krebscycle

Originally published in Daily Kos 9/24/2010.

Thu Sep 23, 2010 at 10:24:21 PM PDT

Around 2000, Larry Summers did something that is rare among academics and almost non-existent among economists: he let the evidence change his opinion. More remarkable he discarded an opinion that had made him rich and high status and embraced an opinion that is still considered taboo and even repellent among economists and political scientists. Summers looked at the economic data and decided that the fundamental problem in the American economy was that the richest fraction of the population were increasing their wealth at the expense of the poor and lower middle class – what people used to call the working class. If you are not familiar with the economics “literature”, you might not appreciate what a heretical position this was, but it was as if a high ranking Catholic Cardinal denounced religion as superstition or the Mayor of Boston became a Yankees fan. Furthermore, Summers said that redistribution of wealth back to the majority was a political imperative:

The failure to ensure that prosperity is broadly distributed represents a problem of legitimacy for society.

This new opinion was so heretical in the conformist world of US economics and political science that it has been almost entirely buried even though it is the key to understanding the economics policies of the Obama administration. Here is Summers in 2007 explaining that the fundamental principles of classical and neo-classical economics don’t fit the data.

When I studied economics in graduate school a generation ago we were taught that it was a “stylised fact” that the US income distribution was very stable. We were shown that the fraction of the population in poverty tracked almost perfectly the performance of median family income over time and that productivity growth and average real wage growth moved together, with both declining sharply after the oil shocks of the 1970s. These observations led naturally to the conclusion that the main way of reducing poverty or increasing the incomes of middle income families was raising the rate of economic growth. Today, we have another generation’s worth of data including the experience of the information technology-driven re-acceleration of productivity growth in the 1990s. This experience forces a reassessment of the earlier economic orthodoxy. It can no longer plausibly be asserted that the income distribution is relatively static or that average wage growth tracks productivity growth. Indeed, in a recent paper on tax policy prepared for the Hamilton project, my collaborators and I concluded from Congressional Budget Office data that, since 1979, changes in income distribution had raised the pre-tax incomes of the top 1 per cent of the population by $664bn or $600,000 per family – an increase of 43 per cent. By definition what one group gains from changes in the distribution of income another group must lose. The lower 80 per cent of families are $664bn poorer than they would be with a static income distribution, which works out to $7,000 less in income per family or a 14 per cent loss. To put this in some perspective, the total gain in median family incomes adjusted for inflation between 1979 and 2004 was only 14 per cent. If middle income families had shared fully in the economy’s income growth over the past generation their incomes would have risen twice as rapidly!

The assumption that productivity increases cause prosperity is a silly one, but it is deeply embedded in the economics profession, so embedded that even smart liberal conventional economists can’t let it go. Furthermore, conventional economists have a great deal of difficulty understanding linkages between health and general welfare and income inequality. Here is Summers, just before the election.

Consider these facts that illustrate how the prosperity of recent years has not been shared widely: The rich have gotten richer and most of U.S. society has gotten poorer. Shifts in U.S. income distribution since 1979 reflect a wealthier top 1% (which has gained about $600 billion per year in annual income, equal to about $500,000 per person in the top 1%) and a less prosperous bottom 80% (which has lost about $600 billion in income per year). The income of those in the 80th to 99th percentiles is unchanged. If incomes in the bottom 80% had kept pace, they would have been twice what they wereover those years. 􀀁 The gap in health status between the fortunate andless fortunate has widened. Twenty-five years ago, the gap in life expectancy between the well-off and the less fortunate was close to two years. It has expanded to four years, which is hardly a mark of social and economic success. (While two years of life expectancy may not sound like a lot, it is equal to the gain in life expectancy that would be realized if cancer were completely eliminated.) 􀀁 Children of privilege and children of poverty are more likely to remain in those socioeconomic situations as adults. For most of American history, the tendency for prosperity to pass from father to son was diminishing. But for the last quarter-century, that trend has stopped and, some say, reversed. Prioritizing education must be part of the solution, along with creative approaches to assisting adults who are no longer in the educational system. The failure to ensure that prosperity is broadly distributed represents a problem of legitimacy for society. http://www.hbs.edu/centennial/businesssummit/market-capitalism/the-future-of-market-capitalism.pdf

The second point in the argument above leads to the key property of the health care reform bill, a property that has been almost completely ignored both in the conventional media and in the supposedly more left wing blogs.

For all the political and economic uncertainties about health reform, at least one thing seems clear: The bill that President Obama signed on Tuesday is the federal government’s biggest attack on economic inequality since inequality began rising more than three decades ago. Over most of that period, government policy and market forces have been moving in the same direction, both increasing inequality. The pretax incomes of the wealthy have soared since the late 1970s, while their tax rates have fallen more than rates for the middle class and poor. Nearly every major aspect of the health bill pushes in the other direction. This fact helps explain why Mr. Obama was willing to spend so much political capital on the issue, even though it did not appear to be his top priority as a presidential candidate. Beyond the health reform’s effect on the medical system, it is the centerpiece of his deliberate effort to end what historians have called the age of Reagan http://www.nytimes.com/2010/03/24/business/24leonhardt.html

The focus on wealth and income inequality explains the unwillingness of the Obama administration to engage in the long-time favorite liberal tactic of the “line-in-the-sand”. On issue after issue, the Obama administration is willing to concede what they see as minor points to keep working on direction changing. Does the health bill act to decrease income inequality – yes – so get it passed and move on to financial reform and so on. From this point of view, individual items, such as the infamous public option don’t matter as long as the aggregate direction is correct. The emphasis on wealth and income inequality is clearly shared by the President – who stressed this issue in the campaign although that does not seem to be widely remembered.

Oct. 27 (Bloomberg) – John McCain seized upon comments Barack Obama made on a 2001 radio show about the “tragedy” of the civil rights movement’s failure to achieve “redistributive change” as fresh evidence the Democratic presidential candidate is “more interested in controlling wealth than in creating it.” [..] McCain’s campaign and the Republican National Committee circulated the audio clip, excerpted from the Jan. 18, 2001, broadcast and posted on an anti-Obama Web site called Naked Emperor News. During the program, on WBEZ-FM, Obama said “one of the tragedies of the civil rights movement” was that it “became so court focused” there it tended to “lose track” of a political strategy “for power through which you bring about redistributive change.” Obama, then an Illinois state senator and part-time law lecturer at the University of Chicago, defined “redistribution” as “how do we get more money into the schools and how do we actually create equal schools and equal educational opportunity.” Such an effort, attempted almost 20 years after the Supreme Court’s landmark 1954 school-desegregation decision, failed because the high court ruled it had “no power to examine issues on redistribution and wealth inequality with respect to schools,” Obama said. The justices decided “that is not a race issue, that’s a wealth issue and we can’t get into this.” http://www.bloomberg.com/apps/news?pid=newsarchive&sid=a.9RAjNlqSF4

Here’s a note on Summers just before he took his current position.

Mr. Summers has spent much of his career tweaking fellow liberals with arguments he considers unpleasant truths – on the dangers of budget deficits, the benefits of capitalism and other subjects. But he seems to have decided that conservative orthodoxies have become a vastly bigger threat to good economic policy than liberal ones. His favorite argument today is one that instead drives some conservatives nuts. It goes like this: To undo the rise in income inequality since the late ’70s, every household in the top 1 percent of the distribution, which makes $1.7 million on average, would need to write a check for $800,000. This money could then be pooled and used to send out a $10,000 check to every household in the bottom 80 percent of the distribution, those making less than $120,000. Only then would the country be as economically equal as it was three decades ago. The lack of middle-class income growth during that span is “the defining issue of our time,” Mr. Summers has said, in a tacit admission that liberals were ahead of him on this issue. http://dealbook.blogs.nytimes.com/2008/11/26/the-return-of-larry-summers/?scp=3&sq=leonhardt&st=cse

But Summers seems to have also learned something from the critics of globalization. In his Harvard Speech just before the election, Summers tied together three critical issues: growth and stability of the economy, reducing wealth inequality, and – perhaps surprisingly – a sustainable world economic system.

Building a global system that works for the citizens of all nations. This financial crisis, along with events of the past decade, has changed the world’s view of the United States. A decade ago America stood apart on several dimensions. The United States was widely admired for its military strength; despite its faults, America was seen as a moral beacon for the world; and America’s economy was the envy of the world. The situation is different now. Based on the country’s experiences in Iraq and Afghanistan, the country’s military strength has been diminished; after Guantanamo, Abu Ghraib, and Katrina, the United States is not the moral beacon it once was; and the financial crisis has altered the perception of the United States’s economic strength. With this as the context, the United States must work with other nations in creating an integrated, collaborative world system that provides prosperity and peace for all people. (No single issue is more important for this world system to tackle than energy. There is not yet clarity on the specific solutions to the world’s energy-related problems, but what is clear is that the current path does not work economically, environmentally, or geopolitically.)

Of course, left-wing economists have long been making the argument that the rich are robbing the poor but Summers is no left-winger. Instead, like Keynes and FDR, he is proposing that the government must act to save capitalism from itself,that the government must save the social order by protecting it from people at the top of the social order who are too selfish and short sighted and lacking in basic human decency to control their rapaciousness. That’s an argument that would have been familiar to Madison and Lincoln, FDR and Reuther. It’s definitely not the argument of a left-wing social reformer, but it’s also not the neoliberalism often seen by people who are still stuck in the 1990s instead of being here in our revised version of the 1930s. Obama’s administration, like Roosevelt’s, is based on a vision of reform and stabilizing the existing society, not on a radical transformation. Some left-wing theorists will argue that such reforms are doomed because the system itself is inherently unstable and wildly unjust and that may well be correct, but what is not correct is to view Obama’s administration as a failed populist insurrection, when it is basically a conservative reform movement. Summers spelled this out in the conclusion to his Harvard speech.

These three issues reflect the need to forge systems that work for people—people who will never come to Harvard Business School; people who are living lives of great value but who no longer feel secure in their communities, their livelihoods, their nations, or the world; people who are uncertain that they will be a part of the world economy. Thus, the overarching challenge is to make the system work for all of those people. This has happened before. A Republican Roosevelt (Theodore) and a Democratic Roosevelt (Franklin) both presided over periods when capitalism saved itself from itself. Enlightened public policy played a crucial role, and business leaders recognized that while there may be conflicts about their short-run interests, there is less conflict about their long-run interests, because of their enormous long-term interest in being part of successful societies.

That is a restatement of Keynes political view and, as Krugman wrote

“Keynes was no socialist – he came to save capitalism, not to bury it.”