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Introduction

Clausing, Kimberly. Open : The Progressive Case for Free Trade, Immigration, and Global Capital, Harvard University Press, 2019. ProQuest Ebook Central, http://ebookcentral.proquest.com/lib/georgetown/detail.action?docID=5640333. Created from georgetown on 2020-12-14 09:11:36.

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One

Making the Global Economy Work for Every one

In January 2017, Donald J. Trump was sworn in as president of the United States. His election reflected a tide of populist dissatisfaction with economic stagnation, and the perceived threats of globalization and immigration, although of course there were other factors at work in his victory.

In his inaugural address, Trump acknowledged popu lar discontent with globalization explic itly and repeatedly. One excerpt:

From this day forward, it’s going to be only Amer i ca first. Amer i ca first. Every decision on trade, on taxes, on immigration, on foreign affairs will be made to benefit American workers and American families. We must protect our borders from the ravages of other countries making our products, stealing our compa- nies and destroying our jobs. Protection will lead to great prosperity and strength.

Despite his harsh rhe toric, Trump’s diagnosis and policy so- lutions are attractive to many Americans, including some on the left. And these nationalist sentiments are not a uniquely American phenomenon; backlashes against globalization have intensified in many other countries, from both the right and left ends of the po liti cal spectrum.

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This book defends global economic integration, arguing from a perspective that consistently prioritizes the needs of American workers. The substantial challenges of middle- class economic stagnation and increasing income in equality require bold, serious policy responses. But they don’t require a retreat from globalization.

The plight of the American worker is very real. For de cades, economic in equality has increased, and the vast majority of income growth in our economy has ended up in very few hands. Median wages have grown very slowly and, for the first time in generations, American children can no longer reasonably expect standards of living higher than those of their parents.1

At the same time, the importance of capital and corporate profits in the economy has surged; since 2000, corporate profits are 50 percent higher as a share of national income than they were in previous de cades, and the share of national income ac- cruing to workers as wages has fallen steadily.2

These changes have been systematic, they have happened over de cades, and they are large. Indeed, these are the most pressing economic prob lems of modern- day Amer i ca. How- ever, knee- jerk solutions to these prob lems risk making matters worse, harming the very people they claim to help, hurting the future potential of the economy, and weakening our in- ternational relations and our capacity to respond to policy challenges.

Blaming foreigners ( whether trading partners or immigrants) implies quick and easy solutions to our economic prob lems. With more restrictive immigration laws, tighter borders, tariff barriers, tough negotiating with our trading partners, and tough talks with our own companies, we are promised a return to the halcyon days of yore: a time when the American dream

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Making the Global Economy Work for Every one

was alive and well, economic growth benefited all, and children grew up to earn more than their parents.

As po liti cally palatable as these quick- and- easy solutions may be, they are dangerous and wrongheaded, more likely to hurt the very people who voted for them than to return us all to easier times. For example, tariffs on foreign products will make the foreign goods we buy at the store more expensive, harming our purchasing power as consumers. While tariffs ad- vantage domestic companies over foreign ones, any resources that move into producing goods that would other wise have been imported have to come from somewhere. Other sectors of the economy will contract. This will subject the labor market to more “shocks,” as industries that produce the formerly im- ported goods expand, while other industries contract.

While there will be more demand for labor at companies that make the goods that were previously imported, tariffs will not remove the incentive to innovate and mechanize to make production more efficient. Indeed, technological pro gress is a larger threat to American workers than foreign trade is. Al- most every study comparing the two forces argues that tech- nological change has had the more dominant influence on US labor markets.

So should we instead rally against our computers? Perhaps so. If we simply discarded our computers, dumping them into the harbor like so much imperial tea, that would generate a great deal of demand for labor throughout the US economy. We would need labor to do all those things computers used to do more efficiently: computations, filing, data entry, and consumer interactions of all sorts, from booking travel to selling clothes to trading financial assets. Of course, giving up computers would put us at a tremendous disadvantage

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Introduction

relative to workers and consumers in other countries who had access to these technologies. Forsaking technology would also generate huge shocks to the economy, as those industries that relied on computers for their production pro cesses would be harmed, and those workers who used computers to be more productive would see their productivity decline. Further, people really enjoy all the modern con ve niences that computers provide; they would not easily give up their smartphones, movie streaming, computer games, and online shopping—or even their less frivolous work efficiency.

Yet turning to trade protectionism, and reducing immigra- tion, generates shocks that are quite analogous to the shocks associated with giving up technological pro gress. Thirty per- cent tariffs would make almost every item at Gap or Walmart 30 percent more expensive. Steel tariffs harm workers in indus- tries using steel as an input, such as construction. Retaliation from trading partners hurts workers making US exports. Re- strictive immigration policies harm the technological leads of our companies, and fewer immigrants mean fewer entrepre- neurs in Silicon Valley and beyond. Withdrawing from trade agreements and negotiating “tougher” terms with our partners gives us fewer friends and weaker allies, making battles against terrorism and climate change more difficult.3 Reducing the mutual economic interests that link China and the United States makes it more likely that small disagreements transform into broader conflict.

In short, blaming foreigners is easy, but acting on that blame with policies is dangerous and shortsighted. There are a lot of truly wonderful things about international trade, international capital mobility, international business, and international mi- gration that we risk when we threaten globalization. There is

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Making the Global Economy Work for Every one

a good reason why almost every economist on the planet values international economic integration. The case for global mar- kets is strong indeed.

Yet economists peddling international integration have not always explained clearly and persuasively what is at stake. Equally impor tant, they have not spent enough time reckoning with those harmed by the forces of globalization. While plenty of economists study the economic in equality, job loss, and dis- ruption that are caused by the forces of globalization and technical change, they often shy away from the difficult ques- tions of how to address these prob lems in a po liti cally feasible way. It is a quite common affliction of the economist to smugly pronounce what an optimal policy would look like, acknowl- edge that such a policy may prove po liti cally contentious or im- possible, and then pass off the resulting prob lem as one of “politics,” a field too dirty for clean hands.

Something more is required today. It is not enough to simply show that free international trade and unfettered technolog- ical pro gress are optimal for society. It is not enough to explain that these forces create enough gains for society so that “win- ners” can compensate “losers,” and then walk away, dusting off one’s hands, job done. We need to engage with the “art of the pos si ble.” At times, settling for rough justice and second- best (or third- best) policies is better than insisting on the ideal out- come as seen from thirty thousand feet, disengaged from the po liti cal mess on the ground.

For the arguments for trade, immigration, and technolog- ical pro gress to be persuasive, the losers from these policies must be reckoned with. The winners actually need to compen- sate the losers. Economic growth has to be broad enough to benefit all, or at least the vast majority of, Americans. Along

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Introduction

these lines, there are many easily identified policies that would help American workers, such as a more progressive tax system, more society- wide investments in education and infrastruc- ture, and a more robust safety net to catch workers who are left behind.

Yet, while we have made some incremental pro gress here and there, policy- makers have too often been more interested in conflict than compromise. At pres ent, there is a large po- liti cal prob lem. The very po liti cal polarization that has resulted from economic in equality has made it much harder to come up with an effective policy response to the in equality.4

Solving this prob lem is not easy, but it begins with a battle of ideas. This book argues that economic in equality is indeed the dominant economic prob lem of our time, but that the policy solutions to this prob lem should involve both an em- brace of globalization, trade agreements, immigration, and international business, and a much more thorough policy framework to make sure that the benefits from these economic forces accrue to all Americans. The opposite approach—of erecting walls and trade barriers while dismantling safety nets (by, for example, making health insurance more expensive for the poor) and providing tax cuts for those at the top of the in- come distribution—is dangerous and misguided. It will leave the United States a poorer nation with fewer friends, and it will hurt the very workers it claims to help.

The Road Ahead

The remainder of this introduction takes you through the main arguments of the book ahead, or ga nized by chapter.

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Making the Global Economy Work for Every one

Chapter 2 documents the large, vexing prob lems of middle- class wage stagnation and rising income in equality. While the period from 1946 to 1980 generated broadly shared economic prosperity, the period since 1980 is another story. Incomes at the top of the income distribution have surged, whereas the in- comes of the bottom half of the population have been entirely stagnant. These trends have left a large part of the population disappointed. House holds are indebted, economic insecurity is widespread, and discontent is expressed through votes for po liti cally polarized candidates. Chapter 2 explores the causes of these trends. Foremost is technological change, which has transformed our lives in the years since 1980. Trade and global competition have also contributed to making work- places more competitive, hurting some workers. But other factors also play crucial roles, including the phenomenon of “superstars” driving huge pay packages at the top, the rise in business profits resulting from market power and innovation, changes in social norms and bargaining power across groups, and large changes in tax policy.

Chapters 3 to 5 consider international trade. Chapter 3 makes the case for international trade, beginning with intui- tive arguments. Just as it is nearly impossible for individuals to produce all the things they wish to consume, it would be foolish for one country to make every thing its people desire. The United States could produce its own T- shirts, shoes, and bananas, and we could also forsake foreign va ri e ties of cars, appliances, and wine, but these choices would come at a large cost. The resources we devoted to making goods previously im- ported would have to be pulled from other parts of the economy, shrinking those sectors. Making every thing our- selves would mean fewer economies of scale and fewer choices

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Introduction

for consumers. In the end, the country would be far poorer without the benefits of international trade.

In fact, the international community punishes wayward countries by withholding trade; economic sanctions are used as weapons precisely because they impose great costs by re- moving the gains from trade. Chapter 3 explains that interna- tional trade has been a power ful force for good in the world economy, raising living standards both at home and abroad. This chapter also explains how high- wage countries like the United States, Denmark, and Japan still manage to “compete” in the world economy with countries like India, China, and Mexico, where workers are paid less.

Chapter 4 tackles the impor tant distributional consequences of trade, showing that international trade generates both win- ners and losers. Without strong accompanying policies, we have no way to be sure that large segments of society are not harmed by trade. In the United States, international trade is more likely to reward cap i tal ists and high- income, high- skill workers, while reducing wages and opportunities for low- income, low- skill workers. Chapter 4 also tackles other sources of workers’ woes, and most importantly, the effects of rapid technological change, including automation and the rapid spread of computers and the Internet. These technolog- ical forces have been more impor tant than international trade in terms of harmful effects on low- and middle- income workers. Mechanization and computerization have replaced labor in many jobs, and the same technological changes have created outsized profits for those at the top of society. Beyond these two big trends, mono poly profits and luck also play impor tant roles in generating the large pay packages of those at the top. It was recently reported that eight people have a

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Making the Global Economy Work for Every one

combined wealth that is similar to that of the bottom half of the world’s people.5 This type of wealth is typically the result of luck and market power. And this concentration of income has impor tant effects on social norms, the bargaining posi- tion of workers, and the concentration of po liti cal power.

Chapter 5 considers both trade politics and trade policies. People have two big economic roles in their lives: every one is both a producer and a consumer. Trade can make life un- comfortable for us in our producer roles, by heightening com- petition. (If a professor in India or Sweden teaches a better economics course online, will there be no more demand for my ser vices?) But in our consumer roles, our lives are made more comfortable by trade. Low prices, broad availability, and a staggering variety of goods all benefit consumers, and these benefits are particularly large for lower- and middle- income house holds.

How can the United States keep the benefits of trade while reducing the collateral damage? Ending trade agreements is not the answer. Rather, new and better trade agreements will help solve these prob lems. International agreements help coun- tries coordinate, avoiding harmful policy competition. Other impor tant steps we can take on our own. The best way to help workers is to focus on workers. Investments in education, training, and infrastructure will increase the productivity and wages of American workers. Changes in the tax system will help economic growth translate into increased well- being for most Americans. Wage insurance can help workers who have lost high- paying jobs.

Chapters 6 to 8 discuss the international mobility of capital and labor. Chapter 6 considers international capital markets. Consider the United States and China. The Chinese save a

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Introduction

lot— more than they invest in plant and equipment. In com- parison, US savings are low, and our desired investments exceed our savings. Therefore, the United States (as a whole) bor- rows from China; this borrowing is the flip side of our trade deficit with China. We receive more goods from China than we send to China, and China accumulates US assets (like US government bonds) in response, effectively loaning us money. This benefits both countries. US companies (and the govern- ment) can borrow at lower interest rates, and US consumers receive more goods to consume. Chinese savers get safe re- turns on their assets, and China benefits from export- driven growth.

Politicians and journalists too often treat these imbalances as a marker in some strug gle for global supremacy, the score of a zero- sum game. The US trade deficit is not a moral failure that places us at a disadvantage on the global chess board. Trade balances have little to do with the competitiveness of a country’s companies or workers. At current levels, reducing the trade deficit should not be a policy priority.

Chapter 7 discusses international business. Multinational corporations are becoming larger and more impor tant. Among publicly- traded companies, those with more than a billion dol- lars of annual sales are responsible for the vast majority of revenues and stock market value. International business comes with impor tant benefits, but it also raises essential concerns. Workers have far less bargaining power than companies do, and this imbalance is heightened by the mobility of multinational companies. National governments fear that tax or regulatory policies might discourage economic activity at home. When governments attempt to tax the profits of mobile multinational companies, teams of corporate lawyers and accountants swiftly

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Making the Global Economy Work for Every one

move the profits to tax havens. Indeed, tax avoidance now costs non- haven countries over $300 billion in tax revenues each year!

This does not mean that governments are powerless. Chapter 7 explains how economic policy should be modern- ized to suit the global economy. Countries may benefit from strengthening international cooperation. Even without inter- national agreements, however, there are many policy options for the United States. We can protect our corporate tax base through simple, commonsense mea sures, while focusing on building the fundamental strengths of the US economy.

Chapter 8 describes how immigrants are a source of tre- mendous strength for the US economy. Immigrants are often innovators and entrepreneurs; they are more likely to found businesses and to win Nobel prizes. Both high- skilled and low- skilled immigrants provide the economy with abilities that complement those of native workers. Immigrants boost eco- nomic growth and reduce the demographic pressures of an aging population. In turn, immigrants receive tremendous economic benefits from moving to the United States.

With so many advantages, what accounts for the backlash against immigrants? Backlash stems from cultural concerns and economic fears among middle- class workers. Yet, evidence shows that immigrants do not generate large negative wage ef- fects for workers; on the contrary, most workers benefit from immigrants. Even when small groups of workers are hurt, the large gains from immigration are sufficient to offset those harms. With these lessons in mind, Chapter 8 suggests immi- gration policy reforms.

Chapters 9 to 11 provide a roadmap to keep the gains from the global economy that are described in Chapters 3 to 8, while

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Introduction

responding in a serious, bold way to the prob lems described in Chapter 2. Foremost, we should not shoot ourselves in the foot with counterproductive policies. Beyond that, there are smart, substantial ways to combat middle- class stagnation and income in equality. Policy ideas fit into three big areas.

Chapter 9 describes better policies to equip workers for a global economy: modern trade agreements, better tools to help workers, improved support for communities, and strong in- vestments in fundamentals.

Chapter 10 describes the benefits of a grand bargain on tax reform: greater after- tax incomes for those left behind in prior de cades; a simpler tax system to reduce distortions, avoidance, and complexity; and lower tax rates and a cleaner planet due to reliance on a carbon tax. These reforms satisfy goals of both those on the left (who want a more progressive tax system and a cleaner environment) and those on the right (who want lower tax rates and fewer distortions).

Chapter 11 describes a better partnership between society and the business community. The goals of the business com- munity can be met, but a good partnership also requires more tax payments from some businesses, more business transpar- ency on both tax and labor issues, and robust antitrust laws to counter undue market power.

Fi nally, we must counter po liti cal polarization to respond to these big challenges. In Chapter 12, I conclude with some guiding princi ples and constructive solutions.

We are at an impor tant moment in our national history; crucial decisions lie ahead. Do we rise to meet the challenges of the world economy, modernizing our policies so that all Americans benefit from a more equitable globalization? Or do we turn inward, attempting to shelter workers from one aspect

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of a storm that comes from many directions? Do we work with friends and allies to make more stable international institu- tions and a more prosperous world? Or do we alienate our friends by shortsightedly (and erroneously) putting Amer i ca first, and thereby making future conflicts and prob lems more difficult to solve? These questions are essential to our future. Let’s get the answers right.

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Two

Middle- Class Stagnation and Economic In equality

In recent de cades, middle- class incomes have stagnated, fuel- ing economic insecurity. Economic growth did not benefit American house holds as long expected; although growth con- tinued, in equality surged, and prosperity failed to reach the middle class. These trends began around 1980 and they continue today. This chapter takes a close look at this serious prob lem. What is happening to the American middle class? And what has caused these discouraging trends?

Does a Rising Tide Lift All Boats?

Economic growth is supposed to benefit every one. If national income (GDP, for gross domestic product) grows year after year, beyond the growth in population, we expect that economic growth should raise living standards of typical workers. Yet, when we compare growth in GDP per person to growth in me- dian house hold income, we see that something is clearly amiss.

In the past thirty years, GDP per capita has increased by about $20,000, an increase of over 60 percent. But the typical house hold has seen its income grow by only 16 percent in the same time period (fig. 2.1).

These figures explain why typical American house holds are not content with the pace of economic pro gress. The standard

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Middle- Class Stagnation and Economic In equality

expectation that every generation would be better off than the one before it has been disappointed. Nearly 90 percent of children born in the 1940s outearned their parents, but that share has fallen steadily. For children born in 1970, only 60 percent out- earn their parents. For those born in the 1980s, only half do.1

How does so much GDP growth occur without benefiting the typical worker? In short, the growth has been accompa- nied by increasing in equality. This was not always the case. Pretax income growth over the period 1946 to 1980 exceeded 100 percent for the bottom 90 percent of the population, and the percentage growth in incomes was actually lower for the richest members of the population.

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Notes: Both series are indexed so that 1984 = 100. The median shows the typical house hold in the middle of the economy’s distribution of income. Unlike averages, medians are not affected by large incomes at the top of the distribution. Data source: Federal Reserve Economic Data.

Figure 2.1: Growth in US Median House hold Incomes Lags Behind GDP Per Capita

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That pattern has since reversed. Between 1980 and 2014, the income growth of the bottom 50 percent of the population is literally invisible in the chart, at 1 percent. Growth in incomes for the middle 40 percent is 42 percent, and it accelerates from there, with the growth of the top 1 percent exceeding 200 percent.

As a result, there has been an increasing concentration of national income at the top of the income distribution. The top 1 percent now command a fifth of national income, 50 percent more income than is earned by the bottom half of the income distribution. The bottom 90 percent share has shrunk from 68 percent of all income in 1980 to only half of all income in 2015. These trends are a dramatic reversal from the experience of the post– World War II years, when income in equality fell between 1946 and 1970, and was relatively unchanged in the 1970s.

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Data source: Thomas Piketty, Emmanuel Saez, and Gabriel Zucman, “Distributional National Ac- counts: Methods and Estimates for the United States.” Working Paper 22945. NBER Working Pa- pers. National Bureau of Economic Research, 2016.

Figure 2.2: Before 1980, Growth Lifted All Boats. Since Then, Not So Much.

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Data source: World Top Incomes Database. Accessed March 14, 2017.

Figure 2.3: The Top 1 Percent and Bottom 50 Percent Trade Places

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Data source: World Top Incomes Database. Accessed March 14, 2017.

Figure 2.4: In 2015, the Bottom 90 Percent Earn What the Top 10 Percent Earn

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Labor and Capital in the Global Economy

Middle- class income stagnation, economic insecurity, and pat- terns of increasing economic in equality have been accompa- nied by ongoing changes in the role of labor in the economy.2 Workers are getting a smaller share of the pie than they did in prior de cades. For a long time in the United States, workers’ share of national income held steady at roughly two- thirds.3 But in recent de cades, both in the United States and elsewhere, the labor share of income has been falling. Since employment in good jobs is the key engine for raising middle- class standards of living, the falling share of labor is of enormous concern.

If capital income (the income people receive from their in- vestments, such as interest, dividends, and capital gains) were distributed across house holds in the same way that labor in- come is, there might be less concern, since declining work op- portunities might be offset by increased income in the form of interest or dividends. Capital income, however, is far more concentrated at the upper end of the income distribution than labor income. For example, the top 5 percent of taxpayers re- port 37 percent of all income (both labor and capital) in 2012, but 68 percent of dividend income and 87 percent of long- term capital gains.4 Thus, the reduced role of labor has made an impor tant contribution to income in equality.

The declining labor share of income has been confirmed by many studies. Economists focusing on the corporate sector have found that the US labor share declined by 8 percentage points over the period 1980–2012, from 65 percent to 57 percent, and other sources suggest similar declines.5 Labor shares have also declined in other large economies, although the steepness of the decline varies.6 7

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Notes: Figures show the change in the labor share of income. These data were also depicted in ILO and OECD, “The Labour Share in G20 Economies” Report, International Labour Organ ization and Organisation for Economic Co- operation and Development, 2015. Figures refer to the change from 1970 to 2014 for advanced economies and from 1995 to 2012 for emerging economies. Exceptions are the Republic of Korea 1991–2014; Saudi Arabia 2002–09; Turkey and Mexico 1995–2014; South Africa 1995–2013; and Brazil 1995–2009. Note that prior to 1991, “Germany” refers to West Germany. Data source: International Labour Organ ization.

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Panel A: Advanced Economies

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The labor share of income and income in equality are not the same thing, since income in equality can also arise from an in- creased dispersion of labor incomes, if workers at the top ex- perience higher wage increases than workers at the bottom.8

Notably, income in equality has also increased in many (but not all) other countries, despite a wide variety of economic policies and circumstances. Still, income in equality has in- creased more rapidly in the United States than in most other countries (fig. 2.6).

Are Things Really So Bad?

The data reported above come from work that uses the broadest definition of income, including capital income from invest- ments.9 Using other sources of data would somewhat moderate the increase in income in equality, though all sources of data agree that income in equality in the United States has increased substantially in recent de cades.

In equality need not be associated with wage stagnation, but it is particularly troubling when it is.10 Some argue that the wage stagnation of the US middle class is not mea sured accu- rately, since there have been huge gains in standards of living due to new products. The numbers shown here are adjusted for inflation, and since inflation does a poor job of mea sur ing the benefits of new goods and ser vices, it is pos si ble that living standards have increased more than these data indicate.11 As an example, thirty years ago, there was no Internet and we spoke on dumb phones that were tethered to the wall, whereas today a wealth of information and entertainment awaits anyone with Internet access, and most people use smart phones that

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are more power ful than advanced computers were thirty years ago. Do the inflation numbers accurately account for gains in consumer happiness from these inventions?

There are also larger philosophical questions. Do people care only about their absolute living standards, or are there other impor tant economic desires? Is meaningful work itself a source of happiness? Do people determine their well- being by comparisons to broader society, and if so, how large is their circle of comparison? Are they considering the neighborhood, the city or state, the country, or the world?

Regardless of the answers to these larger questions, a few basic facts stand out. First, the United States has recently ex-

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Figure 2.6: In Many Countries, the Share of the Top 10 Percent Rises

Data source: World Top Incomes Database. Accessed March 14, 2017.

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perienced several de cades of large increases in income in- equality. Second, middle- class incomes have not grown as rapidly as GDP. Third, recent generations have not realized the same degree of economic pro gress that past generations experienced.

Fi nally, economic discontent and insecurity are a prevalent and recurrent theme in our po liti cal discourse, so it is not un- reasonable to think this discontent is rooted in real ity. For ex- ample, in a recent Pew survey, 57 percent of Americans said they were not financially prepared for unexpected events, and a third of Americans had no savings. A majority of Americans spend as much as, and often more than, they earn each month.12 Economic insecurity is more than just in equality. When growth in house hold incomes does not keep pace with expec- tations, the economic status of many house holds becomes less secure.

One general marker of financial strain on house holds is rising house hold debt (fig. 2.7). While some categories of debt have not increased, the overall trend of increasing house hold debt is particularly notable given the very low interest rates since 2009.

Why Are These Trends Impor tant?

In addition to the clear economic consequences for the middle class, these troubling trends have grave consequences for society. Stagnant incomes are harmful during recessions, since income gains that are concentrated at the top are less likely to fuel consumption and, in turn, greater production of goods

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and ser vices. Increased in equality amidst wage stagnation also creates social tension and dissatisfaction. When workers’ wages fall short of expectations, people often express their discontent by turning to populist solutions.13

The rise of populists like Bernie Sanders and Donald Trump speaks to the depth of public dissatisfaction. Po liti cal polar- ization extends beyond the 2016 election in both time and space. The US Congress is nearly synonymous with dysfunc- tion, in large part due to ever- increasing polarization. In Eu rope, both far- left and far- right parties are ascendant.14 The shrinking importance of moderate po liti cal groups likely generates several costs: more policy variability, more policy uncertainty, more difficulty enacting policy, and more extreme policies.

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Figure 2.7: Debt in US House holds is Still Rising Steadily

Notes: This is total house hold debt per capita in US dollars. Student loan debt was not included until 2003. Data sources: New York Federal Reserve Bank and World Bank.

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Concentration of incomes also creates disproportionate po- liti cal power for those who are affluent. Those at the top of the income distribution can afford to hire lobbyists to influence the policy pro cess as well as lawyers and accountants to work around existing policies.15 Affluence also brings greater access to policy- makers, since the wealthy are more likely to frequent the same elite institutions and social circles.

There are also impor tant implications for the tax system. Since recent gains in national income have accrued to those at the top of the income distribution, a progressive tax system be- comes more impor tant. Meanwhile, when the share of labor income shrinks, the tax base also falls— since most of the fed- eral tax burden falls on labor income via income and payroll taxes— and this makes capital taxation more impor tant. These policy implications are fully addressed in the final section of the book.

Why Has This Happened?

Six major factors have contributed to these troubling trends, each of which is discussed below. While this list is not exhaus- tive, it captures the crucial mechanisms at work. There are clear causal forces behind each of these six factors, and there are also impor tant interdependencies among them.

Technological Change

The technology of today bears little resemblance to that of 1980. In 1980, there were a few computers, but they were the size of a desk and about as user- friendly as a block of wood.

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The Sears cata log still arrived in most American homes, and if you wanted to place an order, you dialed a large, landline phone. Your orders arrived slowly. Gasoline was paid for by interacting with people, most people waited in line at banks instead of using the relatively new and scarce ATMs, and secre- taries did the vast majority of professional typing and phone answering. Long- distance phone calls were very costly; inter- national phone calls were still more costly, and rare. Manufac- turing pro cesses were mechanized, but rarely computerized.

Since 1980, a computing and Internet revolution has occurred, and this has changed every facet of American life. Computers are everywhere: in our phones, in our gas pumps, on our desktops, at the grocery store, in our cars, and embedded in most aspects of our manufacturing pro cesses. Professionals do their own typing, and voicemail takes what phone mes- sages remain, though most have been replaced by email and texts. The Internet has changed the way we shop, the way we gather information, the amount of information we have access to, and the ease and speed of communicating both within countries and across borders.

These changes have been pervasive, and they have had pro- found effects on workers and their incomes. The effects have been mixed, given that technology acts as a competitor for some workers, reducing demand for their labor, while it serves as an assistant to other workers, increasing their productivity. Secretaries, gas station attendants, bank tellers, and manufac- turing workers all experience less demand for their work, as much of their work can be done by computers. Meanwhile, in- vestment bankers, software developers, engineers, scientists, and man ag ers all use computers to become more productive.

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Technological change helps explain the diminished role of labor in the economy. The price of investment goods for firms (like computers, machinery, and so forth) has been falling even as the capabilities of these machines improve. This has caused an increased demand for machinery relative to workers.

These technological shifts in the role of labor also help ex- plain the increasing income in equality of the past few de cades. There is a strong pattern of increasing rewards to education in the data. Earnings are rising only for those with a lot of education— workers whom technological change makes more productive rather than redundant (figs. 2.8 and 2.9).

For American workers to benefit from technological change, their skill set must keep pace with changes in the economy. Unfortunately, pro gress in US educational attainment has fallen short of pro gress in technological innovation. In earlier de cades, US educational attainment increased steadily, at a rate of 0.8 years of education per de cade between 1890 and 1970. While less than 10 percent of Americans graduated from high school in 1890, by 1970 that portion had risen to 80 percent.16 Since then, American educational attainment has increased more slowly; the most recent statistics show high school grad- uation rates only slightly above their 1970 levels, at 83 percent in 2015. (That was after five consecutive record- setting years; the rate a few years earlier was unchanged from its 1970 level.)17

US students lag behind those in other countries in terms of both high school graduation rates (ranking twelfth among a group of rich countries) and college graduation rates (ranking eleventh).18 In the 2015 international PISA tests, US students were ranked thirty- seventh in math, twenty- fifth in science, and twenty- third in reading.19 This inability of US educational attainment to keep pace with technological pro gress has likely

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Figure 2.8: Earnings Rise with Education (Men)

Source: David Autor, “Skills, Education, and the Rise of Earnings In equality among the ‘Other’ 99 Percent,” Science 344:6186 (2014): 843–851. Reprinted with permission from the American As- sociation for the Advancement of Science.

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been a large contributing factor in the woes of middle- class workers. For a subset of workers, technological change makes them more productive. But for another subset of workers, tech- nological change is a threat, as machinery and robots displace the demand for workers. This prob lem will be further de- scribed in Chapter 4.

Trade and Global Competition

In recent de cades, there have been large increases in global trade and investment flows. Po liti cal decisions made by foreign countries were the key driving force in these trends. Countries that had been more closed to international trade joined the world trading system, increasing trade flows. The number of World Trade Organ ization (WTO) members, for example, increased dramatically. (The WTO is an organ ization that facilitates international trade treaties, working to liberalize trade.) Membership expanded from 18 members at inception, to 84 members in 1980, to 164 members today (fig. 2.10).20

Also helping to fuel increasing trade have been falling communication and transportation costs. The greater access to information afforded by computerization and the Internet makes it far easier to do business across borders. Technolog- ical changes have also enabled global production pro cesses, by solving the complicated logistical puzzles of global supply chains. Fi nally, economic growth abroad has also increased in- ternational trade flows, which tend to increase with the size of the economy.

For the United States and more broadly the world, the im- portance of trade in the overall economy has grown by about 50 percent relative to its level in 1980. Both then and now, the rest of the world is about twice as globalized as the United

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States (fig. 2.11). Foreign countries rely on international trade to a greater extent due to their smaller domestic economies.21

International investment flows have also increased, both in terms of portfolio investments ( people and institutions pur- chasing foreign stocks, bonds, and other assets) and foreign direct investments (companies purchasing other companies or undertaking new investments abroad). Here, the United States is as globalized as the world as a whole.

Of course, foreign investment goes in both directions, and the United States receives amounts of inward foreign direct investment (by foreign companies investing here) similar to what it sends in outward foreign direct investment (when US firms invest abroad). Both types of foreign direct investment are increasing over time (fig. 2.12).

In general, these flows of foreign direct investment under- state the role of multinational firms in the world economy, since they capture only changes in investments from year to year, not the size or importance of global firms. By most indi- cators (sales, profits, assets, or market capitalization), multi- national firms have become steadily more impor tant in recent de cades.22

Net migration flows have been steadier for the United States. That said, the share of the population that is foreign- born has been climbing in recent de cades, and now stands only a bit lower than it was during a previous peak era of immigra- tion, around the beginning of the twentieth century (fig. 2.13).

International trade, international capital mobility, and in- ternational migration are all chief suspects in the search for a culprit to blame for poor US labor market outcomes. For ex- ample, since trade with developing countries has increased

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AsShareof GDP

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particularly rapidly, and these countries have large, low- wage labor forces, this may increase competition facing US workers, lowering wages. Competition from low- wage countries may also encourage US firms to innovate in order to economize on labor, accelerating the adoption of technology that replaces labor with machinery.

Both foreign direct investment and immigration could also bear some responsibility for the woes of US workers. If immi- grants are more likely to compete with workers at the bottom of the income distribution, that could reduce wage growth for those workers, exacerbating income in equality (though there are also many ways in which immigration helps workers, as discussed in Chapter 8). The international business operations of global corporations likely reduce the bargaining power of labor and labor unions, as companies may use the threat of

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Data source: Migration Policy Institute.

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moving abroad to restrain wage growth at home. And if some types of operations are systematically moved abroad, that re- duces demand for those types of workers at home.

Still, puzzles remain. First, in poorer countries, income in- equality is also increasing alongside reductions in the labor share of income.23 That is counter to expectation, since inte- gration with the world economy should be increasing demand for workers in poorer countries. It could be that technolog- ical change is the dominant force throughout the world, in- creasing demand for machinery and higher-skilled workers relative to less- skilled labor. Indeed, computers, the Internet, and broader technological change have affected the entire world economy.24

Another puzzle concerns how much income has been con- centrated at the very top of the income distribution, among the top 5 percent, the top 1 percent, and even the top tenth of 1 percent. Neither trade nor technological change does a good job explaining the huge gains in income at the very top of society. Trade should increase demand for the products of our export industries, while reducing demand for import- competing industries; while such demand shifts should move income across broad groups of people, they should not con- centrate it at the very top. Similarly, technological change should harm those whose labor is replaced by technology, while helping those whose productivity is boosted by technology. Again, as these changes affect broad groups of people, there is no reason to think the gains should be concentrated at the very top of society. The next four items do a better job explaining what is happening at the top end of the income distribution.

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The Role of Superstars

The superstars at the top of the income distribution reap outsized rewards. Top investment bankers, information technology entrepreneurs, corporate CEOs, hedge fund man- ag ers, and corporate lawyers occupy plum spots in the top 1 percent, as do house hold names in entertainment and sports like Beyoncé and LeBron James. These labor markets have characteristics of “superstar” or “winner- take- all” compensa- tion patterns; those at the top receive salaries that are many multiples of those a bit lower in the distribution.

As an example, consider Amer i ca’s favorite pastime, base- ball. In 1970, the average major league baseball player earned $184,000 in 2017 dollars. Now, the typical major league base- ball player earns over twenty times as much, $4.5 million dol- lars. Salaries have climbed especially steeply since the 1980s (fig. 2.14).

Yet, while being in the major league pays well, being slightly less talented pays terribly. Minor league baseball players typi- cally earn $1,200– $3,000 per month for a five- month season, with no pay for spring training. If they only played baseball for a living, they would live under the federal poverty line!

Similar trends hold in music, with greater shares of reve- nues captured by the most popu lar artists. The top 1 percent of artists took in 26 percent of all concert revenue in 1982, and by 2003 commanded 56 percent.25

Both globalization and technical change buttress the super- star effect, turbocharging the relative earnings of the stars. The combination of larger world markets and the ease of digitizing and distributing information creates big paychecks for the most productive (or lucky) talents in society. The best entertainers and athletes earn premium returns, since their

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talents are now accessible to their fans throughout the world, who can watch videos and sporting events remotely. This in- creases the size of the entertainment sector.

Slightly lesser talents (or less lucky ones) often earn far less, however, than those at the top. Less renowned singers and ball- players (and businesspeople) face increased competition from other talented people across the world. They also face the increased costs associated with paying the superstars. The princely pay packages of superstars squeeze pay for the less tal- ented. Some superstar returns also accrue to capital, as the investors and producers that control the owner ship of talent are amply rewarded.

Similar mechanisms are at work in terms of entrepreneurial or corporate returns. The makers of the best search engines, phones, and social networking sites can sell their products

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Figure 2.14: Average US Major League Baseball Salary, Twenty- Three Times Higher in 2017 than in 1970

Data sources: US Bureau of Labor Statistics; Paul D. Staudohar, “Baseball’s Changing Salary Struc- ture,” Compensation and Working Conditions, Fall 1997; http:// hosted . ap . org / specials / inter actives / _ sports / baseball08 / documents / bbo _ average _ salary2009 . pdf.

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all over the world, benefiting from the scale allowed by the world economy. The best hedge fund man ag ers command ever larger pots of investment capital, and earning “2 plus 20” be- comes an enormous sum. (Hedge fund man ag ers often charge 2 percent of asset value as a management fee and also receive 20 percent of earned profits.)

Since someone must pay for these outsized rewards, that leaves less national income for the less successful versions of these entertainers, athletes, man ag ers, or entrepreneurs. Being a 90th percentile talent in these fields can pay orders of mag- nitude less than being a top talent. And increased competition means that very few become superstars.

The Rise of Profits

A closely related issue has to do with the excess (above normal) profits that arise from entrepreneurial and corporate success. The world economy provides large rewards to the most suc- cessful and innovative entrepreneurs and businesses; these profits play an impor tant role in labor market trends.

It is tempting to label these profits as the just desserts of in- genuity and innovation, or the economic “carrot” that offers incentives for risk-taking. To be sure, the creators of Apple Computer, Microsoft, Google, and Facebook have changed the way we use computers and the Internet, benefiting billions of people. Yet for every Bill Gates and Mark Zuckerberg, there are tens of thousands of technology talents that have con- tributed to this industry, and despite very similar levels of in- genuity and hard work, have not become even a thousandth as rich.

Alongside entrepreneurial profits, there is substantial evi- dence of increased market power for many large corporations.

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In parallel with declining labor shares of income, there have been large and pervasive increases in corporate profits and re- tained earnings of corporations.26 In the United States, cor- porate profits since 2000 are about 50 percent higher as a share of GDP than they were in the previous twenty years, and corporations are responsible for more and more of the total savings of our society.27

As compared to 1980, corporate savings have come to con- stitute a much larger share of total savings. Globally, since that year, corporations’ share of total savings has increased by about thirty percentage points (fig. 2.15).28 This staggering increase is mirrored by a declining share of global savings in the hands of house holds. Why are corporations doing more of the saving? Simply put, they are earning more of national income, as the capital share of income is rising relative to the labor share of in- come in most countries.

These trends are related to the troubling issue of secular stagnation: rising corporate profits and changes in the distri- bution of income have increased savings, but investment op- portunities are declining— which reduces economic growth. In the meantime, corporations are awash in cash.29

While we expect all businesses to earn some “normal” level of profit to justify their efforts, excess profits (above the normal rate) are now the norm in the US corporate sector. In the United States, the share of corporate earnings that represent excess profits is over 75 percent.30 This is not just an American phenomenon. Worldwide, the corporate sector is getting more concentrated, and large companies are dominating in terms of profits, sales, and scale. The top 10 percent of the world’s public companies earn 80 percent of the profits, and companies with

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more than $1 billion in revenues account for the vast majority of all global revenues and market capitalization.31 And because these superstar companies use less labor than typical compa- nies, so as the dominant companies account for more of all economic activity, the labor share of income falls.32

Bargaining, Power, and Norms

At the same time that corporate profits and power have become more impor tant, the role of labor unions has shrunk, and worker bargaining power is steadily weakening. In the United States, the unionization rate has fallen from 31 percent in 1960 to 11 percent today. Focusing particularly on private- sector unionization rates, the fall is even greater; now, only 7 percent of private sector employees are unionized. Abroad, the average unionization rate for workers in peer countries was 35 percent in 1960, and fell to 17 percent by 2014.33 These falls in union- ization have impor tant effects on labor markets; unions have historically played an impor tant role in narrowing income in equality.34

The sources of declining unions are vari ous. Right- to- work laws, which make it more difficult to have effective unions, have spread to twenty- eight US states, up from nineteen US states that had right- to- work laws in 1980.35 The decline of the manufacturing sector plays a role, too, since manufacturing jobs are more often unionized. Meanwhile, the dual threats of global competition and technological innovation do their part to weaken labor bargaining power.

Other factors also affect labor. The real value of the federal minimum wage has hovered near its current level in recent de cades, but it was higher (in inflation- adjusted terms) in the

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1960s and 1970s. Shifts in social norms have reduced the bargaining power of labor relative to management. As one example, American Airlines recently tried to give its workers raises to match pay offered at other airlines, but its stock price was punished as a result.36 Investor pressures make it more dif- ficult for labor to succeed in wage negotiations.

While both globalization and technological change have contributed to the erosion of labor bargaining power, they are clearly not the only factors at work. Industries like trucking have experienced similar pressures, yet they are largely im- mune from foreign competition and from labor- replacing technological innovation (so far). For example, the real wages of truckers and warehousing workers have fallen by a third since the early 1970s; the Bureau of Labor Statistics estimates that drivers were paid 6 percent less, on average, in 2013 than they were in 2003. Plummeting salaries are the product of dra- matic changes in union membership, from a 38 percent rate of driver unionization in 1983 to a 13 percent rate in 2016.

At the same time, the levels of compensation considered ac- ceptable for those at the top have never been higher. CEO pay is now three hundred times that of typical com pany workers, a ratio that has increased tenfold since 1980, when CEOs earned “only” thirty times the salary of typical com pany workers (fig. 2.16). CEO salaries have increased over 900 percent since the late 1970s, while worker wages have risen 10 percent.37 To precisely what degree these salaries reflect productivity is a matter for legitimate arguments, but it is unlikely that CEOs are ten times more productive than they were in 1980 rela- tive to their workers. Likely, social norms, market power, and tax policy all contribute to these large ratios.

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Tax Policy

Tax policy plays a role in driving income in equality, the incomes at the very top of the income distribution, and the de- clining share of income that ends up in the hands of workers. Since 1900, the top 1 percent share of the income distribution has followed a u- shaped pattern in the United States.38 Between 1929 and the 1970s, the top 1 percent share fell steadily. Since the 1980s, it has increased (fig. 2.17).

Tax rates have moved in the opposite direction. Top mar- ginal income tax rates increased in the first half of the twen- tieth century, and they have declined steeply since 1980.

This negative correlation between the share of the top 1 percent and the top marginal tax rates is striking.39 Tax avoidance provides one explanation for this pattern, since top incomes are more likely to be hidden when tax rates are

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Figure 2.16: US CEOs Earn Three Hundred Times Their Workers’ Salaries This Century. Are They Ten Times More Productive Than in 1980?

Note: See Lawrence Mishel and Alyssa Davis, “Top CEOs Make 300 Times More than Typical Workers,” Issue Brief 399, Economic Policy Institute, June 2015. Data sources: Economic Policy In- stitute calculations from Compustat’s ExecuComp database, Current Employment Statistics pro- gram, and the Bureau of Economic Analy sis NIPA tables.

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Introduction

high. But many argue that the bargaining pro cess between workers and their man ag ers is affected by tax rates. If tax rates at the top of the distribution decline, this provides more incentive for those at the top to aggressively increase their compensation.

The era of increasing income in equality has also corre- sponded to lower tax rates on capital income, a source of in- come that is far more concentrated in the hands of high- income house holds. Capital gains tax rates were over 30 percent for most of the 1970s, fell to between 20 percent and 29 percent during the 1980s and the 1990s, and then fell to about 15 percent for most of this century, before increasing to 25 percent in 2013.40 Dividends were taxed as ordinary income until 2003, but have since been taxed at far lower rates, with a top rate of 15 percent before 2013, and a top rate of 20 percent since then.41

Indeed, high tax rates serve as a brake, or speed limit, on earnings by high- income earners. Yet the restraint of higher tax rates was eased dramatically over recent de cades, just as other forces were ramping up the pay packages for those at the top. The global economy and technological change have in- creased demand for capital and the most highly skilled workers and superstars. As top earners are also more aggressive in seeking higher pay, compensation at the top surges, and wages further down stagnate.42

What to Do

Beyond these six impor tant forces, there are likely other factors at work, complicating matters further. Also, among these expla-

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nations, there is no clear way to unpack the precise contribu- tion of each to the prob lems at hand. The six factors are deeply intertwined.

International trade is spurred by changes in communica- tions and technology, while new technologies are adopted in part due to the pressures of international competition. Lower tax rates reward individuals and companies that increase their compensation and profits, and higher profits and incomes at the top of the income distribution beget po liti cal power, which leads to tax and regulatory policies that are more favorable to high- income groups. Superstars earn more due to global mar- kets and the easy distribution of their products— distribution facilitated by technological change. The success of superstars fuels changes in social norms about what level of compensa- tion is “justified” by the marketplace.

Still, diff er ent socie ties mediate these same economic forces in diff er ent ways. While many countries have experienced aspects of the trends described here (increased income in- equality, surges in top 1 percent shares, reduced labor income shares), the United States’ experience of increasing income in- equality, accompanied by middle- income economic stagnation, has been particularly dramatic and sustained. Common eco- nomic forces like trade and technological change create diff er ent consequences in diff er ent places, due to diff er ent institutions, social norms, and economic policies.43

The remainder of this book will argue that global forces (namely, international trade, international capital mobility, international business, and immigration) are not the chief culprits behind the woes of the American middle class— and that, while these global forces certainly contribute to the eco- nomic insecurity facing American workers, clamping down

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Introduction

on globalization would harm American workers more than it would help them.

This is not to imply that the prob lems of American workers are not real. On the contrary, increasing income in equality combined with middle- class wage stagnation is the single largest economic prob lem of our era.44 The response to this challenge needs to be swift and bold.

Chapters 9 through 11 will outline an agenda for moving toward a more equitable globalization. This agenda involves three key components, all of which directly target the prob lem at hand, avoiding the large collateral damage that results from erecting walls and raising trade barriers.

First, we need better policies to equip workers for a modern, global economy: updated trade agreements, improved sup- port for struggling workers and communities, and strong investments in fundamentals such as education, research and development, and infrastructure.

Second, a grand bargain on tax reform would generate ben- efits along three lines: greater after- tax incomes for those left behind in prior de cades; a simpler tax system to reduce dis- tortions, avoidance, and complexity; and lower tax rates and a cleaner planet due to reliance on a carbon tax. Such reforms would satisfy goals of both those on the left (a more progres- sive tax system, a cleaner environment) and those on the right (lower tax rates, fewer distortions).

Third, we need a better partnership between society and the business community. The goals of the business community can be met, but a mutually beneficial partnership would also en- tail more tax payments from some businesses, more business transparency on both tax and labor issues, and robust antitrust laws to counter undue market power.

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To make these impor tant policy changes, we will also need a better politics— a vexing prob lem that is addressed in the concluding chapter. By boldly addressing the challenges of the modern economy, we can create a more equitable glo- balization that benefits all Americans— and we can retain the benefits of the world economy, fostering longstanding peace and prosperity.

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