December 11, 2006
Only fairness will assuage the anxious middle
By Lawrence Summers A recent meeting with the incoming freshmen of the 110th House of Representatives made clear to me some of the forces that will shape American economic policy in the next few years. Coming from very different parts of the country and very different political perspectives, the new members of Congress have in common that they have all heard from the anxious middle class. They feel under enormous pressure to respond not just to the economic insecurity that middle-class voters feel, but also to voters’ resentment at what they see as disproportionately prospering corporate elites. If the new Congress sees itself as having a mandate for anything in the economic area, it is for policies that “stand up” for ordinary Americans against the threat they perceive from corporate and moneyed interests. These populist impulses have roots much deeper than campaign rhetoric. In the past, real wages and corporate profitability have moved together – increasing during economic expansions and when the US became more competitive, declining in recessions and when it encountered significant competitive threats. The unique feature of the current expansion is the divergence between the fortunes of capital and the fortunes of labour. While workers normally receive about three-quarters of corporate income, with the remainder going to profits and interest, the Economic Policy Institute has calculated that, since 2001, labour has received only about one-quarter of the increase in corporate income, as real wages have failed to keep pace with productivity growth. Indeed, for most groups of workers, wages have not kept pace with inflation over the past several years. College graduates have been particularly hard hit, with their wages struggling to keep pace with inflation over the past five years. At the same time, profits per share for companies in the Standard & Poor’s 500 index have increased at an annual rate of more than 10 per cent, even after taking into account inflation over the past four years. This is not a trend that can be blamed on companies’ earning more abroad: the US national income accounts, which include only profits earned at home, reveal that corporate profits as a share of gross domestic product are at their highest level in two generations and still rising. With this kind of cleavage between the economic fortunes of companies and their workers, it should not be surprising that ordinary American families do not feel they are in the same boat as US corporations and their chief executives. Charles Wilson, Eisenhower’s defence secretary, famously observed: “What’s good for the country is good for General Motors and vice versa.” Today, an increasing fraction of Americans see corporate leaders as part of Davos’s team rather than America’s. These economic and political trends are and should be of great concern to the business community as well as to policymakers. They have led to populist policy proposals that cut against the grain of the market system by, for example, limiting free trade agreements, restricting outsourcing or limiting the ability of successful companies to expand. The track record of such populist proposals is dismal. They rarely achieve their objectives and come with huge collateral costs. Policymakers forget at their peril that it is globalisation that has enabled the US economy to enjoy the favourable combination of low unemployment and low inflation of recent years – and that without open markets, product prices would be rising much faster, further attenuating living standards for middle-class families. Yet it would not be a sufficient response for business or government simply to explain why populist policies would be counterproductive and to suggest – to borrow a term from a different debate – a “stay the course” strategy, perhaps with increased attention to the displaced. If the anxious middle’s concerns about fairness are this serious when the unemployment rate is 4.4 per cent, they will be far greater whenever the economy next turns down. This puts a premium on finding measures that go with the grain of the market system while also responding to concerns about fairness. The place to start is by restoring the progressivity of the tax system – an area where much can be accomplished before considering changes to the rate structure. It is neither fair nor efficient to audit disproportionately the tax returns of those in the bottom half of the income distribution at a time when most of the $500bn tax gap comes from those with high incomes. There is no policy justification for allowing the erosion of corporate income tax through pervasive use of corporate tax shelters and manipulation of transfer price rules. Not only does this cost the government revenue, it also puts undue competitive pressure on companies that want to meet obligations to their workers. Much more can done in a range of areas, from disclosure of executive compensation, to ensuring that the government leverages the volume of its purchases, to making financing of education at every level more equitable, to making sure that businesses continue to take responsibility for their workers’ healthcare costs. When, as now, concerns become sufficiently serious, those with bad ideas always win out over those with no ideas. John Kennedy famously challenged Americans: “Ask not what your country can do for you. Ask what you can do for your country.” In the years ahead, this question will be put with increasing force to US corporations. A great deal depends on the vigour with which it is answered. The writer is Charles W. Eliot university professor at Harvard University
Martin Wolf: It is interesting to observe what Larry rules out in his discussion. If the response to these anxieties is to engineer transfers through protection, which we all know to be inefficient, why not propose direct transfers? Surely the US needs more of a welfare state, with a considerably better safety net for all and, most important of all, universal medical insurance. In a competitive environment, companies cannot be effective providers of welfare. Only the state can fill this gap. Just think how much more secure ordinary Americans would feel if they knew their medical costs would be met whether or not they kept their job. Moreover, that would also remove an enormous legacy burden on US companies.
What is disturbing is that the answers the Democratic party are proposing are populist, not sensible, because reasonable options are excluded from the debate. If the Democratic party is to change the debate it will have to propose higher taxes. Given the current trends in income distibution, why is that so hard to do?
Posted by: FT Forum - Martin Wolf | December 11th, 2006 at 8:14 pm | Report this commentRobert Wade: Larry’s column suggests that there IS some good news coming out of US politics recently, along with a lot of bad news. The good news is that there is, finally, a tangible chance of some political action to moderate the surging inequality of income and wealth that has been going on for the best part of 30 years.
The surprise is that this has been so long coming. For a long time the dominant notion of “fairness” has been not the one implicit in Larry’s argument, but the one which says that taxes on the richest Americans should be cut and public investment in health and education for the poor should also be cut (so as to improve their “responsibility” and “self-reliance”). One can be sure that had the same rate of increase in inequality occurred in continental Europe the political reaction would have been much stronger much earlier, prompting state action to reign it in. Why the difference?
I argue that Americans (compared with continental Europeans) tend not to see increasing inequality in the overall structure of income/wealth as problematic because they believe they and their children have good chances for upward social mobility within the structure. Which reflects their bias to optimism, as compared with continental Europeans’ acceptance of their lot in life (the difference constituting to many outsiders one of the more attractive qualities of American society). Hence a majority of Americans favor the abolition of estate tax, thinking that they don’t want their hopefully large estate to be taxed at death - even though hardly any of them will have an estate big enough to be hit by the tax.
The trouble is that the American belief in high social mobility is largely a myth. Studies reported in Unequal Chances: Family Background and Economic Success, eds. S. Bowles, H. Gintis, and M. Osborne-Groves (Princeton UP, 2005) show that as better data becomes available on social mobility, the rate of social mobility in the US goes down (for the same period). Jo Blanden and colleagues at the LSE’s Center for Economic Performance found that, in a comparison of social mobility in eight (as I recall ) European countries and the US, the US rate of social mobility was the lowest (for cohorts born in 1958, 1970, and early 1980s). The UK’s was second lowest, and declining. In other words, the transmission of economic status across generations is very high in both the US and the UK.
Perhaps the main reason why the American political class has only recently become concerned about surging inequality (and not before) is that the general low rate of social mobility is finally feeding back into the bias for optimism. But my guess is that more specific factors are also involved:
(a) The “mega-haves” (the top 1 per cent ) have recently pulled far away from the “haves” in terms of share of disposable income in relation to share of population, generating a strong sense of relative deprivation of the “haves” in the comparison with the “mega-haves” (as distinct from the have-nots falling away from the haves, which is politically much less worrying).
(b) The relative number of households in the middle has fallen, while the relative number of households above a high income threshold has risen and the number below a low threshold has also risen. In the metaphor of a caravan, the leading group has been increasing in size and forging rapidly ahead, the lagging group has been increasing in size and slowing down, and the middle has been hollowing out. The caravan is breaking up.
(c) The “middle” is finally realizing from experience that the institutions meant to improve equality of opportunity, especially for the middle - in housing, education and employment - are themselves becoming increasing unequal in access.
As Larry implies, the combination of (a), (b) and (c) is not at all to the liking of the middle, and the middle can be, once mobilized, articulate and politically savvy. Perhaps the worries of new US congressional representatives about the worries of their middle-class constituents reflect the erosion in the long-held belief that the structure of income outcomes does not matter provided opportunities are roughly equal, and the representatives’ knowledge that any public action to narrow the structure of income outcomes would provoke intense resistance from the top.
My final comment is on Larry’s link between Kennedy’s ‘Ask what you can do for your country’ and the responsibilities of US corporations, as in the question, ‘What can US corporations do for their country?’ In a country so devoted to individual rights the question is strange. But it does, I think, pose an interesting challenge: to formulate a “theory” of ECONOMIC citizenship, which emphasises the idea that the profits made by corporations (and individuals) are joint profits, the result of a whole array of collective facilities; which impose duties on corporations (and individuals) to support the rules and provide the tax revenues needed to provide and expand these collective facilities. The idea flies in the face of the armies of financiers and tax lawyers devoted to finding ways to escape paying tax, on the moral premise that taxation is a form of theft. Let’s see the reaction to Larry’s challenge to the responsibilities of US corporations from other members of the Forum.
Posted by: FT Economist Forum | December 12th, 2006 at 9:29 am | Report this commentAdrian Wood: The issue raised by Larry Summers is not, I believe, confined to the United States. In other countries, too, there is growing concern about rising inequality. It is an unhappy coincidence that over the past couple of decades economic forces, including globalisation, have tended to increase the inequality of the distribution of pre-tax incomes, while at the same time political forces have tended to reduce the progressivity of tax (and as Martin Wolf mentions, transfer) systems.
The rational solution, as Larry points out, is to put this political change into reverse. But it will not be easy for individual countries to increase the progressivity of their tax systems in isolation, because of well-justified fears that rich individuals – whether their incomes derive from capital or from work – will move their tax residences away from countries which seek to tax them more heavily. Nor does there currently seem to be enough political will and administrative capacity to co-ordinate rises in tax progressivity across even the world’s major economies
Posted by: FT Economist Forum | December 13th, 2006 at 2:12 pm | Report this commentLawrence Summers: The comments of Martin Wolf, Robert Wade and Adrian Wood all pick up on what was a central if implicit point in my column. Those who dislike indirect protectionist ways of responding to the distributional consequences of globalization and technological progress have an obligation to either advocate direct responses or to explain why they are not concerned with the distributional consequences. My view is that things have now reached a point where it is neither politically nor morally tenable to be unconcerned with distributional trends. I think Robert Wade provides a good list of the reasons why concern is increasing. I am particularly struck by the point on social mobility which was the deep rationale for the steps we took at Harvard to eliminate tuition for families making incomes below $60,000.
I there are two deep challenges in inherent in the current moment. First globalization and technological progress both compel more redistribution activity by widening the distribution of rewards and raise the costs of redistribution by making factor mobility and tax avoidance easier. Second, technology is increasingly rewarding the kinds of cognitive skills that very successful parents can help their children develop. From SAT tutoring, to independent schools, to international experience, to introductions to future employers there is more and more that fortunate parents can do and buy for their children.
There are no easy answers. I agree with everyone on the centrality of progressive tax/benefit systems and especially with Adrian Wood on the advantages of international cooperation here. My sense is that in the united states there is much that can be done in health care to reduce insecurity as well. The question of corporate citizenship is vexing but surely there should be some limits on the aggressiveness with which tax avoidance agendas are pursued. I am attracted to proposals that would limit or eliminate the difference between book and tax income for corporations.
Posted by: Lawrence Summers | December 15th, 2006 at 9:16 pm | Report this comment