Henry Ford once said, “There is one rule for the industrialist and that is: Make the best quality of goods possible at the lowest cost possible, paying the highest wages possible.” In today’s world of neoliberal economics and libertarian selfishness, most industrialists (Corporatists) understand why Ford might have encouraged making the best products possible at the lowest cost possible (some obviously only give lip service to “the best”), but why, they might ask, did he include “paying the highest wages possible?” This admonition goes contrary to all economic development over the past thirty years of conservative ascendancy. In fact, it was contrary to the business ethic in vogue in the early 20th century when Ford made his statement. His answer then—and it applies even more strongly now—was that there had to be somebody around to buy his products!
Henry Ford knew that if he were to make a competitive product for the masses, the masses must earn enough wages to buy the product. Ford realized that if too much profit was awarded to the ownership and executive class at the expense of the working class, the large working class would not be able to buy his product and the small executive class (the rich) wouldn’t need the product in large enough numbers to support mass production, leaving the majority of the product sitting idle and unpurchased. Idle products would mean lost profits, layoffs and a failing economy. The rich by themselves would not provide enough demand to keep a capitalistic economy growing since they save most of their income and spend very little of their wealth on mass-produced items or on real growth-generating investment. Ford knew there would not be enough demand to keep a large economy growing if a disproportionate share of production profits went to the already rich and an adequately paid middle class wasn’t supported to keep economic demand high. That’s why Ford sold his cars for less and paid his employees more than his fellow industrialists thought was prudent. His industrial counterparts and classical economists thought he had lost his mind and called him foolish and stupid—stupid like a fox.
Ford’s observation turned out to be highly prophetic when by the end of the 1920’s the distribution of income in America had shifted so significantly in favor of profits for the rich and away from wages for the workers that economic demand completely collapsed, creating the great depression. After futile attempts by the Hoover administration and classical economists to spur new economic growth through budget austerity (which only caused everybody to spend even less), aggregate demand was finally reestablished by the Roosevelt administration through massive deficit spending designed to give the wage earners enough jobs and wages to spur growth. This new Keynesian economic principle was greatly accelerated by the Second World War where full employment was achieved in a desperate rush to build weapons and fund the war effort.
By the end of the war the leading politicians had learned that full employment was key to economic prosperity, and for three decades the American economy was blessed with tremendous growth, accompanied by very low levels of inflation and unemployment. Throughout these years, improvements in productivity were matched almost identically with increases in wage share for workers, and social security measures were introduced that helped the elderly stay out of poverty and remain in the economic demand loop. While working conditions were not perfect, unemployment of those willing to work was almost nonexistent. Whenever the economy started to go soft, the government was ready to help with strong fiscal stimulus through deficit spending (yes, even Republicans like Eisenhower deficit spent like crazy). At the same time, taxes on the rich were increased to as high as 91%, which didn’t keep them from being disproportionately wealthy, but did keep them from sucking potential aggregate economic demand out of the economy through excessive saving as a percent of the economy. This is not to imply that overall economic savings were eliminated, but that the rich saved less and the new middle class saved more, keeping a lot more resources productively involved in real investment and growth.
The United States and the rest of the world had reached a plateau in economic and social development. Government support was effectively balanced between business interests and the well-being of wage earners. Full employment and maximum GDP growth were the driving forces behind political decision making. This world of wonder came to a screeching halt in the 1970’s because of two major events: The Vietnam War and the OPEC cartel decision to artificially push up oil prices.
The Vietnam War created a deficit funding issue for Richard Nixon. Since the US dollar was tied to gold on an international basis (the Bretton Woods System), Nixon found that he was shipping too much US gold overseas to pay for the war. As a result, Nixon abandoned the Bretton Woods System for a free floating fiat system. With the fiat system the exchange rates between countries would be free floating and no longer tied to gold. From an economic perspective this was a brilliant move since it provided the economy with the most flexible system for maintaining growth—and funding wars, unfortunately. But politically, it opened the door for new neoliberal questioning of the inflationary propensity of high deficit spending. Also, though the new fiat system offered more flexibility for deficit spending, much of that flexibility was largely ignored, with the government pretending that it was still on the gold standard when it came to funding the deficit. Government leaders continued to demand reaffirmation of the principles of borrowing from the private sector to deficit spend in the public sector which were monetarily tied to the gold standard but no longer applied to the fiat system—unless politically forced to do so.
With the conservative economists anxiously waiting for inflation as a result of Nixon’s move to a fiat monetary system, the OPEC community twice provided them with an excuse to blame inflation on too much government deficit spending. While the two OPEC price increases of the early and late 1970’s created a “cost-push” inflation in prices due to price manipulation in a single market sector (the oil cartel), the new neoliberal economists and reemerging conservative politicians argued that it was really “demand-pull” inflation resulting from too much government spending crowding out private spending and pushing up prices. In a single decade, the Keynesian deficit spending revolution was undermined and the long road to a new major recession was fundamentally paved and ready for travel.
Sadly, while Nixon exclaimed, “We are all Keynesians now,” in 1971 as he abolished the Bretton Woods exchange system, Keynesian economics was dead by the end of the 70’s. Reaction to OPEC cost-pushed inflation was deceptive, reactive and intense. Fear of inflation became the excuse for a new political and economic free market conservatism which lowered economic growth, permanently increased unemployment and—most importantly—redistributed income and wealth back to the ownership and executive class (the wealthy).
This economic conservatism was spearheaded by Milton Friedman who aligned himself and his disciples with the corporate elites, producing new anti-Keynesian approaches to economics based on fancy economic fallacies which were bought lock-stock-and-barrel by the misinformed American public and its leaders—along with leaders throughout the world, for that matter. Foremost among these fallacies was the belief that a balanced budget is the ultimate goal of fiat government financing and that deficit spending creates inflation because public debt crowds out private financing. Too much unfunded spending would cause the United States government to go broke. Ironically, while this fallacy was basically possible in a gold standard monetary system, the new fiat system of the 1970’s had none of these implications of bankruptcy, yet the political leaders and economists chose to politically instill gold standard limitations on the fiat system anyway, reducing the effectiveness of economic policy to promote employment and growth even though the government of a sovereign fiat currency can never go broke for pure monetary reasons—the politicians can chose to default on their debt for political reasons, but never because there isn’t enough money. The next economic fallacy promoted by the neoliberal group was the belief in supply-side (trickle-down) economic distribution of profits. They pushed for, and politicians delivered, massive tax cuts on the rich which, they argued, would certainly promote growth as the rich hired more employees and built more businesses. Of course it never happened, but what’s reality in the face of an ideology which religiously believes taxes on the rich stifle growth and destroy jobs. Finally, the new economic movement fallaciously argued that full employment was also inflationary and that an unemployment rate of up to 6% and even higher in Europe was a natural rate, and any government attempt to fiscally reduce unemployment beyond this natural limit has intrinsic inflationary risks.
The new alliance between economic neoliberalism and conservative extremism succeeded in totally transforming economic reality for Americans over the next 30 years. Political attacks on unions and market regulations along with economic pressure to maintain higher “normal” rates of unemployment and balanced government budgets managed over time to radically increase the share of economic profits going to the wealthy class. As productivity and GDP grew, the share of profits going to average middle class Americans began to pale in comparison to that distributed to the top 1% because higher acceptable unemployment levels acted as a buffer to keep wages low and corporations with government backing began sending jobs overseas, seeking cheap and unregulated foreign labor. At the same time, attacks on organized labor unions grew and their political influence was dramatically reduced.
Thisgraph from Bill Mitchell – Billy Blog (A radical redistribution of income undermined US entrepreneurship. Nov. 22, 2011) shows this loss of wage share in graphic detail (other charts below are also from the same post). From the 1940’s up to the mid 1970’s, productivity and real hourly compensation rose hand-in-hand as all levels of American society improved their lots. But after the mid 1970’s, wages clearly lagged behind productivity growth with most of the profits represented by the growing gap going to the top 1%.
With all this shifting of wealth, the gap between the richest 1% and those stuck in the bottom 20% skyrocketed from a mere 300 to 1600 times more income as shown in thisgraph.
So, as Henry Ford said and the great depression proved, too much profit to the rich can cause the economy to collapse as the middle class begins to disappear. With the staggering disparity in profit distribution demonstrated by the charts above, why did it take 30 years for another great economic jolt to occur? Thisgraph demonstrates the reason.
Beginning in the early 1980’s a radical shift in personal consumption (private sector borrowing) made up the difference in the loss of wages to keep the economy growing. The middle class reduction in wages was offset, significantly, by a tremendous increase in borrowing. To put it bluntly, the middle class borrowed extensively to keep its consumption at the level it would have been if its wages had continued to increase with productivity as they did after World War II. This was just what the neoliberals and new radical conservatives wanted: a shift in money and power to the rich covered by leveraged borrowing from the ever poorer middle class. The 1% got to have their cake and eat too, funding the whole scheme on the backs of those who could not afford to pay by feeding them loans that they should not have qualified for and making huge profits in interest payments while they were at it.
The financial markets went crazy keeping this borrowing bonanza going with the help of politicians from both parties who eliminated regulations designed to limit such profligate borrowing. Celebrating all the private debt-generated growth, the neoliberal economists gloated (prematurely) that under their new anti-fiscal, monetary-driven governance the ideal economy had finally been created. There were a few economic outcasts who issued dire warnings (the MMT group, for instance) but almost everyone in the economic mainstream preached the benefits of private borrowing and spending while, at the same time, admonishing fiscal public deficit spending as the root of all evil. For the neoliberal economists economic nirvana had been attained.
Perhaps the most interesting aspect of this thirty year shift in economic reality is the fact that it was promoted by both Democrats and Republicans without either side really understanding the economic repercussions of what was going on—in fact, neither side still understands what Henry Ford clearly foresaw a century ago. True, the Republicans with their limited government posture were the most strident advocates of softening regulations, lowering taxes and handicapping the unions—theirs is the lion’s share of the blame. But the Democrats had also bought into the neoliberal economic fallacies and did their share of contributing to the demise of the middle class as well. For instance, the budget surpluses that the Clinton Administration achieved were, and still are, lauded as great economic achievements.
What the Democrats and Clinton failed to understand was that, by accounting definition, a government surplus (more tax revenues than spending) can only be provided by massive private sector borrowing when a nation imports more than it exports. This is not a matter of opinion, but a mathematical fact (government surplus/deficit=private deficit/surplus-net imports). For the government to run a surplus, the private sector must run a deficit through net borrowing or exports must exceed imports significantly. During the time of these surpluses the import trade imbalance was growing by leaps and bounds which means that the private sector had to borrow even more to overcome that imbalance. So, while everyone thought Clinton was working a miracle, all he was really doing was borrowing from the middle class to fund mass speculation and achieve unsustainable growth in GDP. Ironically, when Clinton bowed to the conservatives and lowered the deficit by cutting government spending, he only succeeded in making the middle class borrow even more. This was especially true since the top 1% were saving like crazy and speculating like wild men in the financial debt that involved all the middle class borrowing.
When Bush arrived on the scene things got even worse. His massive tax reductions on the rich only pushed more money disproportionately their way. Although the Iraq and Afghanistan wars were funded through massive deficit spending, most of the dollars either went overseas or to the already wealthy, causing the middle class to borrow even more to keep their consumption, and therefore the economy, going.
From a macroeconomic perspective the great recession should not have been a surprise to anyone. The wages of the middle class had not risen along with productivity and GDP in much the same manner as before the great depression in the 1920’s. The private sector had leveraged itself dramatically as was also the case before the great depression. Thisgraph taken from the US Federal Reserve Bank, shows how this borrowing progressed. It is really interesting to see how large non real estate consumer loans (primarily credit cards) got to be before the whole gamble crashed.
As the borrowing increased, so did the household debt service ratio as shown in the followinggraph from the same post.
By the time the economy crashed, the debt service ratio had risen to 13.96 percent which meant that 13.96 percent of disposable personal income was going to interest payments on private debt. With this level of borrowing required to sustain GDP growth, a fall from grace was inevitable. The middle class and creative lenders had stretched the string as tight as it could get. Something had to give and it did in a big way—massive defaults. So why was it that the crash caught everyone by surprise?
The overriding reason was, and still is, neoliberal economic policy. Milton Friedman and the neoliberals managed to erase all memories of the Keynesian good years where fiscal deficit spending enabled full employment and kept inflation down. They replaced Keynesian aggregate demand macroeconomic principles with new supply-side microeconomic fears of inflation and free market monetarism. They convinced everyone that deficit spending was unsustainable and caused inflation with inevitable default, that the Fed had all the tools it needed to control the economy through its monetary policy, and that the private sector must always be the long term generator of economic growth. And, most importantly, they convinced policy makers that high unemployment levels and low wage levels were necessary to keep the market effective and inflation at bay. Over thirty years of increasingly lower GDPs with increasingly higher unemployment and ever higher proportions of profit going to the already rich, they actually convinced everyone to accept this new economic mythology of austerity which was designed simply to transfer profits and wealth to those already at the top.
So, when the economy crashed and the neoliberals were shown to be the devils that they are, this whole thing changed. Right? Wrong! Now, after 30 years of ever lower government fiscal intervention resulting in a huge crash caused by too much private sector debt being squandered in nonproductive unregulated financial speculation, these very same neoliberals are blaming the whole crash on too much governmental spending, too high wages in the private and public sector, and too much socialistic welfare. Their answer to the problem is to keep doing the same, but more so. Now we need to get rid of Social Security, Medicare and civil servants in order to find enough money to fund the ever growing transfer of wealth to the already rich. Because, only the rich can generate jobs and they won’t do it if we don’t cut back and treat our government’s monetary resources like a household budget (thank you Obama!).
Here we are on the verge of another great depression and our politicians from both sides of the aisle are acting like Herbert Hoover all over again. We need to deficit spend like crazy to spur the economy just as Roosevelt did in the 1930’s. Or even better, we need to create a minimum wage job program that employs absolutely everyone willing to work. We should be enhancing Social Security and providing basic health care for all. And we have enough money and productive capacity to do it all without causing any inflation. In fact, it’s incredibly ironic that as our real productive capability to provide for the masses has improved over the years, we have become ever more attached to imaginary monetary restraints that are nothing more than political tools designed to keep disproportionate monetary resources going to the already wealthy. This presents us with perhaps the greatest contradiction in modern times which was brilliantly summarized by Naomi Klein in a speech to the OWS movement in New York:
We all know, or at least sense, that the world is upside down: we act as if there is no end to what is actually finite—fossil fuels and the atmospheric space to absorb their emissions. And we act as if there are strict and immovable limits to what is actually bountiful—the financial resources to build the kind of society we need.
The task of our time is to turn this around, to challenge this false scarcity. To insist that we can afford to build a decent, inclusive society while at the same time respect the real limits to what the earth can take.
Our government is the sovereign issuer of its own fiat currency. Every dollar ever spent on taxes was first spent by the government. The government does not tax and spend, it spends and taxes. Every penny of net saving in the private sector came from government deficit spending. In fact, unless our country is exporting more than importing, the only way the private sector can net save a dime is for the government to deficit spend it first. This is a simple matter of sectoral balance accounting and is irrefutable as a matter of basic accounting principles. The government is not a household (are you listening Obama?). A household has to obtain money from somewhere else before it spends or pays taxes (ultimately either from the government or through borrowing). The government can spend as much money as it wants without borrowing from anybody as long as there are products and services available for it to buy. Currently the government borrows (sells treasuries) before it deficit spends only because it is politically constrained to do so. There is nothing monetarily inherent in a fiat system that requires government borrowing to deficit spend. When there are 25 million idle workers and a very high percentage of idle productive capacity basically begging to be used, the decision by the government to pay workers to employ this idle capacity will not create inflation, but instead will generate real GDP growth in great contrast to the speculative debacle generated by the neoliberals over the past 30 years.
But, you may say, what about the national debt? Surely we can’t let it keep on expanding and must, as President Obama argues, begin to pay it off? The national debt is really nothing more than a bunch of treasury bonds that pay interest. In fact, it is really the national savings. It represents the net savings from the private and foreign sector which match penny-for-penny our governments deficit spending over time. If the government chooses to reduce this debt it also chooses to reduce the cumulative net savings of the private sector. I don’t think the 1% would take well to that since they are the ones who own the majority of the debt. One thing is for sure, there is no way in hell that the government is going to pay off the debt by getting the middle class to borrow more—that road is now impassable. In any event, the government can deficit spend and continue to pay interest on the national debt until the cows come home and it won’t make a bit of difference when there is so much idle capacity in the economy. And as a matter of fact, once the economy begins to grow and the rich are once again made to pay their fair tax share, like in the good old days of Eisenhower, the debt will go down all on its own through increased revenue generation as people make more money and pay more taxes. Increased deficit spending actually reduces future deficits and debt over time.
One thing is for sure. If we cut spending—especially on social programs—as the President, the neoliberals, and the Republicans say we must, the economy will slip once again into severe recession. It’s an austerity begets austerity world out there whether the neoliberals want to admit it or not. Trying to reduce the deficit will only increase it, as unemployment grows and its inherent costs demolish the economy. Contrarily, increasing the deficit will strongly reduce unemployment and, correspondingly, the deficit itself over the long run as the economy grows out of its current rut. When we achieve full employment and maximum GDP, we can start to consider running surpluses and reducing deficits, but we’re light years away from that wonderful problem right now. It’s time for the politicians to use the monetary system to promote the overall good of the citizenry and stop holding the citizenry hostage to the neoliberal myths concerning that monetary system. We need to once again promote full employment and real growth over fiscal restraint and profligate financial speculation. The market is only free when it promotes growth for all, not just the privileged.