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The graphic in ManFromMiddletown's excellent and recommend diary terrifies me.  It's a symptom of a deep and fundamental problem in this economy.  Now, I'm no economist, but I can count above ten with my shoes on, and I have some idea of how economies work.  And the lagging of worker's compensation behind the growth in productivity isn't just about the workers getting their fair share.  It's about the economy avoiding a debilitating deflationary spiral and economic collapse- not unlike the one we're now facing.  Follow me below the fold for my reasoning.

First, I'd like to introduce a new economic law- production equals consumption, on average.  Always.  Consumption includes the producer paying to get the unwanted inventory hauled off to the dump- in this case, the producer and consumer are the same person.  This law is implicit in the law of supply and demand.  The law of supply and demand is how the economy enforces the law of production and consumption.  If demand for a product or service outstrips the supply, prices rise until either new sources for the product or service are found, raising production to equals consumption, or prices rise until demand drops, lowering consumption until it equals production.  Likewise, if supply outstrips demand, prices drop until suppliers drop out of the market, lowering production, or new demand is created, increasing consumption.  But consumption equals production.

Consider a much-simplified economy where the only good or service produced is widgets.  Everyone in this economy- all 100 people- are employed at the loan company, Widget Corp, producing Widgets.  These 100 people all produce 100 widgets per time period, and all is right with the world.  This is an incredibly simplified case, but it gets across my main point.  Now, in this scenario, the average real income is 1 widget per time period.  Inflation doesn't enter into the picture- it doesn't matter if people are being payed dollars, drachmas, or federation credits.  The average person gets paid enough to buy one widget per time period.  I'm assuming that any inflationary or deflationary pressures have sorted themselves out, and the economy is at something like a steady state.

Now, enter a productivity increase.  Now, the same 100 people working the same time period, make 102 widgets, not just 100.  Now, at this point, there are three choices.  

Choice number one is to raise everyone's real earnings by 2%.  Make the average real salary 1.02 widgets per time period.  Note that if this option is taken, the increase in real wages does not cause any inflationary pressures- because the labor cost per widget remains the same.  

Choice number two is to not raise the average earnings.  Instead of using the full 100 people to make the 100 widgets per time period there is demand for, only use 98 people.  The problem here is that the people who got laid off also stop getting paid, and thus can't afford widgets anymore- so it fairly quickly becomes obvious that the real demand isn't 100 widgets per time period, it's only 98 widgets per time period, meaning you really only need 96 people- er, except demand is weaker than expected, instead of the 98 widgets per time period, we're only going to need 96, maybe 94.  Etc.  Welcome to the viscous circle, where laying people off lowers demand requiring more people get laid off.  It ends when everyone is out of work.

Choice number three is to not raise the average earnings of the employees, but instead let them borrow to increase spending.  In this scenario, the employees still only get paid an average of 1 widget per time period, but they borrow another 0.02 widgets worth of money to consume the extra widgets being produced.  The problem with this scenario is that you can not borrow an infinite amount of money.  Sooner or later, the gravy train will run out, and the employees, who had been borrowing to keep up with expenditures, will have to lower expenditures.  But they won't just lower them to their baseline average wages- real expenditures will drop much farther than that, as people attempt to pay off their debts.  This kicks off the deflationary cycle described above with a vengeance.  Especially considering, once the employment situation starts looking dicey, people will more aggressively pay off debt.

These all the only three choices, due to the law of production and consumption- that everything produced has to be consumed.  The boost in productivity literally and by definition boosts production, meaning either an increase in consumption is necessary, or a reduction in production.  Choice one increases consumption (demand).  Choices two and three decrease production.

I think we, as an economy, picked choice number three.  For the last thirty years, the amount of debt piled up by households has been what has sustained the economy.  Yes, most of that debt has been accumulated recently, but that's exactly what you expect of an exponential trend- it starts off small, and it's only at the very end does it explode.  Adding 2% of your income to your debt isn't that large of a debt load.  But accumulating debt is an exponential process, as interest charges, and interest charges on the interest charges, accumulate.  And the problem we're facing now is that we've hit our debt limit- the last refuge for increase debt loads, home equity, is tapped out, and home prices are falling.  People are now scrambling to pay off their debts, especially now that the employment situation is looking really shaky.  It may take some time (even decades) before the collapse is really hit.  But it's inevitable.

And I picked the number 2% because it looks like that's been averaging these last half a dozen decades or so.  A 2% per annum in increased average efficiency over the course of sixty years (1947-2007) will give about a 3.6 fold increase is total productivity per hour of labor- which is about what the graph in ManFromMiddletown's diary shows.

I'd like to address on critique of the above argument- my use of average wages.  The basic idea is this: assume that, in the original (pre-efficiency-increase) scenario, Mr. Moneybags owned Widget Corp, and took home 40 widgets per time period as his pay, leaving everyone else to split the remaining 60 widgets.  The average wage excluding Mr. Moneybags is 60/99 or 0.6060... widgets per time period, but the average wage including Mr. Moneybags is 1 widget per time period.  Now, the efficiency increase comes along- and instead of raising everyone's pay by 2%, meaning Mr. Moneybags only gets a 0.8 widget/time period increase, he decides to keep everything to himself.  The average pay excluding Mr. Moneybags remains the same, but the average paying including him goes up to 1.02 widgets per time period, and no economic collapse happens.

The problem with this is the assumption that increasing Mr. Moneybag's monetary salary will cause a proportional increase in his demand.  And I don't think this is true.  As a thought experiment, consider the following- you have to disburse $100 million dollars (no keeping it to yourself).  You have a choice of two ways to do this.  Way one is give the entire wad over to Bill Gates.  Way two is to give $10,000 a piece to each of 10,000 randomly selected lower and middle class families.  Which produces more aggregate economic demand?  Even giving Bill Gates several billion dollars won't really effect his demand- the guy already has tens of billions.  He's not likely to suddenly decide to buy a new car- and if he did, how many new cars would he buy?  One?  Maybe ten?  But what's the probability that, given an unexpected $10,000, the average middle class family will decide to go out and buy a car?  If it's greater than 0.1%, then giving the money to the middle class families will get a lot more cars purchased- as well as a lot more big screen TVs, homes, stereos, computers, dinners out, etc.

This is exactly the argument we're having with the stimulus bill.  The position of the Republicans is that giving the money to Bill Gates (and other really rich people) is as good at creating demand as giving money (and more importantly, jobs) to poor and middle class people.

Also, comparisons to the pre-WWII economy are also invalid, I think.  I'm on somewhat shakier ground here (I am not an economist, remember).  Before the Great Depression, we had a high level of income inequality (per Krugman), but increases in efficiency were distributed more or less equally.  That's the difference between that economy and this economy- the gains being made in increased efficiency are being, not just disproportionately, but entirely appropriated by the least efficient consumers there are- the wealthy.  The problem isn't (just) high levels of income inequality- it's increasing levels of income inequality.

This scenario bares a striking resemblance to the economic problems we're in now- the increasing efficiencies coupled with the stagnation of real wages lead to an exponential increase in debt.  The debt bubble has collapsed, and demand is collapsing- driving a viscous circle of increasing unemployment and decreasing demand.  

If I'm right, then the stimulus package is not, can not be, enough.  Even granted a "Krugman plan"- say $1.4 Trillion is pure government spending, no tax cuts, the best that is hoped for is simply a return to the status quo of four, maybe ten years ago.  But that status quo is not sustainable now, any more than it was sustainable then.  The real wages of the masses must be increased- at the cost of decreasing the incomes of the richest.  We need strong unions, a livable minimum wage, probably a national maximum wage as well (enforced by a 100% tax rate on all earnings above the maximum wage?), single payer health care, paid for by taxes on the rich.  If giving money to the rich increases the economic activity the least, taking money away from the rich decreases it the least.  Everything that redistributes the wealth from the rich to everyone else, and undoes the last several decades of economic unjust, is no longer an option.  It's not a choice between socialism and capitalism anymore, it's a choice between socialism and utter economic collapse.  

In addition, we need to decrease the debt load being carried- especially by individuals, but across the board.  We need retroactive pay raises.  This may be heresy, but I actually think a good bout of inflation would help.  A 15% inflation rate for five years would halve the debt load of everyone.

Last to come out of Pandora's box was hope.  The near-term outlook for the economy is grim, but hold on to this hope, that a rising tide can, indeed, lift all boats.  In an era of increasing efficiency, it is possible for the real wealth of everyone to be increasing.  That social justice for all is not the implacable enemy of the economy- indeed, it is the lack of social justice which is threatening our economy.  And that we have the ability to fix this.

Originally posted to bhurt on Sun Feb 08, 2009 at 11:49 AM PST.

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Comment Preferences

  •  Tip Jar (8+ / 0-)

    Although just reading this diary is tip enough...

    "History does not always repeat itself. Sometimes it just yells, 'Can't you remember anything I told you?' and lets fly with a club." --John W. Campbell

    by bhurt on Sun Feb 08, 2009 at 11:49:59 AM PST

    •  A good diary (1+ / 0-)
      Recommended by:
      yellow dog in NJ

      Sooner or later, the gravy train will run out, and the employees, who had been borrowing to keep up with expenditures, will have to lower expenditures.  But they won't just lower them to their baseline average wages- real expenditures will drop much farther than that, as people attempt to pay off their debts.  This kicks off the deflationary cycle described above with a vengeance.  Especially considering, once the employment situation starts looking dicey, people will more aggressively pay off debt.

      You've identified why I have a problem with the stimulus bill and why I believe it is doomed to fail. The government behaves like people do: you can't borrow for an infinite amount of time, so any money we borrow to save jobs now will simply result in layoffs, inflation, etc later, perhaps creating an even bigger crisis.

      I mean, Obama wouldn't have gotten elected if his position was "A lot of people are going to lose their jobs while we retool the economy and there's nothing anyone can do about it", but I think that this is the basic gist of the current situation. Nothing is free.

  •  Excellent diary (1+ / 0-)
    Recommended by:
    Dirtandiron

    Let the mega banks fail, restore depositors, and watch smaller, regional banks flourish! NO BAD BANK! (for the love of God, Barack, it's not that hard!)

    by Paul Goodman on Sun Feb 08, 2009 at 12:15:34 PM PST

  •  The fatcats could own all our (0+ / 0-)

    houses [as could the government] and the economy could still function.

    They could also own all the books, computers, TVs, personal audio devices, etc.

    Everything could be owned by just 400 fatcats, or 300 fatcats, etc.

  •  Should I grrab my ankels or knees? (0+ / 0-)

    Those seem like the only two choices that I have according to this diarist doom scenario.

  •  I agree, it's not just jobs but good jobs. (2+ / 0-)
    Recommended by:
    RosyFinch, luckylizard

    It has always maddened me that federal  poverty rates are the starting point for discussions about minimum wage. Actual living wages are not considered and consequently not paid for vast numbers of workers. When I first came to live in the US, 30 years ago, a local factory was one of the biggest employers in town. Workers there could afford to have toys like snow mobiles, boats and the luxury with one partner staying home with the kids. Now this same factory pays $10 per hour, pitiful.

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