Toward an Apartheid Economy?

Rising inequality. Stagnant real wages. A declining middle class. High levels of child poverty. Insecure workers. A waning union movement. Homeless people in every city. Bursting jails and prisons. A fraying social safety net. Does that sound like a third-world economy heading toward disaster? Or perhaps a neo-Marxian vision of the future of capitalism? Or is it a description of the United States moving into the twenty-first century? Ten to 15 years ago, you or I would have dismissed the preceding description of the U.S. economy as soapbox radicalism. Save for the Great Depression, the history of the United States in this century has been one in which economic growth benefits all. From 1910 to 1973, the average employee enjoyed substantial gains in real earnings and increases in leisure time. No honest observer could question the success of American capitalism in delivering middle-class standards of living to workers. But today, despite the nation’s great success in creating jobs and maintaining relatively low unemployment, it is not only radical soapbox orators who worry about the ability of our economy to take care of working citizens. From U.S. secretary of labor Robert Reich on the left to presidential candidate Patrick Buchanan on the right, and from the business press to the mass media, comes the message that something is wrong with the U.S. economy. That something is not the country’s productivity, technological leadership, or rate of economic growth, though there is room for improvement in all those areas. That something is an issue normally on the back burner in U.S. public discourse: the distribution of the fruits of economic progress. For many, the rise in AT&T’s stock after it announced plans to lay off 40,000 employees crystallized the picture of an economy gone haywire, with shareholders gaining and employees losing as a result of innovation and advances in productivity. Has the distribution of the benefits of economic growth in the United States in fact gone awry? Is the nation heading toward an apartheid economy—one in which the wealthy and powerful prosper while the less well-off struggle? What are the facts? What do they mean? Are there real problems—and can they be solved? The Sinking American Worker The United States has always had a greater degree of inequality than other advanced countries. Inequality, some would say, is the flip side of opportunity and mobility. Some level of inequality is needed to elicit effort, and historically Americans have preferred opportunity and effort to egalitarianism. But in the past two decades, the country’s normal high level of inequality, except in the category of gender, has jumped: Pay in the upper part of the earnings distribution has risen in comparison with pay in the lower part. College graduates have gained in comparison with high school graduates or dropouts. Older workers have gained in comparison with younger workers. Professionals and executives have gained in comparison with clerical workers, machine operators, and laborers. Higher-paid workers within virtually any group—carpenters, lawyers, laborers, clerks, women, men, blacks, whites—have gained in comparison with lower-paid workers. (See the exhibit “Changes in Workers’ Real Earnings.”) Changes in Workers’ Real Earnings* *Decile figures are for 1979–1993; education figures, for 1979–1995; occupation figures, for 1983–1995; age figures, for 1979–1994. These changes have occurred despite huge gains in employment—about 17 million new jobs in the Reagan and Bush years and some 8 million in the Clinton years—that in the past would have been associated with rising pay for less-skilled workers and falling inequality. So what? you may say. Who cares about inequality? As long as living standards are improving for the vast majority, there is no need to ring alarm bells. Put aside envy or jealousy and enjoy the fruits of progress. But the story of recent decades is not one of economic gains for all. On the contrary, the rising tide of inequality has been accompanied by stagnant real wages. Until the early 1970s, the history of the U.S. job market in this century was one of rising wages—about a 2 % increase per year. Compounding that figure leads to a doubling of income every 35 years, virtually guaranteeing higher living standards from one generation to the next. The rate of growth of real wages from 1973 to the mid-1990s is different. The trend is downward for the most widely used statistical measures of real wages—hourly earnings reported by workers on the U.S. Current Population Survey of households divided by the consumer price index, and earnings reported by employers on the U.S. National Employer Survey, also divided by the CPI. According to the population survey, the median weekly earnings of full-time male workers have dropped by 13 % from 1979 through the mid-1990s. According to the employer survey, the average weekly earnings of non-supervisory private-sector workers (outside of agriculture) have fallen by 12 % . But these measures of real wages are imperfect; for various reasons, they are likely to understate the growth of real earnings. They exclude nonwage compensation—money that goes into health insurance and pensions, for example—which has risen as a share of total wages. And the national employer survey obtains earnings solely for nonsupervisory workers. The most serious problem is that the CPI overstates inflation because it does not fully measure improvements in the quality of goods. And if the rise in inflation is overstated, the growth of real earnings is understated. How much the CPI may be in error is a matter of debate. Regardless of where one comes out in this debate, there is no gainsaying that the growth rate in real earnings has taken a dive. The growth of fringe benefits has slackened over time, so the bias resulting from their omission has become smaller. And the U.S. Bureau of Labor Statistics has continually improved the CPI. Thus the understatement of growth in real earnings was greater in the past than it is now. In fact, better data may demonstrate an even more severe decline in the rate of growth of real wages in recent decades. Whatever the “true” figures are, the problem of stagnant or falling real wages in combination with rising inequality has created a new group of Americans: economically sinking workers. In the United States, the big losers in the earnings distribution are men, particularly young or less-educated men. If the fall in earnings greatly increased their employment, the decline in real earnings would have produced at least one benefit: more jobs. But instead, their prospects for work have deteriorated. As inequality in earnings has risen, so too has inequality in the hours people work over the year. The yearly earnings of the low paid and less skilled have fallen by a larger percentage than their hourly pay. In addition, the likelihood that employers will provide low-skilled workers with fringe benefits such as health insurance or pensions has also dropped. The fall in the real earnings of the low paid means that a substantial number of working men earn less than their fathers did two or three decades ago. Young, less-educated men are working fewer hours for lower real wages. Furthermore, low-paid American men are losing ground in comparison with their counterparts in other advanced economies—even as the United States remains the most productive economy in the world. In Western Europe, a male worker in the bottom 10 % of the earnings distribution earns 68 % of the median worker’s income; in Japan, that male worker earns 61 % of the median. In the United States, he earns 38 % of the median. And a comparison of purchasing power reveals that U.S. workers in the bottom 10 % earn less real pay than their counterparts in other advanced countries. Low-paid German workers earn 2.2 times more than low-paid Americans; low-paid Norwegian workers, 1.85 times more. Comparisons of wages based on exchange rates, which are appropriate for business costs, show even greater differences. It is not just the bottom 10 % of U.S. workers that trail the workers in other advanced countries, however. Approximately one-third are paid less, in purchasing-power units, than comparable workers overseas. Not until the third or fourth decile of earnings do Americans do better than Europeans. That so many workers in the United States fare poorly compared with their peers in other countries shows that the problem of low pay is not simply a matter of low-skilled immigrants or poorly educated minority youths. It is a problem of the overall distribution of income. Because taxes are higher in many countries, comparisons of pay before taxes may seem to exaggerate the disadvantage of low-paid Americans. That would surely be the case if taxes gave nothing back in value, but in most countries they pay for health insurance, pensions, housing subsidies, and other social benefits—the bulk of which Americans purchase from their earnings. Comparisons of wages after taxes are thus likely to understate the U.S. disadvantage in pay among low-paid workers. Nor can U.S. workers depend heavily on the government when they fare poorly in the marketplace. In much of Western Europe, economic assistance programs have created a huge welfare state, which many rely on for years. In the United States, such programs provide an effective safety net provided that workers rebound quickly from their economic problems. But the safety net is weak and has been shrinking in recent years. Declining pay and hours worked translate more commonly into poverty than is the case in other advanced economies. Low-paid Americans who lose their jobs may end up in big trouble: they often lose health insurance, have their cash flow dry up, and have difficulties paying their rent and consumer debt. The principal way in which poverty is reduced in the United States—except for the elderly who are supported by Social Security—is through higher wages in the job market. As real earnings have stagnated, the downward trend in the poverty rate has slackened, and the rate has increased for families of young workers and for children. Many children are brought up in single-parent families whose welfare benefits have been reduced and whose heads have not had much success obtaining work, though various workfare-style reform proposals may alleviate that problem. But single-parent families on welfare are just one part of the poverty problem. Compared with most other advanced countries, the United States has a higher rate of fully employed working poor. In the 1980s, poverty rates in Canada dropped below those in the United States, not because the Canadian economy boomed relative to the U.S. economy (it didn’t) but because Canada has stronger safety-net programs. The absence of a significant safety net has some advantages. Taxes and fiscal deficits are lower than in most other advanced countries, and citizens have greater incentives to work. But it also means that Americans must rely more heavily on the labor market for their well-being. When the job market turns bad, as it did for the less skilled and the low paid in the 1980s and 1990s, people suffer. Who’s Responsible? Nearly everyone has a list of culprits. Pat Buchanan’s list focuses on trade and immigration. The AFL-CIO’s list includes declining unionization. The Clinton administration stresses technological change. The Republican Congress blames the administration, high taxes, and excessive government spending. If we could identify a single culprit, we’d have a good television drama. But the story of rising income inequality is more complex. Several factors have been at work, and honest analysts weigh their importance differently. Let’s examine each factor in turn. As income inequality rises, the better-off can afford to hire personal help more easily. Trade has contributed to the problems of low-wage workers. Losses in pay or employment by those who make products in competition with foreign imports, particularly imported goods from less-developed countries, are the flip side of the much larger benefits that trade brings the nation. U.S. businessman Ross Perot and Anglo-French financier Sir James Goldsmith claim that trade is the main story, but most studies disagree. The estimated effects of trade on the demand for low-skilled labor simply are not big enough for it to dominate the distribution of income in the United States: less-skilled women are most affected by imports from third-world countries, and they have not suffered the economic losses of less-skilled men. Most Americans work in service sector jobs that are not directly affected by trade, and the estimated effects from manufacturing and other traded-goods sectors on the rest of the economy are not large enough to account for the huge rise in inequality. Immigration has also contributed to the problems of low-wage native-born Americans. Fully one-third of employed high-school dropouts are foreign-born. If they had not immigrated, the wages and employment of their native-born counterparts surely would be higher. But our best estimates suggest that the increased flow of low-skilled immigrants is not the major cause of falling earnings for less-skilled Americans, although it is probably a more important factor than trade. Much of the rise in inequality in the United States has occurred among workers with vocational skills that are unaffected by immigration, such as those of mechanics or lawyers. The decline of trade unions has contributed to inequality. Unions reduce inequality by standardizing pay among workers, bringing the pay and benefits of their members closer to that of higher-paid executives and professionals, and inducing nonunion companies to raise pay or benefits to avoid unionization. Imagine if 30 % of the private sector were unionized, as it was in the 1960s, instead of 11 % , as it is today. Would there be less inequality in earnings? Yes. Studies suggest that about one-fifth of the rise in inequality is due to the decline of unions. The fall in the real value of the minimum wage has also contributed to rising inequality. However, the impact of the minimum wage is felt mostly in the bottom decile, particularly by women and teenagers. Unlike in countries such as France, changes in the minimum wage in the United States do not spill over to many workers. A boost in the minimum wage can help lessen inequality, but it’s not a perfect solution. The Clinton administration has favored technology as the culprit, perhaps because it seems to let policymakers off the hook. No one knows how to predict or control the direction of technological change. There is evidence that computerization has adversely affected low-skilled workers, but the case for technology as the main culprit is underwhelming. Why hasn’t the same technology produced massive inequality in other advanced countries? Why, if we have entered a brave new world of accelerating technology, have increases in productivity been moderate? Every generation deals with new technology and often blames it for whatever ills occur: in the 1960s, we had the great automation scare, for example, which blamed rising unemployment on machines and robots. The influx of women into the job market may also have contributed to the problems of low-wage workers: an increase in the supply of labor drives wages down. But because women’s pay has risen relative to that of men, and because women and men generally are employed in different industries and occupations, it is difficult to see how women’s increased presence in the workforce adversely affects men. Not even the U.S. Senate’s Whitewater Committee can blame Hillary Clinton for this one. Another factor has been the slowdown in the rate of growth of the supply of college graduates. In the 1960s, Jan Tinbergen, the Nobel Prize-winning Dutch economist, wrote that inequality was a race between the increasing demand for highly educated workers due to technology and the increasing supply of such workers due to expanded public education. For most of Western economic history, the increase in the supply of skilled workers has offset the increase in demand for them. In the 1970s, the increase in supply in advanced countries dwarfed the increase in demand, reducing the economic value of education. In the United States, higher education lost some of its attractiveness, and the rate of growth of the college workforce decelerated in the 1980s, contributing to the rise in the earnings advantage of the more educated. In countries where the educated workforce grew more rapidly in the 1980s, differences in pay between more-educated and less-educated workers did not widen much, if at all. In some cases, they even fell. But again, the 1970s slowdown in the flow of young people, particularly men, into college is not sufficient to explain the massive rise of inequality. The debate over how much weight to give these various factors has enlivened economic conferences and journals. It is an interesting debate, but it is largely irrelevant to the policy question of how, if at all, the nation should respond to the rise in inequality. That is because there is no necessary link between the causes of a problem and potential cures. When someone has myopia, a largely genetic disease, we cure it with glasses or contact lenses. We do not mess with the genes, although they may be the root cause. When you have a headache, you take aspirin rather than go into a long exegesis about where the headache came from. The same reasoning applies to the problem of rising inequality and stagnant real wages. If a cause of the rise of inequality is trade, should we build a tariff wall around the country? No. Protective tariffs are one of the most inefficient ways to redistribute income that the mind of man has ever conceived. If the United States wanted to help citizens suffering from foreign trade, it could do so with other tools. And if the cause of rising inequality is technological change, should we become Luddites, smash our computers, and march on MIT with pitchforks? Only a devotee of professional wrestling might find that attractive. The heart of the matter is not how we got into the inequality fix but whether we should care about it and what we can do about it. Should We Care? Rising inequality and falling real earnings reduce the living standards of individuals and families on the lower rungs of the income distribution. Many of those affected will feel alienated from society and behave accordingly. For people with high incomes, however, inequality has some benefits. If I am rich and you are poor, I can hire you cheaply as my gardener, maid, or nanny. Not surprisingly, the personal services sector has grown with the rise of inequality. Moreover, if the middle class shrinks and buys fewer tickets to basketball games and concerts, there will also be more places for the well-off at those events. Still, many people in higher income brackets are upset when fellow Americans and their families struggle in a land of plenty. Those distressed by the poverty of others range from bleeding-heart liberals and religious people to the philanthropists and volunteers whose contributions to charities give the United States the largest private charitable sector in the world. Personal feelings aside, inequality can also impose costs on the entire society, including the rich who don’t give a hoot about how their poorer neighbors fare. One such cost is a high rate of crime, which has generated a growing prison population and huge expenses for the criminal justice system. By 1995, more than 2 % of the U.S. male workforce was incarcerated, and nearly 7 % was under the supervision of the criminal justice system. Mass incarceration may be the reason the crime rate is finally falling, but it is an incredibly expensive way to deal with the problem. Incarcerating a criminal costs about as much per year as sending someone to Harvard. In 1995, the state of California budgeted more for prisons than for higher education. While there is no smoking gun linking the high crime rate to falling real wages or employment opportunities for the less skilled, the economic logic is clear: whatever makes legitimate work less attractive to young men makes crime more attractive. Most studies support that logic. In 1995, California budgeted more for prisons than for higher education. Another cost of inequality is found in the sense of insecurity at work. When inequality is high, people worry that they may have to work for less pay if they lose their current job. That may underlie the great concern over downsizing among middle-aged men, who are typically unemployed for many months if they are laid off and take a 20 % or so wage cut when they finally find a new job. Insecure workers may be less productive, less willing to share their knowledge, and less likely to talk about problems with supervisors than more secure workers. The recent repudiation of the virtues of downsizing by Stephen Roach, the chief economist at Morgan Stanley, shows that even proponents of lean companies recognize the costs to productivity of a workforce frightened about its future. Falling real earnings of the low paid may also breed antagonisms between groups as well as general social instability. Animus against CEOs and Wall Street is a logical consequence of rising inequality. When my earnings are falling despite my hardest efforts, whom shall I blame? If year after year, you are getting wealthier and I am getting poorer, who knows what demagoguery might appeal to me? Inequality has consequences for family structure, as well. There is nothing more antifamily than the falling level of earnings and declining job prospects for less-educated young men. If a young father cannot earn enough to support a family, he is unlikely to try to form one. If he engages in crime and ends up incarcerated, one result is more fatherless children. Hundreds of thousands of children in single-parent homes in the United States have fathers in jail or prison. Inequality also affects business in various ways. Some businesses—those providing services to the rich—may gain; others—those producing for the great middle class—may lose. Consumer credit defaults may rise. Savings by ordinary citizens, already low, may fall. As the divide between bosses and subordinates grows, many may come to view business unfavorably and support policy interventions harmful to the nation’s economy. How much are you making, Mr. CEO? This list of costs—high crime, insecurity at work, stress on families, skewed business decisions, and political turmoil—is neither exhaustive nor definitive. The magnitude of the costs of rising inequality is not well known, because there is little in our history to provide guidance. But the ultimate cost of increasing inequality lies in the potential for an apartheid economy, one in which the rich live aloof in their exclusive suburbs and expensive apartments with little connection to the working poor in their slums. Just as many South African whites were blind to the plight of nonwhites, so too in an apartheid economy will many of us be blind to citizens of lower economic status—if we are not blind to them already. When was the last time you were shocked by the homeless? Preventing an Apartheid Economy If you are happy about this picture of the emerging U.S. economy—if the benefits of inequality exceed its costs to you—stop reading. The remainder of this article considers ways to reduce inequality and rebuild the middle class. It is a menu of possibilities, not a sales pitch for any specific policy. The economy is a highly complex system that continually surprises us; no one can be sure what will work best to alleviate the trend toward inequality. Still, it is important to put on the table at least some policies that might prevent the development of an apartheid economy. For starters, many policies on the front burner today won’t do much to raise up those at the bottom of the earnings distribution. For instance, some supply-siders believe that faster economic growth by itself will cure the woes of the low paid, and that tax cuts for the wealthy (embodied in a flat tax) or reduced capital-gains taxes are the way to spur that growth. Such views fly in the face of recent experience. The sad lesson of the expansion of the 1980s and 1990s is that even very healthy growth may not improve the pay or income of those in the lower parts of the income distribution. The Reagan-Bush recovery from the 1981–1982 recession was one of the longest and most impressive in U.S. history: employment and income grew significantly. If divided evenly, the $ 2 trillion increase in the GDP from 1980 to 1994 would have been enough to give roughly $ 2,000 more to each American family. That’s not what happened. Median family income was stagnant. Only the upper 20 % had healthy gains in real income, with most of those gains concentrated in the top 5 % . The proportion of aggregate income going to the top 5 % rose from 15.3 % in 1980 to 19.1 % in 1993, while the proportion going to 80 % fell. Men and especially women had to work more to maintain their standard of living. Nearly a decade of gains in the GDP and in employment were accompanied by falling incomes for the bottom half of American families! Growth alone is no cure for the problems of rising inequality and stagnant real wages. Some believe that further deregulation of the economy will create more and better jobs. This is the standard solution of the Paris-based Organization for Economic Cooperation and Development to nearly any economic problem. But the United States has the least-regulated economy among advanced countries. Its problem is not creating jobs but making work pay. There are reasons to cut some regulations, but preventing an apartheid economy is not one of them. Others believe that cutting the federal deficit will improve the economy so much that real earnings will begin rising rapidly once the markets are assured that deficit reduction is for real. I know of no historical support for that claim, even if cutting the deficit in fact increases investment and growth. There are reasons to cut the deficit, but boosting the earnings of the low paid is not one of them. Education and job-training programs for the less skilled are popularly suggested solutions to the problem. In the long run, education and training will help reduce inequality by increasing the number of people in higher-paying jobs and by diminishing the number competing for low-wage jobs. But, on their own, such supply-side changes have not yet shown themselves capable of offsetting the market forces that favor the highly paid and skilled. Many economists expected that the wages of young workers would rise once the baby boomers aged. The logic for this expectation was impeccable—the decline in the number of young people after the baby boom would cause a shortage of young workers in the market—and shortages raise prices. But wages did not rise; instead, the economic position of young job seekers worsened in the 1980s and 1990s. In response, more young people have flocked to colleges and universities than in the past. Eventually, the growing number of college graduates should reduce the difference in pay between graduates of high school and college, but for now the gap remains high. As for government-funded training programs designed to improve the skills of those who do not go to college, even the best such programs increase wages or employment only modestly and cannot conceivably restore losses of earnings of 20 % to 30 % . Will higher tariffs, repeal of NAFTA, or other protectionist policies cure the inequality problem? The economic costs of protectionism so dwarf the potential benefits for low-wage workers that they make the cure worse than the disease. What about policies to reduce immigration? They would cut the supply of low-skilled workers, but if the massive decrease in young Americans entering the job market after the baby boom did not improve their economic position, why should modest changes in immigration do the trick? The problem with many of the policies described above is that they address low wages and rising inequality indirectly rather than tackle it head-on as an issue of income distribution. The topic of distribution has never been popular in the United States. In a society where economic growth benefits everyone, it is sensible to worry about efficiency and growth first and distribution last. In other words, let the Swedes worry about whose slice of the pie is bigger—we’ll worry about baking a bigger pie. But new problems require new solutions, and it behooves us to examine more carefully the redistributive tools at our disposal if we wish to prevent an apartheid economy. The earned income tax credit, which gives cash payments to low-wage workers, tackles the problem of low incomes head-on. At one time, both conservatives and liberals favored it, and the Clinton administration increased the credit in its first year in office. Another redistributive tool is the minimum wage. Like the earned income tax credit, it is not perfect—it is not well targeted at the poor and cannot be raised too high for fear of increasing unemployment—but it does buttress the bottom parts of the earnings distribution. And we should look at the payroll tax that funds Social Security: the tax is a high, regressive levy on employment that does nothing to increase national capital investment. Perhaps we should combine privatization of Social Security with cuts in the payroll tax for low-paid workers in forming a new national retirement plan. Finally, a more lively and successful trade-union movement—led by a truly new AFL-CIO that succeeded in winning a raise for workers—would help reduce inequality. Perhaps business should rethink what the “union-free” private sector toward which we are headed really means for society. Having warned you that no one can be sure about the best way to reduce inequality and that some policies won’t work much, if at all, I would be insulting your intelligence and mine if I did more than list possibilities. Perhaps a judicious mixture of policies might prove effective. Another mixture might backfire. You may have better policies to suggest. Perhaps, magically, the invisible hand will resolve the problem of its own accord—although if I thought that likely, I would have written a very different article. At this stage, we need to recognize that the country has an inequality problem based on falling real earnings for low-paid workers that is unparalleled at least since the Great Depression. We need to begin debating ways to prevent the United States from developing an apartheid economy. We have a great record of solving problems once we recognize them and put them on the national agenda. Rising inequality and falling earnings for those at the bottom of the income distribution are real problems. Let’s start reasoning together about how to solve them. Is U.S. society becoming dangerously segregated by class? Robert B. Reich is the U.S. secretary of labor. Seven Modest Steps Toward More Equality The 20-year trend toward widening inequality is America’s biggest economic challenge. What should we do about it? Most important, resolve that it must be reversed. Reject the views of those who either deny that inequality has grown or argue that there’s nothing that can be done about it. Denial and resignation are society’s most dangerous ideologies. Accept that there’s no quick fix, no easy solution. Americans are impatient and prefer bumper-sticker remedies. Too bad. Reversing the trend toward greater inequality will take time and require many approaches. Don’t choose a remedy that hampers economic growth. Reducing inequality is not a great accomplishment if everyone becomes poorer. We must reject the arguments of protectionists who want the United States to withdraw from the global economy, and of neo-Luddites who want to reverse the course of technological progress. Emphasize education and training. These are the major fault lines dividing winners from losers in our economy. Technology and globalization work in your favor if you have the right skills; they work against you if you don’t. We can take the following steps to ensure that workers have the necessary skills: Make sure poor school districts have adequate resources. Classrooms should have a student-teacher ratio that gives kids the individual attention they need. Teachers in poor districts should be among the best paid in the country. Allow parents to choose the public schools their children attend—so long as the poorest kids or those with the most severe learning disabilities don’t get stuck in the worst schools. Set tough but realistic standards. Teachers, principals, and students that don’t meet them should develop plans for doing so. Those who make the most progress should be rewarded. Give high school students opportunities to relate their classroom learning to future employment. Businesses should work with schools to provide internships, summer jobs, and school-to-work apprenticeships. Encourage businesses to hire and train high school seniors who have met minimum standards but cannot go directly to college. Make available low-interest government loans (repaid as a proportion of future earnings) and tax breaks to enable young people to afford college and older workers to obtain new skills. Businesses should be able to provide employees with tax-free tuition assistance. Small businesses providing tuition assistance should get a partial tax credit. Convert funds from all federal and state job-training programs into vouchers that can be used at community colleges and technical institutes by people who have lost their jobs and need new skills. Allow unemployed workers to use their unemployment insurance benefits to start a new business. Upon completion of an adequate business plan, they should get a portion of their benefits in a lump sum. Encourage businesses to invest 3 % to 5 % of their payrolls in upgrading the skills of all employees. Make work pay for those at the bottom. The two best vehicles for doing so are an expanded earned income tax credit and a higher minimum wage. Opinions differ about the ideal mix. But we’ll need enough of both to ensure that everyone with a full-time job gets out of poverty. Strengthen labor unions. Lower-wage workers need to have enough bargaining leverage to get an adequate share of the profits. Policymakers should run the economy at the lowest possible rate of unemployment consistent with nonaccelerating inflation. In tight labor markets, the wages of lower-wage workers rise with productivity; in slack labor markets, productivity gains go instead into higher profits, more generous executive salaries, and lower prices. Josh S. Weston is chairman and CEO of Automatic Data Processing in Roseland, New Jersey, and chairman of the research and policy committee of the Committee for Economic Development, a research and policy organization of business leaders and educators in Washington, D.C. Invest in Human Capital Richard Freeman’s article discusses an issue of great importance to U.S. business and society. Unfortunately, it does so in a prejudicial and hyperbolic manner that is unlikely to persuade thoughtful businesspeople. An analysis that envisions an apartheid economy—which implies virtually immutable segregation—but then refers only to static cross-section income-distribution data, without so much as mentioning earnings and income mobility, does not greatly advance our understanding. Nevertheless, rising earnings inequality is a genuine problem. The Committee for Economic Development recently released a study, American Workers and Economic Change, that examines the issue in the larger context of changes in the work-place and in the economy. The study recognizes that many Americans are being left behind or threatened by economic change, and that “a society increasingly divided into ‘haves’ and ‘have-nots’ is unlikely to have social cohesion and stability.” Although I do not share Freeman’s certainty about the moral implications of inequality or its responsibility for social pathologies, large and rising economic disparities cannot be good for U.S. citizens or business. Our business system, which fuels the nation’s general prosperity, requires broad social and political support for the institutions and public policies that allow it to operate effectively. In addition, increasing wage disparities imply a relative shortage of the skilled workers vital to the productivity growth on which living standards in the United States depend. What can we do to reverse or mitigate the trend toward inequality? There are no quick fixes, as shown by Freeman’s modest and half-apologetic list of possibilities. It is encouraging that he eschews protectionist policies and those that would require or extort “correct” (and inefficient) business behavior. And he sensibly supports the earned income tax credit. But it is astonishing that he dismisses the two major approaches that are likely to be effective over the long term, if only we could muster the political will to employ them. First, economic growth is essential to raise economic opportunities for the less skilled. Although the linkage has weakened, the sharp slowdown of growth in productivity since 1973 appears responsible for about half the reduction in the wage growth of high-school-educated men. In addition, slower growth probably has reduced mobility within the earnings distribution. This is not a plea for trickle-down, supply-side tax-cut nostrums. Quite the contrary. We desperately need to raise national savings and investment, and the most effective means of doing that is to eliminate the budget deficit. Second, Freeman disregards the importance of focused educational investments in low-income children. He nowhere mentions the lack of meaningful educational standards or the failure to offer even a minimal education in too many public schools. Talk of education reform is cheap, but many schools remain adrift, lacking clear goals, accountability, and incentives for achievement, and beset by special interests. Before we dismiss educational investments as useless, we should try making them effective. Finally, as a matter of enlightened self-interest, business can take some measures to mitigate rising inequality, although they necessarily will be limited to employable individuals. Employer-based training, known to be effective in developing productive skills, should be extended to a larger proportion of the workforce as new knowledge-based work systems spread. As the U.S. labor market comes to place more emphasis on employability than on job tenure, health and retirement benefits should be made more portable and available to workers who are currently without coverage. Economic rewards based on results should be shared more broadly in order to motivate employees and reward productivity improvements. Economic gains in our society are determined principally by the increased productivity of individual workers. We can cushion some of the jolts of economic change, but we cannot eliminate the fundamental gains and pains that go along with it. Expansion of economic opportunity and protection for the less skilled require investment policies aimed at increasing productivity. It’s time we got down to the task of improving our human capital. John Sweeney is president of the AFL-CIO in Washington, D.C. Give Workers a Voice Freeman’s thoughtful article adds much to the public debate about an economy in which a fortunate few are profiting richly while the great majority endure stagnant wages. If anything, the problem is even more severe—and the need for solutions even more urgent—than Freeman maintains. I have four points to add to his compelling case. First, the problem isn’t only the inequality between the highest paid and the lowest paid; it’s also the growing gap between the very wealthy and everyone else. For more than 20 years, the buying power of most working people’s earnings has declined. The only way most families have been able to stay even is by sending more wage earners into the workforce and working longer hours. That is a problem not just for workers at the bottom of the wage scale and for those who are less skilled or undereducated. It is a fact of life for the great majority of working families. Second, who’s to blame? Stagnant wages and growing inequality result not only from the causes that Freeman discusses but also from a conscious decision that corporate America made almost a quarter century ago: to meet the challenges of the global economy by driving down labor costs in this country. That is why real wages for most working Americans have declined while productivity has increased, corporate profits have soared, the stock market has reached record heights, and executive salaries have skyrocketed. Third, working Americans understand that they’re getting a raw deal. In a survey of a cross section of working Americans sponsored last spring by the AFL-CIO, 70 % said the most important reason for their economic problems is that “corporations have become too greedy.” Only 29 % believed that companies have been downsizing and outsourcing because they are “doing what they have to do” to compete in the new global economy. The same survey also found that working Americans are angry at their government. They reported that government is taxing them too heavily while letting the wealthy get away without paying their fair share. This anger could tear at the nation’s social fabric. Finally, Freeman is absolutely right when he welcomes the prospect of a more lively trade-union movement. A revitalized labor movement would offer working Americans a way to win their share of growing productivity, profits, and prosperity. Perhaps even more important, it would provide them with a voice in their companies and in their country. And, by easing economic inequality and offering workers some say in their future, it also could help to heal the anger and alienation that are polarizing our society and embittering our politics. Americans of goodwill should follow Freeman’s analysis to its logical conclusions. That means national economic policies, including pro-growth decisions by the Federal Reserve Board, to help business create jobs. It means promoting equity and security through a higher minimum wage, guaranteed health insurance for all, and the preservation of Social Security, Medicare, Medicaid, and the earned income tax credit. It means investing more in education and training, in new technologies, and in what has come to be called “infrastructure”—for example, mass transit, highways, and public facilities such as waste treatment plants. It means insisting on greater responsibility from corporate America so that profitable companies will think twice before raising executive salaries while wiping out workers’ jobs or freezing their wages. And yes, it also means a revitalized labor movement that offers working people better living standards and a stronger voice in their lives on and off the job. Together, those policies will make Americans more confident in their future, more comfortable with one another, and more committed to our democracy. All that adds up to an America where, once again, we are moving forward together, not suffering separately. William J. McDonough is president of the Federal Reserve Bank of New York in New York City. The Challenge to U.S. Business Too often, the business community gives only glancing attention to the risks associated with the rising inequality of incomes and wealth. We can no longer afford to ignore this serious threat to our future economic growth. The crux of the problem is that widening disparities between rich and poor endanger our ability to maintain the quality of the world’s most productive workforce. Furthermore, if we fail to reduce these disparities, they will badly fray our social fabric and fuel economic or civil disruptions—or force the adoption of harmful or costly quick-fix policies to avert such disruptions. Research suggests a variety of changes underlying the trend toward greater income inequality. They include technological innovations that raise the productivity of skilled workers more than that of unskilled workers, reduced government support for training, fewer curbs on immigration, relaxed trade barriers, declining unionization, and a stagnant minimum wage. Although many of those changes have helped stimulate economic growth and boosted incentives to join the trained workforce, they also have created labor market losers—including many workers who played by the rules but chose training or employers that eventually led to joblessness or declining earning power. From 1973 to 1993, the average real income of families in the lowest fifth of the income distribution may have fallen by as much as 15 % . The implications for much of the nation’s future workforce are dire. Often, today’s labor-market casualties cannot provide their children with adequate health care, good education, or safe neighborhoods. Frighteningly, by official measures 23 % of American children lived in poverty in 1993, up from 14 % in 1980. If we fail to act, those children will not experience the labor market as a level playing field; for them, it will be a mountainside. To meet the country’s future hiring demands, we must ensure that all children have a genuine opportunity to acquire the skills that they—and we—need to succeed. Thus our attention is indispensable now, before technological changes and widening inequality combine to worsen the imbalance of skills. What can the business community do? It must participate more in educating children and employees. Although it may seem simpler to find skilled employees by relocating to prosperous areas or by hiring only children of the elite, those are hardly viable long-term options. The nation’s schools are doing what they can, but they need help. Businesses must support schools’ efforts to educate students from all backgrounds and to link graduates’ skills more closely with employers’ changing demands. Along with a full array of academic courses, students need access to advanced technology, software, and information on careers. Businesses can help by establishing adopt-a-school programs, internships, work-study arrangements, and school-to-career programs and by providing schools with computer equipment, software, and supplies. In the workplace, employers’ doors must serve as entrances to the global workforce. Many of us can provide low-skilled employees with more training and tuition reimbursement, as well as enriched career paths. We also can work with schools, community colleges, and software and computer companies to devise a national system of credentials that would give workers clear incentives to obtain training. In turn, we would be able to assess job applicants’ skills more accurately. The central responsibility of the Federal Reserve system is to promote sustainable economic growth by formulating and implementing effective monetary policy. In doing so, our key contribution is to provide stable prices. In other realms, as an employer and member of the business community, the Federal Reserve Bank of New York has no less of an obligation to promote growth. We have implemented many of the programs mentioned above and plan to do more. We firmly believe that strong economic growth can be sustained only if the benefits of a robust economy—more and better jobs, higher incomes, and an elevated standard of living—are shared by all members of society. John Mueller is a principal of Lehrman Bell Mueller Cannon, a financial-markets forecasting firm in Arlington, Virginia. From 1979 to 1988, he was economic counsel to the House Republican Caucus. Don’t Round Up the Usual Suspects Let’s begin by jettisoning the term apartheid economy. Such a comparison cheapens the discussion not only of apartheid but also of the problems facing America’s working families. Fortunately, this flourish does not affect the substance of Freeman’s article. In the article, we hear, first, a recap of “the most widely used statistical measures of real wages”; second, a disclaimer about their shortcomings (they don’t include nonwage compensation or account for taxes or benefits); third, a roundup of the usual suspects (deunionization, technology, trade, demographics); finally, a list of the usual cures (another increase in the earned income tax credit, another hike in the minimum wage, more training programs, privatizing Social Security). The trouble with this scattershot approach is that not a single one of the usual suspects can possibly explain the central problem facing working families. How, exactly, could the minimum unemployment rate rise from 1 % in the 1940s to 3 % in the 1960s to 5 % in the 1980s, while the take-home pay of workers declined as a share of national income? Unemployment is supposed to go down, not up, when the price of labor declines. The puzzle is solved when we make the calculations that everyone talks about but few trouble to undertake. If we include nonwage compensation along with wages—but ignore taxes and government benefits—we find that workers consistently have received about two-thirds of gross national income, and property owners about one-third. That means gross labor compensation has kept pace almost exactly with the rest of gross national income. Because they stop here, some say there is no wage problem for workers as a group, only income disparities among workers. But that argument ignores the fact that part of workers’ income is taxed and distributed to people who do not contribute to current output. When we account for that, a very different picture emerges. Since World War II, the share of net national income devoted to transfer payments has risen by about 16 percentage points; net property income has dropped by about 6 percentage points as a share of net national income, and take-home pay has dropped by about 10 percentage points. Those figures mean that workers not only take home less as a share of national income, they also face higher unemployment because the cost of hiring has gone up. The proposals mentioned by Freeman would mostly worsen the problem. Instead, we should relieve the burden on workers in two ways. First, we must reform government programs to restore a reasonable proportion between benefits and wages. Refusal to reform Medicare and Medicaid is sheer poison for workers and their families. Moreover, we should keep Social Security solvent on a pay-as-you-go basis by cutting payroll taxes, say, 20 % today while there is a surplus but reducing future benefits up to 20 % for those who receive the tax cut. Privatization would only worsen the problem because the last generation of workers under Social Security would have to pay twice for retirement: their parents’ and their own. Second, the tax system must be reformed to end the disparity in the treatment of labor and property income. Workers earn two-thirds of national income but pay nearly four-fifths of all federal taxes. That disparity places a greater burden on investment in child rearing and education—the main form of savings by lower- and middle-class families—than it does on investment in property. It could be corrected, first, by replacing the standard deductions, personal exemptions, and earned income tax credit with a single earned personal tax credit, which would refund all federal income and payroll taxes on wages below the poverty line. Such a credit for “human maintenance” would match existing deductions for maintenance of business property. Second, just as we allow no deductions for investments in human capital, we should remove tax deductions for investments in new machinery. That would so broaden the tax base that we could have a revenue-neutral flat tax rate of 18 % , even after paying for Social Security reform. The problem facing working families is neither mysterious nor insoluble, but it won’t be solved by rounding up the usual suspects.

Toward an Apartheid Economy?

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