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household income fell by 4 percent after adjustment for inflation. It presumably did not rise in 2009, and may not in 2010 either. A median is not an average; average income rose because the incomes of high earners rose, and so the effect was to increase the inequality of the income distribution.

Three factors appear to have contributed significantly to this trend. One is the continuing increase in the returns to IQ and education as the United States shifts to a highly automated economy; another was and is the historically unprecedented revenue of the finance industry during this period, much of it received by financial executives in the form of very high incomes; and third is the steep increase in premiums for employer provided health insurance: the increase was almost 80 percent between 2000 and 2009. Much of this is nominally paid by the employer, but because it is a cost of labor it substitutes for wage increases and so holds wages down.

There is no reason to think these trends will not continue; and until unemployment falls to a normal level, it is hard to see what might work to overcome the trends if they do continue.

In considering the effect of wage stagnation and growing income inequality, it is important to distinguish between money income and standard of living. As long as the quality of goods and services increases (largely because of technological innovation in a broad sense that includes new business methods as well as scientific and engineering progress) faster than their cost, the standard of living will rise even if incomes do not. The quality of health care continues increasing rapidly, and part at least of the rapid rise in health insurance premiums is payment for that increased quality. The quality adjusted cost of consumer electronics has plummeted in the same period.

But even if the standard of living has increased for most people whose incomes have not risen, or have even fallen, this would not alleviate the growing political problems that wage stagnation and the resulting increase in economic quality are likely to create, if they haven’t done so already. People take for granted most improvements in goods and services, and do not consider the improvements to be full compensation for a flat or declining income. Then too liquidity constraints may exclude people from access to many of the improvements; this is a problem for many people who cannot afford health insurance.

Economic anxiety arising from wage stagnation was masked until the fall of 2008 by the Federal Reserve’s low interest rate policies; people could borrow cheaply to maintain and even increase their consumption. Now they realize they are overindebted and cannot continue to support consumption by borrowing.

Economic anxiety can produce dire economic consequences by increasing the demand for trade protection, for restrictions on immigration, for union protections, for other anticompetitive measures, and for government subsidies; it can also create class resentment, and thus lead to inefficient regulatory policies, as we may be seeing with proposals to “rein in” the “greedy” banks. One reason I continue to believe that what we have gone through in the last two years is a depression and not a mere recession is that it has raised economic anxiety to a politically dangerous peak. I regard the “tea party” movement as rooted in a widespread sense (not limited to those who identify with the movement) that something is seriously wrong with the country.

My analysis suggests that measures to reduce income inequality, especially measures that raise the median household income (as distinct from reducing inequality by leveling down the incomes of the well off, which would have serious disincentive effects), could increase economic efficiency by reducing political pressures for inefficient policies. That was the rationale for “socialist measures,” beginning with Bismarck, designed to secure capitalism against communism and other radical political ideologies. And the measures worked!

The problem is that the social safety net has become too expensive to be expanded further without jeopardizing the nation’s solvency, given our huge and growing public debt. The only measures that would address wage stagnation without increasing our public indebtedness further would be subsidies that could be realistically defended as profitable investments in human capital (such as public subvention of college tuition), and essentially costless regulatory changes such as eliminating the tax subsidy for employer provided health benefits, eliminating or at least reducing many other tax subsidies, instituting means testing for Medicare and Social Security benefits, relaxing certain safety and environmental laws to reduce costs to businesses, weakening teachers’ unions and other public employee unions and reducing the number of public employees, further privatization of public services,
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reducing tariff barriers, and allowing greater immigration of highly skilled workers.

I agree the focus should be on raising middle incomes instead of lowering the highest incomes, but not because I think lowering top incomes some would cause important disincentives. Lowering top incomes would increase the returns to capital but not increase middle incomes or aggregate demand much. Posner seems to assume that any substantial changes in economic policy will make things worse rather than better. I disagree. Not only have real cash wages been stagnant since 1973, but labor force participation rates for men have been declining since then and for women since 2000. The US economy is inefficient because it is not creating enough jobs here at home (although it has done a marvelous job of creating them elsewhere). Substantially continuing the policies of the last 30 years cannot rationally be expected to start producing different results.

Basically, we have to make a decision whether we want (i) middle class incomes to stay stagnant or decline so they can better compete on price with competent low wage workers abroad or (ii) domestic wages and workforce participation to rise to produce a healthier domestic economy, in which case there must be some protections against foreign wage competition. The elephant in the room is that there is no set of policies that can increase globalization and simultaneously increase personal incomes for middle class Americans. We have to pick one objective as paramount. If we pick (i), the serious fiscal problems Posner cites, and others, will persist until falling domestic wages levels have converged with rising foreign wage levels.

yay! what a good post, though you might as well throw state governments and the military and the bailout in with the stuff costing too much. I don see why students can bring half of the funding they would bring to a public school to a private or charter school? It seems to me that would leave more dollars per student at the school she chose to leave, and provide a very meaningful subsidy to her getting out of a school she didn like for whatever reason. I have yet to hear a solid argument against a compromise that falls in that range, other than it will allow for strange private schools cropping up(it should not go for home schooling imo). That is a real threat, but parents are somewhat qualified to decide, and our current system seems expensive for the results it produces.

so thanks for your share and it is good post i like to read it The troll who made the first nfl jerseys comment should take note, there are plenty of “out” Democratic politicians. So the conceit that Massa v was “outed” as a penalty for his healthcare vote is silly. That was nobody fault but his own.

While it may look kinda glossy at first glance problems abound. That student packing a half funded voucher will soon find little choice, so such a program is largely for those who can afford voucher plus and plus plus. Soon, after those people are paying a substantial cost for “their” private school the support for our long tradition of universal, free public education will erode leaving those students with a choice of crumbling public schools or low buck voucher only schools.

In another dimension public schools are where we learn understanding and acceptance of those of differing religions, ethnicities and economic strata. As you might imagine those of certain religions or economic strata would tend to congregate with their peers. In the case of religious schools, while you might finesse the separation of church/state problem, today private schools can and do exclude students on about any criteria they choose. Once they accept government money, like colleges today, that the end of discriminating, most likely including more costly special needs kids.

Roger: You make a great point in noting a drag on US productivity due to unemployment and underemployment. Even in the “good times” of “full employment” I thought the amount of retail and low wage “service” sector jobs were indicative of our not creating nearly enough career jobs that pay the bills and create demand for easily produced excess production.

Your other point suggests other questions:

“Lowering top incomes would increase the returns to capital but not increase middle incomes or aggregate demand much.”Does concluding that any returns not given to top earners indicate either such market power that prices would not fall in order to be more competitive with other nations that do not pay such exorbitant salaries to top execs? or that those at the lower (stagnant) sector who helped to double productivity but not benefited, have too little market power to improve their lot? Interest too that the returns might accrue to “capital” which in most companies are the who provided much of the capital but also have weak voices these days.

My friends on the left attack executive compensation because they seem to assume the excess will get spread around to lower paid people. My friends in the investor class want excess executive compensation eliminated to improve the bottom line and their stock values. My assessment is that generally speaking labor has lost its bargaining power and would get none of any reductions in executive pay because, on average, sole production workers stopped sharing in productivity increases after about 1975. That leaves improved earnings as the likely beneficiary of any return to sanity in executive pay. I agree with your points about market power: It is the way it is because US markets are broken and CEOs have market power and labor and shareholders don’t. For example, ousted GM CEO Rick Wagoner total compensation of $14.9 million in 2008 was 0.01% of COGS ($2 for a $20,000 vehicle), and Jeff Immelt compensation equaled $48 for each of GE 323,000 worldwide employees (2.4 cents per hour).

Secondly our economy is not a zero sum or static model. Consider what changes might take place and did take place, if we were in a tight labor, full employment era like the As labor became more costly we respond with more efficient mechanization and use of scarce labor as we always have done. Those in marginally productive jobs like retail and fast food would be drawn to higher paying and more productive enterprises, with no harm done to retailing which would quickly adapt to more efficient models or higher productivity per employee.

At the “top” those now engaged in the shell games on WS of creating shoddy financial products to pawn off on more naive buyers and garnering 30% of all the profits of the US in a recent year would also be drawn to more productive enterprise.

Given that the world markets are increasing from the billion or so of advanced nations to four or more times that number it would not be surprising the good jobs of the future might be in designing exporting expensive products like windmills or millions of inexpensive computers or other electronics, while our big project guys now bilking the military in the M/E might be heading up roads or other large infrastructure projects in lesser developed regions.

In short the road to lower wages (apparently for all but the top 6.3% eh??) in hopes of “competing” with such as China leads to the bad ending of “Get 50 guys out here with shovels” instead of “Bring a couple guys with a backhoe.”

Dr. Bajaj, where have you been? At one time the majority of American Heavy Industries had magnificient and advanced R. facilites that were the envy of the World. No longer. They were sacrificed and shut down years ago in the interests of ever greater margins by the CFO Board of Directors and Accounting Exec As for “Electronica gizmo these are usually done by small startups and fabricated overseas. Much like the world largest newest advanced solar cell fab. plant being located, guess where, China (utilizing global labor arbitrage and statist controlled capital). Does us a lot of good.

We behind the eight ball now and it going to take a lot of moxy and intelligence to get us back into a leading position again.
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