity for decades. But US economic dominance has been in slow decline since the 1970s as Japan and Germany recovered from post-war stagnation, a commodity boom boosted Latin America, China adopted market-oriented policies, and India has opened its economy and lessened bureaucracy.

In the coming years the US may get some respite from the negative pressures of globalization as the catch-up by China and other Far East nations has already resulted in middle classes that demand higher wages. But the rate of technological change shows no signs of diminishing, and may widen America’s inequality gap over the coming decades. Along with manufacturing roles, the numbers of secretaries, bank clerks and even brick-and-mortar retailers look set to dwindle.

History may provide some hope for America. Britain’s Industrial Revolution brought much of the population from low income agricultural jobs to a higher standard of living via manufacturing roles in cities. Yet benefits were not immediate. The industrialization began around 1750, but 70 years later real wages had grown little.

Despite some social resistance, innovation continued and between 1820 and 1870 the average real wage jumped 60% as the supply of skilled workers increased and political reforms saw labor’s share of income rise relative to that of capital owners. Some jobs were lost along the way, but advancements in machinery generated demand for new goods and services, creating new roles that compensated for displaced workers.

Of course, America’s current situation may not signal the second coming of the Industrial Revolution. There are concerns that this is not similar to the transition from physical labor to human-operated machines, but more like an elimination of workers in place of full automation. Such fears are overblown. The levels of automation will depend on economics, not just the ability to automate. The current cheap cost of labor makes laying-off workers in times of stress a more attractive option than the burden of monthly payments for a new tech system.

Yet even if we are entering a new Industrial Revolution, few will take comfort from the prospect of a half century of stagnant income. Again, such a scenario seems unlikely. Eighteenth century Britain underwent a transformation from the type of manual labor that was done for centuries. Physical toil is no longer a significant part of the American economy when so many jobs already involve usage of modern technology. The impact of accelerated innovation figures to be less dramatic, and social reforms are easier to implement today than 300 years ago.

The benefits of globalization and technology can be immense. Relatively low barriers to entry have seen tech startups flourish in recent years, create booming companies in a short period. Moreover, they allow young people who were not born into significant wealth to become wealthy and influential, providing new voices among the nation’s most powerful figures.

Embracing new technology and trading partners has enabled countries such as Ireland and Germany emerge from decades of economic stagnation partly by investing in the skills of their workforce. Neither nation is a perfect economic role model, but their commitment to education and pro-employment initiatives has helped Ireland become a global tech hub and Germany an exporter of high-quality goods.

A more educated US workforce would help tighten labor markets. As job vacancies rise and the supply of workers shrinks, power would shift to employees, enabling them to pressurize firms into higher wages. However, there are many obstacles to boosting employability. In the past decade, the average cost for tuition and fees at a private nonprofit college jumped 25%. To facilitate attendance, government-backed loans have been doled out freely, but that has resulted in a student debt burden of $1.1 trillion, which will have its own drag on the economy. Government assistance must be scaled back, which will limit the excessive spending of colleges. The lack of easy credit will also make many people think twice before enrollment. A study by the OECD showed that less than half of all US college students actually graduate; indicating that many attendees would be better focusing on non-academic skills.

In addition, both colleges and employers must embrace three-year bachelors degrees; the traditional four years is an arbitrary number that just extends the time in education. Institutions can also reduce costs by adapting to the modern age and offer more online learning. Policymakers should also look at Germany’s “dual system” of vocational training, which combines classroom instruction with work experience. Almost half of Germany’s high-school students go on to training in one of hundreds of trades, with many of the courses set by unions and employers' federations.

As economic theory suggests, the best strategy to increase the earnings of low skilled workers is to have fewer of them. Aside from education, other options include tax credits to incentivize lower paid workers to stay in the labor force and increase their skills, and schemes to boost savings accounts that may help more people to purchase assets and benefit from rising prices. Higher minimum wages will be largely ineffectual. While helping some of those workers at the margins, they will not pressurize employers into raising wages further up the pay-scale and may prove a disincentive.

The US is still the global superpower, but its influence is waning. The economic share between the developed and emerging nations is now nearly even as a shrinking world allows easier navigation around the barriers to prosperity. For nearly a century the US has been the center of the economic world due to its ability to consume and produce. The British Empire enjoyed that status for a hundred years before it. Environments change and bring new obstacles that once seemed fictitious. But a global convergence of wealth is underway, with the prospect of a sole superpower gradually diminishing.

The US must compete with the new challenges by moving away from a reliance on credit-fuelled spending and instead focus on innovation as a method for generating economic activity. It has achieved this in the past, but has yet to prove it can do so in the future.