Only fairness will assuage the anxious middle

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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

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