The middle class is squeezed even as the stock markets hit record highs. What does this mean for our economy and our democracy? Excerpted from “Inequality for All,” November 20, 2013.

ROBERT REICH,Chancellor’s Professor of Public Policy, University of California, Berkeley; Former U.S. Secretary of Labor

 

Something very strange is happening. It has happened before, but it is happening in a way now that looks remarkably weird, odd. The stock market is doing very well. It is breaking records – the Standard & Poor’s 500, the Dow, most of your indices. But at the same time the real economy – that is, the economy in which most people live and work – is not doing all that well.

This is the most anemic recovery on record. If you consider how far down we came in the Great Recession, it’s even more troubling, because usually the further the economy sinks, the faster it comes up after a decline to get back on track. I mean, after the Great Depression hit bottom in 1933, the following years were very, very good. There was a lot of growth in 1934, about 4.5 percent; in 1935 about 8 percent; in 1936 about 12 percent. Now, something happened in 1937. If we have time we’ll get back to that. But my point is that this economy is remarkably underwhelming. It’s under-functioning.

You also have large numbers of Americans still out of work. Fewer people are employed today than before the Great Recession. The number of adults capable of working, willing to work, who are not working, is extraordinarily high. The labor participation rate – technically that is the percentage of people who are working age who are in the labor force versus not in the labor force – is really at its lowest level since 1978. And 1978, 1979, those are the years that women, many of them, went into paid work. Wives and mothers in large numbers went into paid work. Poor women, by the way, had always been in paid work. Wives and mothers had always worked, but it just wasn’t paid. Starting in the late 1970s, women went into paid work in large numbers; it was the 1980s when you really had the big influx. We have not seen a labor participation ratio this low since before women headed into work in such large numbers.

So, what is going on? How can the stock market be doing so wonderfully well and the real economy be doing so poorly? I should add, if you’re not already giddy from the things I’m telling you in terms of the real economy, median household income – as in the typical household, adjusted for inflation, is seeing its income drop. I said median. It’s important that any time somebody says median or average, you know the difference. In fact, when anybody tells you that average wages are rising, or that average people are doing well, watch your wallets. The basketball player Shaquille O’Neal and I have an average height of six foot one. Do you get my drift? People at the top bring up the average. It’s much more meaningful to look at the median; that is, the person smack in the middle. Equal number above, equal number below. Even with two wage earners, median household income is dropping adjusted for inflation.

How do we explain this dissonance? One thing that’s going on is that corporate profits are up, partly – some would say largely – because they are cutting their payrolls and continue to do so. They started this in the Great Recession, but there has been not much of a letup. They’re cutting their payrolls, many companies, not only by hiring fewer people or by cutting back on the numbers of people, [but by] substituting technology, outsourcing or reducing wages or keeping wages level without any inflation adjustment, or reducing benefits. However it is being done, it is being done to squeeze down the costs, since labor costs tend to be about 70 percent of the total cost of the business, and that’s understandable. I’m not blaming businesses for trying to make money, particularly in difficult times when there’s not that much purchasing power among the middle-class or the poor – another point I’ll come back to in a moment.

Another thing that’s happening is that companies are using their cash. Big companies are still sitting on about $1.6 trillion of cash; that’s a lot of money to sit on. They’re using that cash to buy back their shares of stock. If that’s the way you boost your stock price, and if that’s the main way you have a boost in your stock price, it’s not as if it’s generating much innovation or many new jobs or much by way of social benefit or is even sustainable. You can’t just keep on purchasing your shares.

There is a third thing going on and maybe it is the major thing. It has to do with this institution called the Federal Reserve Board. Janet Yellen, whom many of us know personally, is an absolutely wonderful person. She will make a fabulous chair of the Federal Reserve Board. What she said in her hearings on her nomination and she has said over and over again, not all that different from Ben Bernanke, and what she and Ben Bernanke both have been talking about doing is engaging in a process of buying securities and, by buying securities, keeping interest rates low. This has taken a couple of different forms. Ben Bernanke has called it quantitative easing. Other people have called it different things. Sometimes it has to do with long-term bonds. Other times it has to do with short-term bonds; right now it’s mostly short-term.

Here is the point: When the Fed keeps interest rates very, very low as it has been doing, then everybody who has any savings at all tends to look at the bond market and say, “I don’t think I’m going to put my savings into bonds, because I can’t really get very much interest out of there. Where shall I go?” There are not many alternatives, but there is equity – that is, the stock market. By keeping interest rates low, what the Fed has been doing is pumping a lot of money that might otherwise go into bonds into the stock market. When you pump money into the stock market, that also tends to raise stock prices. Not incidentally, those low interest rates have made it easier for the companies to borrow, because big companies are low credit risks, so they can borrow at very low rates, and some of that borrowed money can be used to buy back their shares of stock. You see how beautiful the system becomes.

It does depend on a couple of things continuing, not only to keep payrolls down and continuing to cut real payrolls. Also, the ability to continue to buy back shares of stock, if that’s what companies are doing, but also the Fed continuing to buy about $85 billion a month of long-term and short-term securities. That’s a hard thing to do. Eventually people start worrying. Don’t we have to worry about inflation? Don’t we have to worry about when this ends?

It has to end eventually. Did you notice what happened today? There was a little flurry of worry, because the notes of the October meeting of the Federal Reserve came out and the Fed governors were actually talking about ending this program [of] buying securities, which would cause interest rates to rise. Merely on the publication of the notes of the meeting, Treasury yields started to rise and the stock market – you know, people got nervous. Can you imagine what will happen when the Fed actually announces it’s no longer going to continue to buy all those securities and it’s going to allow interest rates to rise?

I’m not here to make you worry. I just want to illustrate to you something that’s going on that can’t go on forever.

When you have this dissonance, this gap between the financial economy and the real economy, something has got to give. What usually gives is the financial economy because the financial economy is, to use a word advisedly, derivative of the real economy.

That brings us back to a debate going on in Washington these days. The debate has been going on actually for longer than anybody even wants to remember, between two different schools of economic thought in terms of fiscal policy. A moment ago I was talking about monetary policy and the Fed. I might, just to segue into fiscal policy, let you have my thinking about the relationship between the two: The Fed probably should, as long as unemployment is high, continue to keep interest rates low.

But the problem is, if fiscal policy – that is, spending and taxing, that’s what Congress does – is not expansionary at the same time, if you have an expansionary Fed with a monetary policy that is very stimulative but you have austerity prevailing with regard to fiscal policy [and in] regard to what the spending and taxing functions of government do, then you have essentially a Fed that is handicapped dramatically. What we’re doing is asking the Fed single-handedly to support the economic expansion. The Fed simply can’t do it alone.

With regard to fiscal policy, why are we locked into this austerity economics? We’re locked into austerity economics because of politics. You’ve got these two economic schools of policy. One is basically austerity. It says that debt is the worst thing that we could possibly have; we’ve got to get rid of the debt, the deficit, which is the yearly deficit that becomes the cumulative debt. Then there is the other side that says we need more spending, more stimulus now. Maybe we can worry about the debt once the economy gets going, but we want to do something in the interim to stimulate the economy. You have essentially that battle. It’s been going on for a while. It’s become a battle where there is no compromise at all. Those people who think that the biggest problem right now is debt – well, they just don’t know what they’re talking about, if I may say it politely.

The yearly deficit is coming down as a proportion of the GDP, the total economy. What you really want to look at is the debt as a proportion of the total economy. An absolute number means nothing. It’s quite large now, but it’s not as large as it was after the Second World War [when] it was 120 percent of the national economy. What happened to FDR’s debt? What happened to that debt was that the ratio of the debt to the GDP changed, not because we spent that much less. The real reason that the debt-GDP ratio changed was because the economy grew so rapidly in the 1950s. The problem we are having now with regard to our debt is that we are growing so slowly. As I said before, it is remarkable on its own. It’s even more troubling given how far down the economy has been. That’s the problem.

Growing our capacity to do all sorts of things, including sustainable environmental protection and better energy sources, more health care and better health care and better education – our capacity to do all these things is what’s really at issue. That’s what is not growing, and that’s what is disturbing.

I am a proud Keynesian. Keynesianism was all in fashion in the 1950s, ’60s and early ’70s. Richard Nixon said – and I’m not quoting him, because his quote was more complicated than this, but it was recorded, like everything else he said – “We’re all Keynesians now.” Keynesianism got a very bad rap in the 1970s when, as some of you remember, we had double digit inflation and Paul Volcker took over the Fed and broke the back of inflation by basically breaking the back of the economy and sending Jimmy Carter home to Georgia. From that time on, instead of worrying mostly about inadequate demand, we started worrying mostly about too much demand and inflation.

Let me suggest something to you. We’re now back to a time where the central economic challenge is not inflation. The central economic challenge is inadequate demand. We are not growing, because the American middle class and the poor do not have the purchasing power to keep the economy going. Why not? And here I come to what I think is the crux of the issue. It’s not simply Keynesianism versus economic austerity. What’s a good word for the austeriterians? Austerics. It’s not simply the debate between the Keynesians and the Austerics. It is much more profound. It is about inequality.

Because we’ve seen, for the last 30 years, that increasingly the economic gains from growth have gone to a smaller and smaller number of people. We’ve seen increasingly, over the last 30 years, that the middle class has been under greater and greater stress, there has been less upward mobility, fewer poor people are joining the middle class. One of my colleagues at Berkeley, Emmanuel Saez, has shown that since the recovery began in 2009, roughly 95 percent of the economic gain has gone to the top 1 percent.

The problem when you have so much income and wealth concentrated in so few hands is that, in Keynesian terms, there’s no way that the relatively few people at the top can spend all that much.

The richest 10 percent of us owns 80 percent of the shares of stock in the United States. What’s the major asset that the bottom 90 percent have, if they have any assets at all? Their homes. Home values are going up a little bit but not everywhere, and certainly they have not made up for where they were before. Yet, the stock market has done wonderfully well. Do you get my drift?

The kind of inequality we are now experiencing – when the 400 richest Americans have more wealth than the bottom 150 million Americans put together – is undermining our economy overall. The rich would do better with a smaller share of a rapidly growing economy – rapidly growing because more people can participate in it – than they’re doing now with a large share of an economy that’s basically dead in the water.

We also know that democracy suffers when we have extraordinary degrees of inequality. Political power follows the money. We also know there is divisiveness. I want to suggest to you something that political scientists looking at divisiveness and political anger and polarization noticed years ago and have been tracking carefully. It correlates almost exactly with the degree of inequality in society. The more inequality, the more polarization.

Why is that? There are many theories, but the easiest and most straightforward is that most people are working harder and harder and not getting ahead. They get frustrated, they get scared, they get angry, particularly when they feel that the dice are loaded, the deck is stacked against them. They are very vulnerable to demagogues, on the right or the left, who point the finger of blame at some set of scapegoats. Maybe they’re immigrants, maybe they’re the poor, maybe they’re the rich, maybe they’re corporations, maybe they’re unions, maybe they’re government.

When we get into a politics of scapegoating, that leads to a degree of anger and divisiveness of a sort that we have right now. Inequality of this extent – of the sort we are now experiencing – in short, is very dangerous for our economy and it’s very dangerous for our society and our democracy.